Protesters raise their fists as they sing "The Internationale" during a Labor Day demonstration in Madrid on May 1, 2012. Thousands of workers across southern Europe protested against spending cuts on that day
Two years ago this month I was in Madrid reporting a story on the troubles of the Spanish economy and what they meant for Europe and its debt crisis. And here I am today writing about the troubles of the Spanish economy and what they mean for Europe and its debt crisis. I usually don’t like to repeat myself, but the fact that I am anyway shows just how badly Europe’s strategy for resolving its debt crisis is failing.
In fact, Spain’s predicament has actually worsened in the past two years. The national statistics bureau revealed on Monday that GDP contracted by 0.3% in the first quarter from the previous one, placing Spain officially back in recession. Unemployment has continued to rise: now, a staggering 1 in 4 people are out of work. Standard & Poor’s downgraded the government’s credit rating last week, and followed that up on Monday by doing the same to 11 Spanish banks. Meanwhile, Spain’s borrowing costs remain elevated. The yield on 10-year government bonds is back near 6%.
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We should all be very worried about what’s going on in Spain — because Spain isn’t Greece. The Greek crisis was most likely not a direct threat to the survival of the monetary union. Its economy was simply too small. The danger was in the possible contagion effect Greece might present if it outright defaulted or bolted from the union. Spain, the zone’s fourth largest economy (after Germany, France and Italy), can do a lot of damage all by itself. If Spain ultimately requires a bailout, it would strain the resources available in the zone’s rescue fund (the European portion of which was recently boosted to a total of $925 billion) and put pressure on the zone to fatten up the fund even more, which Germany and others have been reluctant to do. Such an event would also be the biggest blow to the future of the euro yet, likely reigniting the crisis in Italy and making other bailouts more likely (especially for Portugal). With emerging markets slowing down, Europe in the toilet, the U.S. recovery uncertain and energy prices high, a Spanish meltdown is exactly what the global economy doesn’t need right now.
How bad will the pain in Spain get? Concerns are escalating that Spain will ultimately need a bailout like Greece, Ireland and Portugal. Here’s what Megan Greene at Roubini Global Economics had to say a few days ago:
Watching developments in Spain since the beginning of April has been source of non-stop déjà vu for anyone who spent 2010 watching events unfold in Ireland. There are a number of striking similarities between the position in which the Spanish government now finds itself and the Irish government’s situation in November 2010, just before it was forced into an EU/IMF bailout programme. Based on Ireland’s experience, a bailout for Spain seems inevitable.
The fact that we’re even talking about a bailout for Spain shows how badly the economy has been mismanaged by the euro zone. Spain is not Greece in another way. Before the Great Recession, Spain didn’t really have a serious government-finance problem. In 2007, Spain’s government debt-to-GDP ratio was only 42%, far below Germany’s 66%, according to OECD data, and it posted a budget surplus. Granted, government finances have been deteriorating ever since because of the recession, but Spain’s true difficulties have always been elsewhere — in the private sector. The financial sector got slammed in a gargantuan property bust, leaving banks with tons of bad loans on their balance sheets. Though the administration of Prime Minister Mariano Rajoy, following in his predecessor’s footsteps, has taken action to repair the banks — demanding they set aside new provisions against further property-related losses, for example — fear remains that pressure on the banks will continue to build. Property prices, which have already fallen by about 22% from their 2007 peak, could, by some estimates, fall a further 20% from current levels, sending more property-linked loans into the bad category. Nonperforming loans have already been on the rise. The concern of investors is that a banking sector in increasing distress will eventually need a bailout. Since such funds are unlikely to come from private investors, the government would have to step in — putting even more strain on already strained national finances.
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The recipe being employed in an attempt to fix Spain’s problems is making the situation worse. The euro zone has insisted Spain adhere to the austerity-first crisis-fighting strategy imposed on Greece and other weak euro-zone economies. In doing so, however, the government is further depressing the economy, which increases the number of bankruptcies and defaults within Spain, and thus further weakens the banking sector. That makes it all the more likely that Spain’s banks will need a bailout the state can’t afford. And so on and so on. The result of the current policy is, therefore, weakening the weakest parts of the economy — the banking and property sectors — while at the same time failing to strengthen the country’s finances or bolster investor confidence in the country. Despite severe budget cutting, the government admitted earlier this year that its debt level would continue to rise.
The response from the powers of the euro zone has been: too bad. After meeting with his Spanish counterpart, German Finance Minister Wolfgang Schäuble insisted that there was little flexibility in the current austerity-crazed policy. “The first precondition in order to have sustainable growth everywhere in Europe is fiscal consolidation,” Schäuble said. In other words, Germany is dead set on a crisis-fighting strategy that is proving not to work.
That isn’t to say austerity should be scrapped. Spain and all of the governments of the euro zone need to count their pennies. But the problem is the one-size-fits-all approach to the crisis. Not every crisis-hit economy is experiencing the same problems, and therefore the euro zone shouldn’t be imposing the same solution uniformly. What we need is a policy mix for each country that actually fits the problems of each country.
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How can Spain avoid a bailout? In my opinion, the government, in cooperation with the euro zone, has to finally tackle the real problem: the financial sector. Rather than the ongoing, slow-moving bank-repair program, we need a bite-the-bullet approach to bring clarity to the situation. Perhaps the banks can somehow be shored up with private capital, so as not to further burden taxpayers and the finances of the state. But if that is not possible — and it probably isn’t — the state should come in fast and furious, clean out the bad loans and recapitalize banks. If the Spanish government doesn’t have the money, it should tap the euro zone’s rescue fund. That fund has already been handed the mandate to use its money to recapitalize euro-zone banks, but it is a weapon in combating the debt crisis that has yet to be unsheathed. In doing so, Spain would alleviate the main cause of investor concern and perhaps gets its banking sector functioning — and lending — again. That’s good for growth.
The authorities in Madrid have been reluctant to take such drastic action. Part of the reason has been an attempt to keep the problems of the banks from further undercutting national financial strength, as happened in Ireland. That is understandable. There are risks involved in a big bank-reform program as well. Any attempt to tap official euro-zone financing could scare off private investors and raise borrowing costs. But watching what has happened in other countries with banking disasters, a go-slow approach never seems to work. Japan is suffering today because it dawdled in attacking its banking crisis in the 1990s. Spain may be moving toward a more aggressive policy toward its banks. Officials are talking about forming a “bad bank” to take the load of bad property-related assets off the banks’ books.
There are no easy solutions. The point, though, is that Europe needs to tailor its crisis-busting methods to the real situation on the ground, rather than blindly insist on a cookie-cutter approach across the zone. If that doesn’t happen, I’ll probably have to write about a Spain in crisis in another two years.
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