On Saturday, Spain’s Finance Minister Luis de Guindos announced that, in an emergency meeting, Eurozone and other European financial leaders agreed to a €100 billion bailout of private Spanish banks. While Spanish Prime Minister Mariano Rajoy, Japanese Finance Minister Jun Azumi, and U.S. Treasury Secretary Timothy Geithner rallied to sing the plan’s praises, German Chancellor Angela Merkel seems concerned about the prospects of a bailout without budgetary austerity.
Upon what bases they stake their claims is unclear – the terms and even the exact amount of the bailout are yet to be determined. What is evident, however, is that Europe and the U.S. have made many attempts to respond to financial crises (or “the crisis”). The financiers who partook of the emergency meeting have seen the U.S. real estate crisis caused by collapse in collateralized debt obligations (CDO’s, here distinct from “bonds” to avoid confusion with government bonds); they have witnessed the Greek bond collapse related to massive, chronic, and opaque public debt; and they have watched as individual economic problems plague Portugal, Ireland, and Italy. They have also seen – if not participated in – attempted solutions. So, for better or for worse, they have had lots of examples from which to draw inspiration.
Spain’s crisis has been, perhaps more often than not, compared to Greece’s recent financial situation. Greece faced out-of-control tax evasion and a 50% increase in public wages (without a commensurate increase in GDP or top-bracket tax revenues). At the onset of the global recession, the Greek government found itself unable to pay off the loans it had accrued. In 2010 and 2012, Greece received in total over €200 billion in loans from the IMF and the EU. Accompanying these loans was a debt-refinancing deal that halved the value of the public liabilities to the private sector and lowered the interest rate of the remainder. This package, however, came with “Merkozy” conditions (named for France’s then-President Sarkozy and Germany’s Chancellor Merkel) which demanded a more austere Greek budget including cuts to public programs and payroll. Even recognizing the disconnect between wage growth and the Greek economic reality, critics of the Merkozy school have called these standards everything from “harsh” to “Draconian.”
In Spain, individual regions have a reputation for outspending their revenues. Some have accrued debts in the hundreds of millions, often for projects with no revenue, i.e.: cultural centers and unused airport expansions. The Spanish national government, however, may deserve the best credit rating of any of the Euro countries. According to the Bank for International Settlements, Spain in 2010 had lower government debt (as percentage of GDP) than Germany, Italy, and France. In fact, up until 2008, Spain was the only Eurozone country to maintain the 3% borrowing limit set by the Euro establishment in 1997. Further, Spanish households have a saving rate ranging from twice to quadruple that of U.S. families. The perception of Spain as a debt-ridden country thus arises largely from its aforementioned regional spending (akin to “state spending” in the U.S.) and private sector liabilities to international investors (harking back to similarities with U.S. banks before the onset of the recession): private Spanish debt outdoes government debt 4 to 1.
The proposed bailout, judging by the few details released thus far, is resultantly different from the Greek package. While the Greek loan attempted to cover public spending, the €100 billion to Spain will go exclusively to private financial institutions. What is inexplicably similar, however, is accountability: as Athens is held responsible for the repayment of the public spending loan, the Spanish government ultimately will be the party repaying the loan destined to go to the country’s private sector. What remains unclear in the Spanish package is repayment rates: how much Madrid will give each bank as a percent of their outstanding debt, whether these banks will need to refinance their debts as Greece had the opportunity, and how much of the payments to the private sector Madrid will recoup.
The constant comparisons of this bailout to the Greek plan not withstanding, the nature of the Spanish package likens it more to the U.S. Troubled Asset Relief Program (TARP). Even the crises are more closely related; both Spain and the U.S. had significant international investments in the private housing market, all of which systematically collapsed. Although TARP is considered by many economists and leaders as successful, even its supporters admit it is not without flaws. Less than a week after the start of TARP, the American International Group (AIG), recipient of $180 billion of the program’s funds, hosted a half-million dollar retreat for its upper echelon. Further, despite the allegedly “stabilizing” effect of this American bailout, banks like Citigroup and Morgan Stanley are now less prepared for a major economic shock than four years ago, according to research by Nobel Prize-winning economist Robert Engle. And though U.S. taxpayers are expected to ultimately profit from TARP, the U.S. Treasury reported in August 2011 that it had received only 76% repayment of its TARP investment. *Note: If the Spanish government is 24% shy of collecting the €100 billion at the time of repayment, the difference would be a loss almost twice the value of the country’s GDP growth in 2011. Finally, the intent behind TARP was two-fold: first, stabilize the financial sector, and second, help to stabilize the mortgages upon which it stood. If the program had accomplished the latter, Congress may not have needed to enact two additional programs — the Home Affordability Modification Program (HAMP) and the Home Affordable Refinance Program (HARP) — to help struggling homeowners stay off the streets.
All things considered, one question remains – will a financial package be more effective than a public spending bailout? Charles Diebel of Lloyds Banking Group called the proposal “Bailout Lite,” citing that the primary intent of the payment, like TARP, would be to stabilize private investment institutions, not necessarily promote growth. While some leaders have expressed hope that stabilizing the financial sector would promote confidence in markets leading to economic improvements, Nobel laureate-economist Paul Krugman claims belief in this “confidence fairy” evaporated after repeated such attempts failed to improve growth in Europe. The value per-person of the bailout is in the neighborhood of €2,100, which could increase consumer spending by 6% if distributed to families rather than banks. The high propensity for the Spanish to save could also lend much needed financial support to the banks.
Negotiating a public use-package without the addition of austerity conditions, however, might prove difficult.
Germany’s Chancellor Merkel seemed reluctant to accept a bailout without austerity conditions, even when aid is directed at private financial institutions rather than public sector spending. This trend continues, even with France and Greece rejecting their respective austere political parties. In the quarter after austerity conditions were introduced in Greece, the GDP shrank by over 6%. Irish GDP growth, too, sank with the budgetary changes. Portuguese unemployment has approached 15%. After Italy installed austerity, unemployment rose from 8.4% to 10.2% in a country where it hasn’t broken 9% since 2001. Further, these programs tend to decrease consumer-confidence; Spain’s consumer-confidence is already the lowest it has been since the start of the global recession.
The announcements of this weekend leave many questions unanswered, perhaps intentionally. The leaders of the European Commission, the European Central Bank, and the IMF have established a bank-audit as their next step. While auditors determine the level of need, policy-experts will likely pour over the details of Spain’s particular needs and draw lessons from past bailouts to finagle the conditions of this particular package. Details are expected to be released within the week. Regardless of the decision, someone will doubtless be disappointed.