Another weekend, another bailout for Europe. And there’s little reason to think it’ll have any more success in breaking the downwards spiral. The whole continent is being dragged backwards by a conjoined crisis: on one side banks, on the other, states.
Spain, like Ireland and Portugal before it, was the model of fiscal responsibility before the crash. Unlike Germany and France, the Spanish government ran consistent surpluses – it received more in taxes than it spent, year after year.
The debt crisis there took a different form to that of Greece, but it developed from the same immediate causes: profound imbalances in trade across the eurozone, with southern countries (like Spain) importing heavily from northern (like Germany), combined with a deregulated financial system. Those trade deficits had to be financed, since a country cannot simply buy more than it is selling abroad, and it was the financial system that stepped in. Rising debts in the periphery helped fuel continued import expenditure. A property boom, in turn, provided the fuel to enable private debts to keep on rising.
When the bubble began to fold from 2008 onwards, Spanish banks were left exposed to bad debts. The cajas, the regional banks, were particularly vulnerable, having severely overstretched themselves. Government interventions attempted to prop up the system, including the creation of Bankia from a merger of seven failing regional banks.
This was to no avail. Bankia has now needed a partial nationalisation to survive, while confidence in the rest of the Spanish system has led to a slow-motion run on the banks as depositors, in fear, withdraw their savings. Just as in Ireland – and the US – a collapsing bubble of private debt became a problem for the public sector. Bailouts and government support have not ended the crisis: merely shifted it from private to public sector.
The Spanish state itself, despite its earlier supposed good behaviour, is running out of cash. Severe recession has hammered tax revenues just as it pushed up spending on unemployment benefits. Spain’s public deficit has widened every year since 2008, and is still growing. Unable to afford to support its stricken banking system, now needing (on IMF estimates) at least a €40bn injection, the Spanish government has been forced to request outside assistance.
That has come in the form of a €100bn bailout, targeted – unlike previous rescue efforts - solely at banks. Unlike previous efforts, the package has dropped the demands for strict austerity measures.
But despite brave words – none braver, perhaps, than Spain’s Prime Minister Mariano Rajoy hailing this as a 'victory' – and the substantial sums involved the crisis will not be broken, for two reasons. First, although the new European Financial Stability Facility (EFSF) and European Stability Mechanism (ESM) bailout does not come attached to demands for austerity measures, this is largely because Spain is already implementing a severe round of spending cuts and tax rises. But as elsewhere, it is austerity that is drawing the crisis out – not ending it. Cutting spending in a recession is the worst possible policy to follow, for reasons that have been essentially well-known since the Great Depression of the 1930s: as government spending falls, demand falls with it. Firms sell less. Firms selling less make redundancies and cut wages. The unemployed, and those on reduced earnings, spend less, making demand fall still further. And as the economy shrinks, dragged down by this spiral, its ability to repay its debts falls with it. Austerity is entirely self-defeating.
Second, although Spanish property prices have fallen sharply over the last year, they may not have fallen by much. Official statistics – based on bank valuations, rather than actual sales - point to a roughly 20% decline from its 2008 peak. Ireland, for rough comparison, saw a 50% fall in prices from its peak. In other words, prices may have a lot further to go, threatening a far greater crisis later. Of course, the two aren’t identical: the Irish credit bubble was larger than Spain’s, with property loans peaking at 77% of GDP in Ireland, but only 17% of GDP in Spain. But they give some indicator as to why this initial €100bn may not be enough. A recent research note from JP Morgan suggested the total cost could rise to €350bn, just to stabilise the situation.
That’s assuming the situation can be stabilised at all. After an initial rally, at the time of writing bond markets already appear to be turning against the bailout, with Spanish government borrowing costs pushing back up beyond 6%. Although large, the bailout is unlikely to be enough to drag Spanish banks back from the brink. And the risk of the crisis now spreading – having already severely battered the eurozone’s fourth largest economy – is appreciable. Europe’s banks remain stuffed with bad debts, from both public and private sectors, that could become rapidly exposed if the situation worsens. Both French and German banks retain huge holdings of debts scattered across Europe, even if both have managed to ditch the more obviously risky assets, like Greek government bonds.
Breaking the crisis will require a decisive intervention to break the cycle of bad debts and declining economies: write-offs for debt; nationalisations of failing banks; and an end to austerity. If European institutions cannot deliver this – and current evidence suggests a preference for fudge – then they cannot break the death-spiral European economies are now locked into.
First published on the New Economics Foundation blog.
By Lindsey German
By Neil Faulkner
By Chris Nineham
By John Rees
By Lindsey German and John Rees
By John Rees and Joseph Daher
By John Rees
By Chris Nineham