Spain bailout reaction moves from joy to gloom

North American stock markets reacted with a shrug after Spain sought a lifeline for its ailing banks.

North American stock markets reacted with a shrug after Spain sought a lifeline for its ailing banks.

Monday had started well with markets across the globe rising on news that that Spain had become the fourth — and largest — European country to seek a bailout.   

But that market relief was short-lived, as investors began to question the mechanics of the 100 billion euros ($124.68 billion) loan package and whether the country could manage the extra debt or be forced to ask for more help.   

The TSX closed down 98.85 points, or 0.86 per cent, at 11,401.78.

New York markets were in similar shape, with the Dow Jones Industrial Average down 142.97 points, or 1.1 per cent, at 12,411.23. Markets had been higher at opening before the reality of Spain's lifeline set in.

The Nasdaq composite index was off 48.69 points, or 1.7 per cent, at 2,809.73 and the S&P 500 index dipped 16.73 points, or 1.3 per cent, to 1,308.93.

The move was portrayed by Spanish and European officials as a bid to contain Europe's widening recession and financial crisis that have hurt companies and investors around the world. Providing a financial lifeline to Spanish banks was designed to relieve anxiety on the Spanish economy — the fourth-largest in the 17-country eurozone.   

Bank of Canada governor Mark Carney, speaking at an economic conference in Montreal, called the Spanish deal "important progress" and "further evidence of Europe's resolve" to contain its financial crisis.

Carney said moves to centralize and recapitalize banks on a European rather than national basis will help to "break the increasingly toxic links between banks and sovereigns."

Markets shoot out of the gate

Spain's Ibex-35 was up five per cent in the minutes after opening Bank stocks also started the day strongly. Shares in Bankia, which had requested 19 billion euros in aid to cover its bad loans and assets, rose about 15 per cent, but later fell to a seven per cent gain.

But any enthusiasm fizzled out, with the index down 0.5 per cent at closing.  

The bond market was a good proxy for overall sentiment. The rate on Spain's 10-year bonds closed rose to close at 6.47 per cent on Monday. In the early hours of Monday the yield had dipped below six, and well off the danger zone of seven that threw other countries into turmoil. But the 6.47 figure is actually higher than where it was on Friday, before the bailout deal emerged.

Investors appear to be growing increasingly concerned that by taking on so much new debt via the rescue package Spain's ability to make interest payments on its debt could be strained dangerously.    

"As much as the perception of the situation in Europe may have changed, plenty of risk still remains in place, with question marks over the ability of Spain to repay the debt, especially, if the country fails to get back on the growth path, the outcome of the upcoming Greek elections and the perception of situation in Italy," Anita Paluch of Gekko Global Markets wrote.   

Eurozone finance ministers said they would make up to 100 billion euros available to the Spanish government to prop up banks laden with non-performing loans and other toxic assets after the collapse of a real estate bubble. That was a lifeline to Spain, whose own fund aimed at paying out failed firms is almost empty.

Recession-hit Spain has yet to say how much of this money it will tap while it waits for the results of two independent audits of the country's banking industry. The bailout loans will be paid into the Spanish government's Fund for Orderly Bank Restructuring (FROB), which would then use the money to strengthen the country's teetering banks.   

In a report it released late last week, the International Monetary Fund estimated Spain needs at least around 40 billion euros.   

Investors now are very eager to know how much Spain asks for to strengthen its banks and how large a safety margin of extra money it allows itself to cushion itself against further shocks.   

"People in the financial markets will be very keen to know what that cushion is, particularly in an environment where the real economy is in poor condition," said Mark Miller of Capital Economics in London.   

Unemployment remains high

Spain's economy is in recession, the second in three years, while its jobless rate is nearly 25 per cent. The jobless rate for young workers under 30 is above 50 per cent.

"Markets will certainly ask the question about whether a second bailout might be required and the margin for error between the sort of 40 billion euros the IMF is saying and the 100 billion euro ceiling in terms of what we heard," Miller said.   

Miller added that with the bailout, Spain's debt-to-gross domestic product ratio — which was a relatively low 68.5 per cent at the end of last year — could shoot up to the 90s next year. And bond yields will remain high.   

If the ratio gets up to Greek levels of 120 per cent or so, and 10-year yields back to the near-seven-per cent levels of a few weeks ago, "then people will ask that question about a second bailout," Miller said.   

Another issue is whether the European money comes with strings attached for the government, and not just an obligation for banks to restructure. When the bailout was announced on Saturday, Spanish Economy Minister Luis de Guindos said the rescue would not force any new austerity measures on the government.   

Spanish Prime Minister Mariano Rajoy avoided using the term 'bailout' to describe the aid on Sunday, calling it instead a credit line without the strict austerity conditions that have accompanied similar deals for Greece, Portugal and Ireland.   

However, on Monday the European Union made clear the money is more than just a loan. Besides being paid back with interest, there will be strings attached for the Spanish government.   

"When people lend money, they never do it for free. They want to know what is done with the money," said Joaquin Almunia, the European Competition Commissioner.   

"I am not talking about the just the obligation to pay back the money, but also some other kind of terms," he told Cadena Ser radio, adding that these remain to be determined.   

Repayment details murky

But the economy ministry later released a statement saying the package entails "the necessary conditionality for the financial sector" but no new fiscal consolidation or structural reforms beyond those the government has already embarked on.   

The loan will be supervised by the European Commission, the European Central Bank and the IMF, Almunia said.   

A European Commission spokesman, Amadeu Altafaj, told Spanish state television that this troika will have people on the ground overseeing the restructuring of the Spanish financial sector.   

He noted that last month the European Commission recommended Spain undertake further reforms such as speeding up the phasing of a higher retirement age — it is to go from 65 to 67 — and raise VAT sales tax. The newspaper El Pais quoted EU officials Monday as saying these changes and others are part of the conditions that come with the bank rescue package.

With files from The Associated Press and The Canadian Press