The euro zone has been a mess since the autumn of 2009, when Greece admitted it had been fudging its debt figures for years. Since then, we’ve seen three sovereign bailouts, one massive sovereign debt restructuring, endless European Union crisis summits, savage austerity programs and an ocean of liquidity injections into dying banks.
Somehow the haphazard, lurching -- and occasionally moronic -- response to the so-called debt crisis managed to keep the 17-country euro-zone intact. Barely.
This week, the vague sense the euro-zone would somehow "muddle through," to use an expression beloved by the Brits, all but vanished. The crisis is back with a vengeance, hovering over the euro zone like the Death Eaters in a Harry Potter movie.
That Greece is hurtling towards the euro-zone’s exits has been accepted, and apparently fully discounted, by the markets. Far more worrisome is the rapid deterioration of the Spanish economy and its banking system, to the point that Spain seems destined to become the fourth country -- after Greece, Ireland and Portugal -- to sue for international financial assistance as its debt markets dry up. And if that weren’t bad enough, yields on Italian debt are soaring once again.
We remind you that Italy and Spain are the euro zone’s third and fourth largest economies. If tiny Greece could not be sorted out, imagine the hell the E.U. will have go through to keep Italy and Spain solvent. There is simply not enough firepower for full-scale rescue programs for economies of their size (Italy’s gross domestic product is bigger than Canada’s). The end of the euro-zone may be nigh.
Here is what Chris Beauchamp, market analyst in London with IG Index, wrote on Wednesday morning, as the European markets were crumbling. "Without wishing to sound apocalyptic, it does feel as if Spain is gradually shuffling towards the abyss...Investor confidence wanes by the day, and it could only be a matter of time before the Spanish government is forced to ask for financial aid. This would be an event of a far greater magnitude than the bailouts of Ireland, Portugal and Greece, since Spain’s size means it would exhaust Europe’s financial firepower."
Indeed.
Spain troubles worsened greatly this week, largely because of a botched bank rescue plan (Spain’s problems, like Ireland’s, have far more to do with dud banks than excessive debt). The Spanish government’s plan to recapitalize Bankia was outright rejected by the European Central Bank as a bridge too far. Spain wanted to recapitalize Bankia by injecting €19 billion of sovereign bonds into its parent company, which would then be swapped for cash at the ECB’s refinancing window. The E.C.B. said, in effect, that this was a back-door bank bailout via the E.C.B., and the E.C.B. doesn't do that sort of thing.
Spain’s faltering bank rescue plan mashed up the markets Wednesday. By early afternoon, London time, the FTSE-100 was down more than 1% and the euro extended its decline, trading at $1.244 U.S., down 0.40%. Oil and copper were also down.
Market sentiment wasn’t helped by Wednesday’s big Italian debt auction. The good news is that the Italian treasury got €5.73 billion of five- and 10-year bonds out the door. The bad news is that it sold less than the target amount, because of waning investor demand, and had to pay a hefty yield.
The yield on Italian 10-year paper was 6.3%, the highest rate since January. That’s dangerously close to the crisis yields of 7% that delivered Greece, Ireland and Portugal into the hands of the E.U. and the International Monetary Fund. The honeymoon of Italian prime minister Mario Monti, who replaced Silvio Berlusconi last autumn, is definitely over.
Spain’s bond yields were even closer to the crisis zone. The Spanish 10-year bond yield reached 6.7%, taking the spread between Spain’s and Germany’s borrowing costs to a record 532 basis points (100 basis points equals one percentage point).
The European Commission has a plan to fix the banks before they take down the euro-zone. It wants the ESM -- the European Stability Mechanism -- the permanent bailout fund that is to be launched later this year, to recapitalize the banks directly. At the moment, the ESM is allowed only to lend to governments themselves. While cutting out the middle man might be a good idea, it, like all the other EC/EU initiatives, is too little, too late. The euro-zone just can’t keep muddling through.
