Bloomberg
June 13, 2012
Europe’s latest initiative to subdue its financial crisis fell apart in less than a day.
The instant response to the plan for supporting Spanish banks had been euphoric. Even as bond markets pushed the cost of Spanish public borrowing even higher, in effect declaring the country insolvent, politicians were still applauding themselves.
European Union leaders thought the plan would impress the markets because the sum committed to support Spain’s banks, 100 billion euros ($125 billion), looked adequate -- bigger, in fact, than investors expected. The EU thought it was getting ahead of events for once.
It wasn’t. Mistakes in the deal’s design made the plan self-defeating. These errors are worth noting, because they lie at the core of the EU’s larger strategy.
The crucial thing is that the EU gave its support not directly to Spain’s banks but to Spain’s government, which would then lend it on. This had two fatal consequences. First, it added to Spain’s public debt, making its government less creditworthy. Second, depending on how the loans are structured -- a detail left vague as the rescue was announced -- Spain’s new debt to the EU might subordinate existing bondholders. Curbing the risk of a faster run on Spain’s banks was good, investors presumably calculated, but not good enough.
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