Bailouts and the Euro Zone

June 11, 2012

Spain joins the likes of Greece, Portugal and Ireland in the latest crusade to prop up European banks. Spain’s banks will be recapitalized with up to $125 billion in aid lined up with no strings attached. Unlike previous bailouts, Spain received the aid without having to submit to a full state rescue program.

Spanish Prime Minister Rajoy claims victory, but is it really? The loan to banks must be paid back at some point, and in the midst of this debt crisis, where will the money come from? The bailout is simply an increase in long-term public debt with no promises to cut government spending. According to Reuters, “The bank rescue package will add up to 10 percentage points to Spain’s debt-to-GDP level, taking it close to 90%. Furthermore, Spain still needs to refinance 82.5 billion euros of debt maturing by the end of the year and cover a 52 billion euro deficit. If this bailout fizzles out like the rest, the cost of borrowing will remain high and present more financial challenges for the country starting in the second half of 2012.

It would be too good to be true if Spain was the last of the Euro zone – and our – worries, but Italy looks to be the next contender for a bank bailout as 26 of its banks were downgraded by Moody’s just last week. Investors are fully aware that Italian banks are running off of borrowed money to finance day-to-day operations and that the national debt is 120% of its GDP, much higher than Spain’s ratio and second only to Greece among euro zone countries.

There are two major concerns for European banks:

  1. European banks have loaned out more than what they collect in deposits.
  2. These banks have invested heavily in their own debt and bonds of other challenged countries, such as Greece.

If economic growth slows, government debt remains at astounding levels, and Greece threatens to leave the euro zone, every country in the euro zone will be poised to contend with a bigger problem than a $125 billion bailout package can handle. Europe has spent enough. It is time to stop.

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