May 31, 2012

May 31, 2012 | Commentary on Economy

Six Remarkable Hours (and Counting) for Spain and the Euro

Late last night, Tuesday, May 29, the Financial Times broke the story that the European Central Bank (ECB) had rejected Spain’s original plan for injecting €19 billion into Spain’s beleaguered Bankia. To underscore the extraordinary nature of this story, it came out around 5 p.m. Eastern time, or about midnight in Europe. Europeans only work at midnight if they’re on the graveyard shift or during a crisis, which in the current crisis may seem a distinction without a difference. The ECB decision could have been the signal for a bank run starting in Spain and spreading like wildfire across Europe. It could have signaled the end of the euro, but then . . .

By Wednesday morning, the ECB and the Spanish government had each issued statements insisting there had been no discussions regarding Bankia. According to the Daily Telegraph, the ECB stood “ready to advise on plans to inject capital into the country’s banks” (emphasis added).

Included in the ECB’s original denial was a telling sentence: “It should be noted, however, that the funds needed to ensure banks’ compliance with capital requirements, cannot be provided by the Euro system.” Twenty minutes after its release, the statement was rectified and this sentence removed, the ECB citing “technical problems.” Translation: The ECB staff, whose judgment was overridden by higher ups, did not go down without a fight. Kudos to them, whoever they are. One hopes they remain gainfully employed.

So, which is it? Did the august Financial Times blow a big story about the euro crisis? Did it just make up the story? Or did it really happen, leaving the ECB and the Spanish government to backtrack furiously, dissembling every step of the way to cover their tracks?

To review, Bankia is a conglomerate formed in December 2010 out of seven regional savings banks resulting in the fourth largest bank in Spain. Like all Spanish banks, these regional banks were sinking under the weight of dodgy mortgages following the fairly recent and ongoing bursting of Spain’s housing bubble. The Spanish government seized the failing Bankia a few weeks ago. The bank subsequently declared it needed help which the government sought to provide by injecting it with Spanish sovereign debt, which Bankia could then turn around and use as collateral to gain access to ECB funds.

According to the original Financial Times story, in explaining why the capital injection plan was unacceptable, ECB officials had told Spanish authorities that “a proper capital injection was needed for Bankia and its plans were in danger of breaching an EU ban on “monetary financing,” or central-bank funding of governments.” That sounds perfectly correct.

How can one square the Financial Times account with the subsequent denials? Who to believe? The Financial Times breaking a financial story or European leaders facing the abyss?

A big clue is the fact that Spain quickly changed its tune, now asserting it will sell Spanish sovereign debt to raise the funds to recapitalize Bankia. All well and good, but if it were that easy Spain would have pursued this course in the first place. After that fiasco, and in light of a rapidly deteriorating economic and fiscal picture, yields on 10-year bonds then shot up 25 basis points, to 6.67 percent.

What does it all mean? Bankia’s bailout aside, it means Europe continues, two years into the crisis, to scramble desperately to fend off disaster: bank runs, bank nationalizations, the break up of the euro, worsening recessions, and — for Europe’s elites — the final recognition that the European dream failed. Europe’s leadership has proved adept at delaying the inevitable, and may well be able to continue for awhile. Either way, there is virtually nothing the United States should do or can do to help. Sometimes, having bought the ticket, there’s nothing left but to ride it out.

J.D. Foster is the Norman B. Ture Senior Fellow in the Economics of Fiscal Policy at The Heritage Foundation.

About the Author

J.D. Foster, Ph.D. Norman B. Ture Senior Fellow in the Economics of Fiscal Policy
Thomas A. Roe Institute for Economic Policy Studies

This article first appeared on National Review Online on May 30th, 2012.