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Eurozone crisis explained Eurozone crisis explained
(about 6 hours later)
Spain, the eurozone's fourth-largest economy, has had doubts cast on the strength of its banking sector thanks largely to the country's property crash. Spain has become the fourth member of the eurozone to have to seek outside assistance to help it deal with a debt crisis.
Its banks have lent billions of euros they might never get back and this has made investors very nervous, as the scale of the losses is not yet clear. Spain's main problem is its banks, and as such, the up to 100bn euros ($125bn; £80bn) it will receive will be targeted at its financial sector.
Many of its smaller, weaker banks have had to merge or been rescued by larger ones. The Spanish government has had to nationalise one, Bankia, and may have to bail out more.
As a result, Spain is having to pay out more on its bonds, or debt, to entice investors to buy them.
But with borrowing costs rising to unsustainable levels, it may now not be able to borrow the money it needs to shore up its banks, which may force it to ask for international assistance.
What went wrong with Spain?What went wrong with Spain?
Spain's story illustrates the fact that the eurozone's problems run far deeper than the issue of excessive borrowing by ill-disciplined governments.Spain's story illustrates the fact that the eurozone's problems run far deeper than the issue of excessive borrowing by ill-disciplined governments.
Greece, Portugal and Italy all had way too much debt.Greece, Portugal and Italy all had way too much debt.
But the Spanish government's borrowing was zero - that is, it ran a balanced budget on average - every year until the eve of the 2008 financial crisis.But the Spanish government's borrowing was zero - that is, it ran a balanced budget on average - every year until the eve of the 2008 financial crisis.
And as Spain's economy grew rapidly before 2008, its debt ratio was falling. Germany's, by contrast, continued to rise. And as Spain's economy grew rapidly before 2008, its debt-to-GDP ratio was falling. Germany's, by contrast, continued to rise.
When Spain joined the euro, interest rates fell to the much lower levels typical in Germany and while the Spanish government resisted the lure of cheap loans, most ordinary Spaniards did not. When Spain joined the euro the Spanish government resisted the lure of cheap loans, but most ordinary Spaniards and its banks did not.
The country experienced a long boom, underpinned by a housing bubble, as Spanish households took on bigger and bigger mortgages.The country experienced a long boom, underpinned by a housing bubble, as Spanish households took on bigger and bigger mortgages.
House prices rose 44% from 2004 to 2008, at the tail end of a housing boom, according to ministry of housing data. Since the bubble burst, they have fallen by 25%.House prices rose 44% from 2004 to 2008, at the tail end of a housing boom, according to ministry of housing data. Since the bubble burst, they have fallen by 25%.
The economy, which grew 3.7% per year on average from 1999 to 2007, has shrunk at an annual rate of 1% since then.The economy, which grew 3.7% per year on average from 1999 to 2007, has shrunk at an annual rate of 1% since then.
When the housing bubble burst, so did the construction sector. So, although the Spanish government still had relatively low debts, it is now having to borrow like crazy to deal with the effects of the property collapse, the recession and the worst unemployment rate in the eurozone.
So, although the Spanish government still has relatively little existing debts, it is now having to borrow like crazy to fill the gap left by the jump in unemployment benefits and collapse in tax revenues during the downturn.
What does this mean for banks?What does this mean for banks?
The banks had been thriving thanks to the rapid expansion of the property sector.The banks had been thriving thanks to the rapid expansion of the property sector.
But its collapse meant default from borrowers who were suddenly bust and a plunge in the value of the assets the loans were based on. But its collapse brought default from borrowers who were suddenly bust and a plunge in the value of the assets the loans were based on.
Since the onset of the recession, which some believe will continue for the rest of 2012 and into 2013, losses on loans have continued to mount as borrowers struggle to make repayments.
The situation has been made worse by the fact that the banks borrowed the money on the international markets to lend to developers and homebuyers, a much riskier strategy than using the deposits they get from savers.
As market confidence has deteriorated, it has become harder, and more expensive, for them to fund their operations.
They are sitting on massive losses whose size is not yet fully known - some say it could be as much as 180bn euros.They are sitting on massive losses whose size is not yet fully known - some say it could be as much as 180bn euros.
Bankia, Spain's fourth-largest bank, was formed when it took over a string of regional banks, the cajas, which were too small to bear the knock from the economic downturn. Not all of the banks are in this situation, however. The International Monetary Fund said a large part of the banking sector, including Santander and BBVA, is well run and resilient.
In May it asked the government for 19bn euros to keep it afloat, on top of the 4.5bn it had already requested. What has been done to help troubled banks?
Other banks, including CatalunyaCaixa and NovaGalicia, are thought to need for 9bn euros. Spain has begun to restructure its banking sector.
The IMF said the banking sector needed an injection of at least 40bn euros to stabilise their finances. This figure could rise when the results of two independent auditors are known by the end of June. Many of its smaller, weaker banks have had to merge or have been rescued by larger ones. The number of branches has been cut by 15%, and 11% of the jobs in the industry have gone.
Up to the end of April, the government had injected 34bn euros into its banks, according to the IMF.
That is not including the 19bn euros Bankia, Spain's fourth-largest bank, asked for last month, shortly before it was nationalised.
Bankia itself was formed when several regional banks, or cajas, were brought together because they were too small to bear the knock from the economic downturn.
The IMF said the banking sector needs an injection of at least 40bn euros to stabilise its finances and protect it against future shocks. This figure is expected to rise significantly when the results of two independent audits are known by the end of June.
To put these figures in context, Spain's budget this year - described as the most austere in 30 years - included tax rises and spending cuts worth 27bn euros.To put these figures in context, Spain's budget this year - described as the most austere in 30 years - included tax rises and spending cuts worth 27bn euros.
Does Spain need a bailout? With the crisis of confidence in the markets about the state of the banking sector and its impact on government finances, it has become increasingly expensive for the government to borrow on the markets.
All parties are desperate to avoid this. Like credit card companies, investors demand higher interest the riskier a prospect they think you are. As a result, Spain has had to turn to emergency funding from its eurozone partners.
Most see it as inevitable that Spain will need external help, but they are hoping it can be in the form of direct help for the banks, rather than the government. How will the bailout work?
What Madrid would like is for the banks to borrow directly from the eurozone rescue fund the EFSF, something that would mark Spain as different from the bailout countries Greece, Portugal and Ireland. Spain is likely to need to borrow up to 100bn euros. But it isn't a bailout or rescue, it insists.
The cost of servicing government debt is the key. The help it gets will differ from the bailouts given to Greece, Portugal and Ireland in a number of ways.
The Spanish government's cost of borrowing money on the financial markets - a barometer of lender fear - is over 6%. It is approaching the level deemed unaffordable, making it very difficult for Spain to raise the money it needs to shore up its banks. The loans will come from two eurozone funds set up to help members in financial distress: the European Financial Stability Facility and the European Stability Mechanism, which comes on stream in July.
Greece, Ireland and Portugal were all forced to turn to international authorities for loans when their bond yields hit 7%. In previous cases, money has come from the troika of international authorities - the European Union, the International Monetary Fund as well as the eurozone.
What is the state of the economy? Also, the money will be targeted specifically at Spain's banks, rather than at the economy as a whole through central government.
The Bank of Spain recently confirmed that the country's economy had returned to recession. Spain was desperate to avoid this, as the sovereign bailouts have previously come with demands to cut spending and raise taxes.
It contracted in the first quarter of 2012, the central bank said, after shrinking 0.3% in the three months to December. It is expected to shrink by 1.7% overall in 2012, with some suggesting it could remain in recession into 2013. The conditions this time will be focused on the finance sector, Spain says. It will however be the one that signs the deal and have to stand behind the loans.
Spain currently has the highest unemployment rate in Europe, at 24%. More than half of its young people are out of work.
And the country has said it will miss its deficit target - set by the European Commission - of 4.4% of total economic output in 2012.
The Commission has now set a new target of 5.3% for this year (Spain's deficit ran at 8.5% of economic output in 2011).
The EU's Economics Commissioner, Olli Rehn, has said the situation in Spain is "fragile" and the country "needs to stick to its targets in order to avoid any setbacks in terms of its borrowing costs".
What is the political situation?
In November, Spain's centre-right Popular Party won a resounding victory in a parliamentary election dominated by the country's debt crisis.
The new Prime Minister, Mariano Rajoy, committed himself to cutting the deficit.
In January, he outlined 8.9bn euros ($11.8bn; £7.4bn) in new budget cuts, as well as tax increases designed to raise 6.3bn euros.
Legislation approved in February makes it easier and cheaper for companies to fire employees.
It also reduces maximum severance pay to 33 days' salary for each year worked, compared with the current 45 days.
The government insists the reforms will create a more flexible system for businesses and workers, in a country with a stagnant economy that needs to start creating jobs.
But many are unhappy with the deep austerity cuts and Spain's first nationwide general strike in more than a year took place in late March.
But the prime minister has vowed not to back down, pushing ahead with measures including freezing public sector workers' salaries, reducing departmental budgets by 16.9% and raising electricity prices by 7%.
"The biggest mistake would be to do nothing," Mr Rajoy has said.