July 24, 2012 at 3:37 PM ET
If you want to see what it looks like to be headed off a fiscal cliff, look at Spain.
As the U.S. government counts down toward a year-end tax and spending crunch that threatens to throw the economy into reverse, Spanish officials already are desperately scrambling to save their country from economic and financial ruin.
They are also facing a widening political backlash from Spanish voters who are coping with the kind of tax increases and government spending cuts that will take effect in the U.S. unless Congress acts before the end of the year. Last week, tens of thousands of angry Spaniards took to the streets in 80 cities throughout the country to protest the government's latest austerity package.
Fresh from a drawn out, contentious battle with its eurozone neighbors over terms of a massive bank bailout, Madrid is now getting calls from local government officials saying they can no longer pay their bills.
Last week, the national government set up an 18-billion euro ($22 billion) emergency fund to backstop those regional governments. Days later, Valencia said it would need to tap the fund, and the Murcia regional government followed suit over the weekend. More regions are expected to call for help, overwhelming the fund. The total debt load isn’t known, but one Spanish newspaper estimates it could be as much as 140 billion euros ($169 billion), some 36 billion ($44 billion) of which has to be refinanced by the end of this year.
Spain’s debt hangover follows an era of cheap credit that the birth of a common currency helped create. When the eurozone economy was booming, investors buying euro-based bonds accepted the same interest rates whether the debt was floated by Germany or by Greece.
In Spain, those lower borrowing costs sparked a housing boom much like the buying and building frenzy unleashed by low rates in the U.S. The result was a windfall, in the form of building permits and fees, for Spain's regional governments. Those governments, in turn, took advantage of cheap credit to embark on their own building sprees, sinking billions of euros into new roads, parks, airports and government buildings to house expanded payrolls of government workers.
Now that the property boom has gone bust and the Spanish economy is contracting, the regional governments can’t raise enough revenue to pay the bills and make their debt payments. Fearful of debt defaults, investors are now balking at lending money that the regional governments need to roll over existing debts.
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With the regions now calling on Madrid for backstops, investors have also begun treating the Spanish government like a subprime borrower. Many potential buyers have fled Spanish bonds; those still willing to lend are charging as much as 7.6 percent interest. That surge in borrowing costs makes Spain’s national debt load even more difficult to manage.
The government’s cash squeeze further raises the likelihood that the Spanish government will be the next in line -- after Greece, Ireland and Portugal -- to call on its eurozone neighbors for a government bailout. But northern eurozone officials, led by Germany, face a political backlash at home if they agree to write unlimited checks to countries with no credible solutions to their debt crises.
That backlash will likely intensify when European officials wrap up their latest review of the ongoing Greek bailout, which has shown little progress in reviving the local economy or reversing Athens’ downward spiral. On Tuesday, three EU officials told Reuters that Athens appears unable to pay what it owes and will need to undertake another debt writedown, a cost that would have to fall on the European Central Bank and eurozone governments.
"Greece is hugely off track," one of the officials told Reuters, speaking on condition of anonymity because of the sensitivity of the issue. "The debt-sustainability analysis will be pretty terrible."
That puts Greece further at odds with its bailout benefactors and raises the likelihood that it will be forced out of the currency union. Europe’s relatively well-off northern nations, led by Germany, are growing weary of what they see as calls for a blank check to rescue their southern neighbors.
News of the Greece’s widening debt debacle will only worsen the “bailout fatigue” enveloping the eurozone’s stronger economies and further complicate a Spanish rescue.
“The problem is there isn’t enough in the (eurozone) kitty to bailout the Spain sovereign, its banks and its regions and then have to deal with Italy,” wrote David Rosenberg, Gluskin Shiff chief economist, in a note to clients. “The break of the eurozone is no longer a taboo topic, even at the highest levels of the European Union and International Monetary Fund. “
The more immediate risk is that Spain’s banks, which already need an estimated 60 billion euros ($73 billion) to avert insolvency, face a continued cash drain as households and investors withdraw their money.
Unlike U.S. banks, European banks don’t guarantee depositor savings when a bank fails. Nor is there a system in place to shut down a bank headed for insolvency. That increases the risk that the recently-approved 10 billion euro ($121 billion) bank bailout will simply throw good euros after bad.
The bailout of the Spanish banking system has also been stymied by ongoing political backlash among eurozone member countries and the thicket of red tape that has bogged down what passes for a central European government in Brussels.
The longer European officials haggle over a Spanish government bailout, the greater the risk of a wider financial calamity.
“These guys are juggling with dynamite sticks,” said Art Cashin, The head of Swiss bank UBS's operations at the NYSE. "If people in any of those countries begin to run on their respective banks, it goes out of the hands of leadership and puts the crisis into the streets. We’re getting very close to that."
The Spanish banking crisis has also brought lending there to a virtual standstill, which has sent the Spanish economy reeling. Businesses that can’t get loans can’t expand and hire new workers. The unemployment rate has surged to 25 percent; among younger workers, roughly half are out of a job.
Spain’s government debt and banking crisis also threatens other European banks that are holding Spanish debt or loans to Spanish businesses. The crisis has also sent much of the rest of the eurozone into recession as businesses and consumers hunker down. Not surprisingly, consumer confidence hit a three-year low in July.
"It is hard to see eurozone consumers being anything other than cautious in their spending in the near term," said IHS Global Insight chief European and UK economist Howard Archer.
So far, Germany has largely escaped the economic blowback from its southern European neighbors, thanks to low inflation, robust savings by German households and a flood of money seeking financial shelter in Frankfurt.
But that relative calm may be coming to an end. On Monday, bond rater Moody’s Investors Service lowered its outlook for the German economy, which is one of the last pockets of eurozone growth. Recent indicators have pointed to a softening of the German economy, and the German central bank warned Monday that the outlook is “characterized by great uncertainty.”
That could further complicate efforts to rescue Spain, as any further weakness in Germany’s economy would further weaken support for expanded eurozone bailouts.
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