Spain Near Tipping Point for Bailout

Spanish bond yields soared to near record levels on Tuesday, ratcheting up concern that the 5th largest economy in Europe would need a bailout to prevent defaulting on its debt.

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Spain paid the second highest yield on short-term debt since the birth of the euro at an auction on Tuesday, reflecting a growing belief that the country will need a full sovereign bailout that the euro zone can barely afford.

Spain’s increasingly desperate struggle to put its finances right has seen its borrowing costs soar to levels that are not sustainable indefinitely. Italy, commonly regarded as too big to bail out, has been dragged along in its wake.

The Spanish Treasury raised 3.04 billion euros ($3.7 billion) of 3-, and 6-month T-bills, meeting its target. The average yield [cnbc explains] on the 3-month bill was 2.434 percent, up from 2.362 in June. For the six-month paper, the yield jumped to 3.691 percent from 3.237 percent last month.

“The most important takeaway from this auction is that Spain was able get all its debt out the door,” said Nicholas Spiro of Spiro Sovereign Strategies. “Still, in March, Spain was able to issue six-month debt at a yield of under 1 percent, now it is paying 3.7 percent.”

Spain had cushioned itself by securing well over half its annual debt needs in the first six months of the year when market conditions were more benign but that advantage has now evaporated.

On Friday, the government said it expected the economy to remain in recession well into next year while the autonomous region of Valencia became the first to ask Madrid for aid to pay debt obligations it cannot meet. Others are expected to follow.

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The Spanish economy is experiencing a double-dip recession which has put enormous pressure on the banking system, resulting in a $120 billion bailout by the EU:

Last Friday, Spain finally got approval from the other 16 members of the eurozone to access up to €100 billion ($121 billion) in loans to prop up its banks which are weighed by down by €180 billion in soured real estate investments.

Spanish officials had hoped a solution for the banks would ease some concerns about the state of the country’s finances and prompt investors to stop demanding unmanageably high interest rates for government debt. Such high rates forced Greece, Ireland and Portugal to seek full-blown public finance bailouts.

But instead of easing off, investors panicked again.

On Monday the country’s central bank said that the economy shrank by 0.4 percent during the second quarter, compared with the previous three months. The government predicts the economy won’t return to growth until 2014 as new austerity measures hurt consumers and businesses.

On top of that, Spain is facing new costs as a growing number of regional governments that function like U.S. states ask federal authorities for assistance.

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Spain has dutifully made an effort to lower its budget deficit, but the lack of growth is reducing revenue, thus causing those targets to slip. Prime Minister Mariano Rajoy’s center-right government planned to pass a mix of tax increases and budget cuts that would have trimmed about 70 billion euros from the budget, but with 25% unemployment – 52% for the young – the costs for services continues to rise.

A bailout by Madrid of the autonomous economic regions might cost as much as 36 billion euros this year alone. More might be necessary given the 140 billion euros that the regions are in arrears.

The stars — and economic conditions — appear to be aligning against the Spanish government and a bailout appears a near certainty. The problem for the EU is that the bailout mechanism they have created — the European Stability Mechanism — has only 500 billion euros in lending power, and other EU countries appear reluctant to fully fund it. The ECB has limited ability to buy bonds outright, although they can make it easier for European banks to purchase sovereign debt. The bottom line is that there isn’t enough cash to cover what might be a near trillion euro bailout for Spain, trying to bolster Greece, and perhaps deal with a domino effect that a Spanish bailout might initiate.

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Solutions are lacking which is why the systemic problems with the concept of a unified currency keep getting kicked down the road. Someday soon, the Europeans will realize the can can’t be kicked anymore. It is then that we will either see total economic integration — a United States of Europe — or the collapse of the euro zone into a bunch of quarreling states unable to rise above their petty jealousies.

Don’t bet on the former.

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