06.10.12

Spain becomes the 4th EU country to get bailed out

Posted in Economics, Financial Markets, General Musings, Politics and Policy at 7:41 am

Yesterday, the EU agreed to provide Spain with a 100 billion Euro ($125 billion) rescue package.

The money will go into a fund called FROB (Fund for Orderly Bank Restructuring) modeled loosely after the US TARP prgram.  The Spanish government will be responsible for paying back the loan, but they are constrained in how they can use the money; essentially, it has to be used to recapitalize their banks.

It appears this will calm the markets, but for how long?

Why is “calming the markets” always the proximate (and often the ultimate) goal?  Spain has an overall unemployment rate over 24%, with unemployment levels hovering around 50% for the young.  GDP growth was negative in 2009 and 2010, barely positive in 2011, and now has gone negative again for the first half of 2012 with consensus estimates for all of 2012 coming in around -1.5%.  The housing market is in shambles after a boom and bust.  Where are the plans to address crisis-level unemployment and jump start economic growth?  Where are the plans to fix the housing market?

It’s interesting to note the similarities between Spain and Ireland, both of which pursued fiscally responsible policies prior to the financial crisis.  Spain ran budget surpluses in 2006, 2007, and 2008.  In 2009, Spain’s public debt was under 60% of GDP, well below the EU average.   Even now, after the crisis, it only stands at around 68% of GDP.  Like Ireland, Spain is not a tale of fiscal profligacy, it’s a story of a country that experienced the collapse of an asset price bubble followed by a banking crisis.  Awhile back, Paul Krugman noted that Rogoff and Reinhart got the correlation between public debt as a % of GDP and economic crisis correct, but they had the causation reversed.  An economic crisis causes public debt to skyrocket, not vice versa.  Spain is a perfect example.

Where do we go from here?   What will the political repercussions be, both in Spain and in the rest of the EU?  Will Ireland and others demand a renegotiation of their bailouts to remove or reduce the austerity measures attached to them?  What impact will this have on the Greek elections?  Will the contagion spread to Italy next?

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