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Headlines today are swirling around Spain, and the likelihood that it will receive a bank bailout as early as this weekend.Experts agree there’s no way it can avoid a European-led bailout at this point, but there are two important ways this could happen, each with two possible consequences:
1—Spain gets a banking sector bailout that imposes few restrictions on its government
While Spain has not officially requested a bailout, it has signaled that it wants aid that imposes few restrictions on its government. It argues that its own finances are in decent shape, and that its problems are cyclical and not structural. If Spain succeeds in getting this, there are two possible outcomes:
BEST CASE: Game-changer for Europe: Any bailout that transfers the weight of Spain’s banking sector to the shoulders of the European Union marks a monumental shift in European policy, as this is a strong move towards banking union and fiscal integration. Further, this could mean a huge reprieve for Spanish borrowing and Spanish equities, as the
WORST CASE: Even more angst about Spain: The bailout plan fails to truly transfer the weight of the banking sector from Spain to Europe. Regulations imposed by EU leaders on banks cut off their willingness to purchase Spanish government bonds, and Spain continues to have difficulty finding funding.
2—The Spanish government is forced to accept stringent restrictions along with its banking bailout
Germany appears to support stronger restrictions on the Spanish government, potentially limiting the latter’s ability to embark on stimulus plans that would ease the fallout of a housing bubble. If it must face the negative market consequences of fiscal integration, then Germany (like the Netherlands, Finland, and Austria) wants to wield as much control over the central political organisations as possible.
BEST CASE: Germans are reasonable: Europe imposes few restrictions on the Spanish government, regardless of their power to do so. They are lenient on deficit targets and allow Spain to support failing industries and families to ease the pain of the recession. Further, European leaders do everything they can to separate the banking sector from the government, taking strong action on the former and serving as a mere watchdog on the latter.
WORST CASE: Spain’s economy turns into even more of a disaster: Germans force Spain to pass deep austerity measures in return for its bailout package, subjecting the Spanish economy to an even sharper recession. This recession inflates concerns about the Spanish government, as tax revenues fall and it takes on more debt.
Admittedly, these choices and outcomes are extremes. As Spain is one of the eurozone’s largest economies, European leaders know they must acquiesce to some of Spain’s demands for independence. Austerity measures would likely have to be limited so as not to kill off economic growth for years to come, and everyone would prefer that investors stop speculating against the Spanish government.
With an IMF report on the banking sector due out Monday and reports that a preliminary bailout deal could be agreed upon sometime this weekend, it will be important for leaders and investors to consider the stakes of any plan that is considered.
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And watch our 70-second guide to the Spanish bank bailout:
Produced by Robert Libetti