Spain has announced it will pour €19 billion into troubled real estate lender Bankia, SA. Even with the €20 billion in aid already dispensed to financial institutions, this may not avert a run on Spanish banks and economic collapse. Much larger than Greece, Spain could prove beyond Germany and other northern countries’ capacity to rescue, and its collapse would spell the end of the euro.
Spain’s economic crisis did not result from government overspending. Prior to the Great Recession, Madrid’s budget was consistently in surplus, and Spain’s debt to GDP ratio is only 70 percent—lower than Germany or France.
During the boom years, wealthy northern Europeans rushed to purchase second homes and vacation in Spain’s sunny climate, instigating a rush of foreign funds into its banks to finance dwellings and hotels. After the 2008 global crisis, land values fell, and banks were stuck with non-performing real estate loans.
Faced with similar challenges, the United States had tools that neither Spain nor the EU possess.
The Federal Reserve pumped some $2 trillion into US banks and financial institutions—including purchases of many non-performing and high-risk loans. The ECB has extended long-term credit to banks against mortgages and business loans deemed secure, but it cannot bail out banks with too many non-performing loans.
The ECB can lend money to national central banks, which extend credit to commercial banks against their loans, but if those loans fail, national central banks assume liability. Unlike the Fed and ECB, those can’t print money, and their central governments must either tax citizens or borrow euro on international capital markets to make up losses.
Madrid’s current bank bailout has undertaken an exercise similar to the US Treasury’s TARP—selling bonds to finance bank bailouts; however, the ECB does not stand ready, as the Federal Reserve did for the Treasury, to print money to buy any bonds Madrid can’t sell.
The ECB should remain reluctant to acquire powers similar to the Federal Reserve, because it lacks authority the US central bank shares with the Comptroller of the Currency to regulate banks. The European Banking Authority has very limited powers, and bank supervision remains in the hands of national governments, subject to whims of national politicians and elections.
Investors, recognizing that guaranteeing Spanish banks is an enormous burden for Madrid to shoulder without a central bank that can print euros, have driven up Madrid’s borrowing rates. This has forced draconian spending cuts and deepened the Spanish recession.
A terrible negative feedback cycle has been unleashed—a contracting economy lessens Madrid’s tax revenues, this engenders further investor doubt and even higher interest rates, higher borrowing costs require more spending cuts, and those further worsen economic contraction.
Depositors, fearing bank failures or a Spanish pullout from the euro and conversion of their accounts into less valuable peseta, could force Madrid to alter strategy by withdrawing funds.
To discourage bank runs, the Eurozone has no analog to the FDIC, which is backed up by the US Treasury’s capacity to tax and sell bonds, and ultimately the Federal Reserve’s ability to print money. Instead, national agencies back up deposits, and Madrid’s ability to stand behind Spanish banks with €663 billion in real estate loans is highly uncertain.
Throughout the European sovereign debt crisis, much has been made of Brussels’ lack of taxing, spending and borrowing powers. However, monetary union also requires that the ECB, like the Federal Reserve, be charged with guaranteeing the solvency and regulating banks, and that a continental deposit insurance system—backed by taxing authority in Brussels and the ECB’s capacity to print money—be established.
Those won’t come in time to save Spain. It may simply have to dump the euro, so that it can print its own money and solve its problems much as the United States did in the wake of the financial crisis.
Peter Morici served as Chief Economist at the U.S. International Trade Commission from 1993 to 1995. He is an economist and professor at the Smith School of Business, University of Maryland.