EU urges direct bank aid in boost for Spain

The European Commission advocated direct aid from a euro zone rescue fund to recapitalize distressed banks in a move that could eventually help Spain, the latest front in Europe's debt wars, overcome a worsening banking crisis.

Spanish government borrowing costs earlier lurched higher and the Madrid stock market hit a nine-year low on Wednesday as investors rattled by fears about its financial sector fled to the relative haven of German bonds.

In a major economic policy document, the Commission said the vicious circle of weak banks and heavily indebted states lending to each other must be broken. While the Commission is responsible for proposing laws, it is the member states, most notably Germany and France, that decide whether or not to implement those proposals.

Commission President Jose Manuel Barroso told a news conference that tighter euro zone integration could include a banking union, a joint bank deposit guarantee scheme and euro area financial supervision, saying the mood had changed since member states only months ago unanimously rejected a joint deposit guarantee fund.

"In the same vein, to sever the link between banks and the sovereigns, direct recapitalization by the ESM (European Stability Mechanism) might be envisaged," the report said.

EU paymaster Germany has so far firmly opposed any collective European banking resolution and guarantee system and any use of bailout funds without a country having to submit to a politically humiliating EU/IMF austerity program.

Spain's banking woes - the result of a burst property bubble aggravated by recession - have combined with growing uncertainty about Greece's survival in the euro zone to reignite Europe's sovereign debt crisis. That drove the euro to a two-year low below $1.2450 on Wednesday, while European shares also fell after Italy had to pay heavily to sell bonds.

Madrid said its bank rescue fund would issue bonds to inject funds into nationalized lender Bankia, but that looks expensive with 10-year borrowing costs at 6.67 percent near their euro era peak and close to levels at which Ireland and Greece sought international bail-outs.

The Economy Ministry played down a Financial Times report that the European Central Bank had rejected an initial plan to rescue Bankia, Spain's fourth biggest bank, by stuffing it with government bonds that could be used as collateral to borrow from the ECB.

"Spain did not formulate any proposal to the ECB on funding the Bankia plan, so it was difficult for it to have an opinion," a ministry spokeswoman told Reuters. "The Economy Ministry maintains as a first option to go to the markets to recapitalize the entity."

The Frankfurter Allgemeine Zeitung, an influential voice in the conservative German financial establishment, said that by considering such "tricks", Spain was provoking the market distrust it sought to avoid at all costs.

Investors unnerved by Spain's deepening financial crunch pushed Italy's funding costs sharply higher at a bond sale, with 10-year yields topping 6 percent for the first time this year.

In a sign of heightened anxiety in Washington, top U.S. Treasury official Lael Brainard was dispatched to hold talks in Greece, Germany, Spain and France "to discuss their plans for achieving economic stability and growth in Europe", the Treasury Department said.

Barroso said Europe's G8 partners, at a summit in the United States 10 days ago, had asked the euro zone to go further in financial and economic integration.

A sudden economic deterioration in Europe would pose a serious threat to the U.S. economy and hence to President Barack Obama's re-election prospects in November.

No bailout?


Spanish Prime Minister Mariano Rajoy has insisted the government has no intention of seeking an EU/IMF bailout either for its banks or for the state.

But the abrupt resignation of Bank of Spain Governor Miguel Angel Fernandez Ordonez on Tuesday, a month before his term was due to end, added to market concerns about the handling of the Bankia crisis and relations with European institutions.

Highlighting Spain's difficulty in meeting fiscal targets while gripped by a worse-than-forecast recession, the outgoing central bank chief said tax revenue may fall short of government estimates and spending may be higher than expected.

He recommended bringing forward a rise in value-added tax set for 2013 if the deficit objective goes off track this year.

Greece in background

Three weeks before a crucial second general election in Greece that may determine whether the country stays in the 17-nation currency area, Greeks were warned by their biggest bank that they face economic catastrophe if they leave the euro.

Living standards would plummet, incomes would be slashed by more than half, and inflation and unemployment would skyrocket, the National Bank of Greece (NBG) said.

The latest opinion poll showed the pro-bailout conservative New Democracy party has a slender lead over the anti-bailout leftist SYRIZA movement ahead of the June 17 vote but the outcome remains uncertain.

"An exit from the euro would lead to a significant decline in the living standards of Greek citizens," the NBG wrote.

Per capita income would collapse by at least 55 percent, the new national currency would depreciate by 65 percent against the euro and a recession, now in its fifth year, would deepen by 22 percent, pushing unemployment and inflation through the roof, the bank said.

The dire warning came hours before the NBG was due to report first quarter earnings, expected to show a loss. Greek banks, including NBG, have hemorrhaged deposits since the crisis began and are perceived to favor retaining the euro because the alternative might trigger a run on their reserves.

The worries about Spain and Greece have hit efforts by other trouble euro zone countries to emerge from their own debt woes.

The Irish vote in a referendum on a European budget discipline treaty on Thursday which is seen as a precondition for receiving further EU/IMF aid.

Opinion polls forecast a solid win for the "Yes" camp, but Ireland's hopes of returning to bond markets late next year as a reward for textbook implementation of an austerity program have been clouded by wider uncertainty in the euro zone.

Safe-haven German bond yields hit a record low of 1.34 percent as worries about Spanish banks intensified while Spain's benchmark IBEX stock index, which is down 28 percent this year, fell 1.2 percent after hitting a new nine-year low earlier in the session.

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