EU Faces More Bailouts as Euro Contagion Spreads to Portugal: Euro Credit

By John Fraher and James Hertling - Nov 30, 2010 5:20 PM GMT+0800


The failure of the Irish rescue to stem a selloff across euro-region bond markets may spell more bailouts to come, starting with Portugal.

The costs to insure Portuguese debt against default rose to a record today and Spanish bonds slid the most since the euro’s debut for a second day, highlighting investor concerns that officials lack the tools to contain a debt crisis threatening the currency’s survival. The extra yield that investors demand to hold Italian debt over German 10-year bonds rose to the highest in more than 13 years.

“We are barely halfway through the current crisis in the euro zone,” Paul Donovan, deputy head of global economics at UBS AG in London, said in an interview with Ken Prewitt and Tom Keene on Bloomberg Radio’s “Bloomberg Surveillance” program. “Unless we can see a further significant decline in bond yields in Portugal, the market is going to expect another bailout. And then market attention will turn to Spain.”

Market declines began yesterday less than 24 hours after European Union finance ministers confirmed their second bailout of a euro nation after Greece’s in May, handing Ireland an 85 billion-euro package ($111 billion) to rescue its banks and bolster government finances. While EU officials also agreed on a mechanism to smooth bond restructurings after 2013, investors are speculating that debt-strapped nations won’t be able to cut deficits fast enough before then.

Euro Drops

The single currency dropped for a third day to a 10-week low of $1.3034. The premium on Spanish 10-year bonds over German bunds rose 28 basis points to a euro-era high of 295. The yield on Italy’s 10-year government bond rose 18 basis points to 4.83 percent, about 80 basis points more than Brazil. Portuguese credit-default swaps jumped 11.5 basis points to a record 551, after surging 40 basis points yesterday, according to CMA, a data provider.

The challenge for EU leaders is to stop the crisis without a fiscal union or a clear mechanism to kick profligate members out of the single currency.

Finance ministers found themselves meeting on Sunday, Nov. 28, to calm markets just six months after agreeing to a 750 billion-euro bailout package for the euro region.

While the fund’s size was supposed to head off future speculative attacks, Spanish Finance Minister Elena Salgado arrived at the meeting rejecting talk that she would soon join Ireland in seeking a bailout.

“Speculation exists because it’s part of the fabric of the markets,” she said. “We have certainty that we can control it.”

Focus Turns to ECB

Investors’ attention will soon turn to the European Central Bank, whose 22-member Governing Council will decide on Dec. 2 whether it can afford to stick to a plan to withdraw emergency stimulus at the start of next year.

While the ECB has so far signaled no willingness to deploy new measures, London-based HSBC Holdings Plc says it may provide more help to banks in Spain and Portugal and may even have to conduct broader asset purchases.

“The ECB will once again have a role to play to ensure that financial stability is maintained, albeit reluctantly,” said Janet Henry, chief European economist at HSBC in London. The ECB last week bought the most government bonds in two months.

Investors have also expressed concerns that the European Union’s bailout pot may be smaller than advertised and insufficient to save Spain, whose economy is twice the size of Ireland, Greece and Portugal combined. HSBC’s sums show the country needs 351 billion euros over the next three years.

Enough Cash?

In practice, the EU may only be able to deploy 255 billion euros of the 440 billion-euro European Financial Stability Facility, according to analysts at Nomura International Plc.

That’s because the rescue fund is financed by issuing bonds and in order to secure a AAA rating, governments agreed to set aside a pool of cash, depleting the total amount available to pump into economies. The rest of the bailout pool consists of 60 billion euros from the European Commission and 250 billion euros pledged by the International Monetary Fund.

“There isn’t enough official money to bail out Spain if trouble occurs,” Nouriel Roubini, the New York University professor who predicted the global financial crisis, said yesterday in Prague. While it’s “quite likely that Portugal” will be next in line for financial assistance, “the big elephant in the room” is Spain, he said.

At 9.3 percent of gross domestic product, Spain will have the largest budget deficit in the euro area this year after Ireland and Greece, the European Commission forecast yesterday. Portugal’s shortfall will be 7.3 percent of GDP.

‘Fiscal Union’

Some economists point out that the euro region may ultimately be strengthened by the current crisis if it forces EU governments to work more on coordinating fiscal policy. The Greek crisis led earlier this year to the creation of the euro region’s first bailout fund and Ireland’s rescue accelerated talks over a permanent crisis resolution mechanism.

“In the next 5 to 10 years there has got to be more of a fiscal union within the euro region than we have today,” said UBS’s Donovan. “One of the things that Europe does well is integrate in a crisis.”

Harvinder Sian, a senior fixed-income strategist in London at Royal Bank of Scotland Group Plc says the crisis needs to threaten Germany and its banks before a long-term solution for the euro region can be found.

Until now, German Chancellor Angela Merkel has been reluctant to spend her taxpayers’ money on bailouts. She sparked the latest stage of the crisis by demanding that bondholders help foot the bill of any future rescues.

“The problems need to hit Germany before more viable solutions such as more fiscal and political integration look likely,” Sian said. “That is, it may take a near death experience for the periphery and core EMU banking systems before this realization dawns.”