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By Carrie Harrington
The sovereign debt crisis in Europe developed as countries experienced higher deficits and growing debt and European governments became increasingly unable to pay back this debt. Eventually, credit-rating agencies downgraded the sovereign bonds of several European countries, which made issuing new bonds extremely expensive. In 2010, Greece was the first country to buckle. To prevent Greece from defaulting on its debts, the Eurozone countries and the International Monetary Fund (“IMF”) granted Greece a loan. Later in the year, the Eurozone and the IMF provided a similar loan to Ireland. In early 2011, Portugal’s Prime Minister quit after the government was unable to agree to austerity measures to address its own debt crisis. It, too, will receive a bailout. Spain has experienced similar financial worries, and some are speculating a Spanish bailout is on the horizon. Whether it is through bailout funds or Spain’s own austerity measures, it is imperative that Spain survives the economic crisis because of its economic power and size.
Spain fell into an economic downturn in 2008 due to the collapse of its housing market, and economic conditions worsened when it became clear how entrenched the country’s unregulated savings banks were in the real estate market. Increased public benefits caused higher government spending and government debt skyrocketed. Like other European nations, with Spain’s rising debt, investors became more reluctant to invest and Spain’s economy further declined. This briefing paper will describe the major causes of the Spanish financial crisis. It will also discuss what Spain’s survival means to the Eurozone as a whole, and analyze possible outcomes for Spain and the Eurozone after the crisis and the impact those outcomes would have on the regional economy. Finally, it will describe the actions the Spanish government and the European Union (“EU”) are taking to repair the Spanish economy and ensure a crisis of this magnitude does not happen again. Understanding Spain’s crisis and the European sovereign debt crisis in general requires an understanding of the history of the EU and the creation of the Eurozone.
II. History of the European Union and the Eurozone
After the end of World War II, European countries wanted to reconcile with Germany to ensure lasting European integration and eliminate the possibility of future wars between the countries. This was accomplished through the establishment of the European Community (“EC”), an amalgam of three separate communities: the European Coal and Steel Community, established in 1951, the European Atomic Energy Community, established in 1957, and the European Economic Community, a customs union also established in 1957. Spain joined the EC in 1986.
Eventually, European citizens were free to work, live, and travel throughout Europe without the regular requirements of passports and visas, and many saw the implementation of a single European currency as the next practical step to further integration. Proponents of the euro pointed out that there would be no need to exchange currency when entering another European country (which would benefit tourists and citizens alike), conducting business between countries would be easier because contracts would be in the same currency, and most important, the relationships between European nations would be further strengthened. Additionally, some liked the idea that there would be one European currency that could compete against the dollar.
In 1992, the Maastricht Treaty was signed, whereby the Community members agreed to the creation of the EU and a path towards monetary union—European Monetary Union (“EMU”)—via the adoption of a single currency, the euro. Members of the union would be subject to one monetary policy set by the European Central Bank (“ECB”), but were free to pursue their own fiscal policies (taxing and spending), subject to some constraints discussed below. The euro entered circulation on January 1, 1999. The nations that use the euro are known collectively as the Eurozone (often used interchangeably with EMU). The original Eurozone member countries were Austria, Belgium, Germany, Finland, France, Ireland, Italy, Luxembourg, Netherlands, Portugal, and Spain. Denmark and the United Kingdom, though members of the EU, declined to be included in the Eurozone by using a special reservation in the Maastricht Treaty. Since 1999, six other European nations have joined the Eurozone—Cyprus, Estonia, Greece, Malta, Slovenia, and Slovakia.
There were critics of the single monetary policy before the euro was in place and before there was ever a hint of a financial crisis. After the Maastricht treaty was signed, one of the euro’s most fierce critics, Martin Feldstein, warned against some of the problems that adopting the euro could (and eventually did) cause. For instance, Feldstein supported the creation of a free-trade area but strongly opposed a common currency. He attacked the argument that eliminating currency fluctuations would increase trade among the Eurozone members, noting that other countries like the United States and Japan have separate currencies and find no barriers to their trading. Moreover, countries within the Eurozone would lose control over their exchange rates.
Another criticism was that countries unable to devalue their currency may have difficulty competing in the world market. Countries often devalue their currency when facing an economic downturn. Devaluation occurs when a country adjusts the value of its currency downward in relation to the currencies of other countries. By doing this, the country’s exports will be cheaper and therefore more attractive to other countries. Devaluation also makes importing more expensive, thereby encouraging domestic consumption and production. Countries often use devaluation when there is an economic downturn. Instead of wage cuts, devaluation causes a de facto wage cut because while workers are making the same amount, their wages buy less. History suggests that workers are much less likely to protest currency devaluation than an actual wage cut. Because of this, currency devaluation is a very valuable monetary tool. By joining the Eurozone, members gave up their ability to individually devalue, which would eventually cause problems.
Although many hoped the euro would rival the dollar, critics pointed out the differences between the United States and the Eurozone. The United States has been around for 200 years, and the dollar has gained a strong reputation over that time period. The euro, on the other hand, would be a completely new global currency, and European currencies with good reputations, such as the deutsche mark, would be abandoned.
Critics also pointed out that allowing countries to maintain separate fiscal policies would be a critical flaw in the Eurozone system. If a Eurozone member pursued irresponsible fiscal policies that created inflationary pressures, the ECB would raise interest rates, forcing other members pursuing responsible fiscal policies to bear the higher interest rate costs as well.
To prevent this problem, the EMU adopted the Stability and Growth Pact (“the Pact”) in 1997 to ensure fiscal discipline after the introduction of the euro. The Pact required that (1) countries maintain a government budget deficit of no more than 3 percent of gross domestic product (“GDP”), and (2) a country’s public debt cannot exceed 60 percent of GDP. The European Council (one of the EU’s regulatory bodies) has the authority to penalize any member that does not abide by these restrictions. Nonetheless, there are no fixed rules governing penalties. In fact, the Pact has been enforced inconsistently or not at all. When Germany and France, the main originators of the Pact and two of the stronger members of the EU, were unable to meet the Pact’s requirements in 2002, the European Council faced heavy criticism by not levying penalties against them. The Council defended its decision by arguing that if the countries were already struggling financially, an economic penalty would not help. This argument did not appease the critics.
Because of this criticism faced after its original failure, in 2005 the members reformed the Pact to include some exceptions. The two main goals—budget deficit less than 3 percent of GDP and public debt less than 60 percent of GDP—remained the same. However, the reform stated that “exceptional circumstances” and “other relevant factors” would be taken into account when a member breached the ceilings. Also, members would be allowed two years to correct a breach of the Pact, but if an exception was applicable, it could be granted more time. The 2005 reforms did not mention definite sanctions.
Many critics complained that the reform did not change the Pact at all. It simply gave the members more flexibility when breaching the goals and allowed the Council more discretion in enforcing (or failing to enforce) penalties. Many analysts argue that the lack of enforcement of the Pact was partially responsible for the current sovereign debt crisis.
III. Spain: A Flourishing Economy
In order to join the EU, the Maastricht Treaty requires that countries converge on certain criteria, including interest rates, inflation rates, and government deficits. Since 1990, Spain had faced budget deficits as large as 6.5% of GDP. Because of the strict requirements in the Maastricht Treaty, by 2005 the Spanish government began posting budget surpluses.
The Maastricht Treaty also called for Spain to reduce its long-term interest rates. As a result, businesses and individuals saw their borrowing capacities increase because they could afford paying loans with lower interest rates. More people, especially those in their twenties who had recently graduated from a university, took out loans to purchase homes. Traditionally in Spain, the younger generation lived with their families after school until they married, but in the past ten years, more bought their own residences before marriage because obtaining credit was easy and interest rates were low.
The construction market flourished because of the increased demand for housing. As more Spaniards bought houses, more construction companies required unskilled labor which prompted an increase in immigration to Spain’s labor market. From 2000-2008, Spain’s population grew from 40 million to 45 million, and from 1999 until 2007 the Spanish economy created more than one-third of all employment generated in the Eurozone. As more immigrants came to Spain, more housing was necessary and the cycle continued. During this time, prices of houses increased dramatically, as did the number of loans used to purchase them. The construction market continued to build, heedless that the growing housing market would inevitably begin to cool.
IV. Crisis in Spain
Because of the dramatic increase in construction of new homes and the long time between the beginning and end of a construction project, by the time the demand for housing had slowed in 2007, available housing was just reaching its peak. By this time, construction accounted for 13 percent of total employment in Spain. When prices began falling and housing demand halted, unemployment jumped up 10 percent.
As unemployment skyrocketed, so did unemployment benefits. In a welfare state like Spain, unemployment benefits are generous. However, what was a sustainable unemployment level quickly became a drain on the Spanish government. The reduction in the Spanish government’s tax revenue, which is heavily dependent on real estate, exacerbated the problem. These drains on the economy turned a previous budget surplus of over 2 percent of GDP into a deficit of almost 4 percent of GDP, violating the limits of the Pact.
The Spanish Banking System
Spanish regional savings and loan banks, called cajas, account for half of Spain’s banking system. There are around 24,000 branches of cajas throughout Spain to serve its 46 million residents (one branch for approximately every 1,900 people). The United Kingdom, in comparison, with a population of around 62 million, has only 10,000 total bank branches (one branch for every 6,200 people). Cajas are not publically traded, and usually regional politicians control the cajas instead of shareholders. The majority of cajas’ clients are families, small and medium-sized business, and non-governmental organizations such as health care facilities, environmental groups, and cultural groups. Before the crisis, cajas often loaned to those that the larger banks turned away because they were considered “undesirable”—clients that were less likely to pay back their loans. Unlike the rest of the banking system, cajas were relatively unregulated, and they were not required to disclose certain information such as collateral on loans, repayment history, and loan-to-value ratios. This nondisclosure prevented the Spanish government from understanding cajas’ financial situations before and during most of the crisis. The government was also unaware of the depth of cajas’ investment in the real estate market.
When Spain’s two largest banks, Santander and BBVA, slowed lending in 2007, the cajas continued to lend heavily into the cooling housing market. By 2009, cajas owned 56 percent of the country’s mortgages, and loan payments from property developers accounted for one-fifth of the cajas’ assets. Because the cajas were not required to disclose much of their investment information to the government, their continued lending to the real estate market went relatively unchecked.
When the housing market crashed in 2009 and debtors fell into bankruptcy and bad loans dramatically increased, the cajas were paralyzed by a lack of income from these delinquent loans and the high costs attributable to this bloated caja system. The Bank of Spain estimated the amount of potential troubled loan exposure in the Spanish banking system (any problematic loans that may face default) in the real estate market was around €180.8 billion in mid-2010. According to some analysts, Spanish banks were only capable of handling losses of only a third of that amount, and the cajas could handle much less.
By 2009, the construction industry owed billions of euros to the Spanish banking system. Many construction companies had already gone bankrupt. The regular, listed banks had delinquent loans including construction loans of approximately of 3.2 percent of their portfolios, while troubled loans at cajas reached 4.4 percent. In March 2009, the Spanish government announced its first bailout of a caja. Although there is a difference between cajas and banks, investors saw this first bailout as an indicator of the unhealthy status of the Spanish financial sector as a whole. After the bailout, investor confidence in Spanish banks plummeted, causing bank shares to plunge. Banks needed more cash to pay the depositors who lined up to extract their deposits, creating a “run on the banks.” During the first four months of 2010, depositors withdrew €21.6 billon. This caused more bank bailouts by the Spanish government. While these government bailouts kept the banks from going bankrupt, investor confidence in the Spanish economy sunk even lower.
V. Where is Spain Now?
The main cause for concern when banks have made too many loans is that the borrowers will not pay back the funds and the banks themselves will go bankrupt. In the United States, for example, this is especially concerning because most U.S. loans are non-recourse. In a non-recourse loan, the creditor’s recovery is limited to the loan collateral—the asset the borrower commits as a guarantee of repayment. When a borrower defaults, the creditor is only allowed to foreclose on the collateral (i.e., a residence) and cannot go after other assets of the borrower. Even if the collateral is worth less than the value of the loan, that is the extent of the creditor’s recovery.
Unlike the United States, Spanish loans are typically recourse loans. With a recourse loan, if the borrower is unable to make payments on the loan, the creditor is not limited to pursuing the collateral for loan recovery but can pursue the borrower’s personal assets. Because of this, most Spanish borrowers have continued, however possible, to make their loan payments out of fear of losing all their assets. In an economy such as Spain’s right now, people will not begin borrowing again anytime soon because many are still trying to repay their previous loans. Less money will be spent in other sectors because more money will be needed to make mortgage payments each month. Therefore, some analysts claim recourse loans generally ensure people make their loan payments but also hinder the rest of the economy. However, in Spain’s case, recourse loans might lure possible investors in the cajas as part of their recapitalization efforts.
The current statistics surrounding Spain’s economy illustrate the dire economic situation. As of February 2011, unemployment in Spain still hovers around 20 percent of the labor force (4.3 million people), the highest in the industrialized world. Unemployment for Spaniards under 25 years’ old is a staggering 40 percent. The unemployment rate for Spanish residents with university degrees is at 9.4 percent, twice than in the rest of the EU. Not surprisingly, the Spanish government estimated that 70% of the jobs lost after 2008 were related to the construction sector. However, despite the staggering unemployment (which leads to higher government spending on public benefits), Spain’s public debt as of 2010 was estimated to be 63.4 percent of GDP, lower than the debt of the United Kingdom and Germany. Finally, analysts estimate that there are 1.5 million vacant homes in Spain, and it will take an estimated six years to sell all these properties.
VI. What Went Wrong?
There were many contributing factors to the Spanish financial crisis. The failure of the Stability and Growth Pact highlights the lack of regulatory authority within the Eurozone. Despite the Pact’s reform, there is still little supervision. Although the Eurozone members use the same currency, and the Pact sets guidelines, there is no oversight of fiscal policies. Eurozone nations are left to self-regulate, even though the Eurozone economies are integrated.
An easy target to blame is the Eurozone itself. The introduction of the euro meant that Eurozone countries had the same monetary policy but completely different fiscal policies. Because there was no uniformity between member states’ fiscal policies—meaning that members were able to maintain their own spending and taxing policies—member states have found themselves in the vastly different economic positions, and the inability to devalue the currency has hindered recovery. Although the euro was seen as the next logical step in integrating Europe, it has become a major hindrance in the Spanish (and European) crisis. Critics warned against some of these eventualities, but by the time danger was apparent, it was too late.
Another factor causing the Spanish financial crisis was the lack of regulation of Spanish lending institutions and the real estate market. As previously mentioned, cajas made too many loans to individuals and corporations (especially to those less likely to be able to repay the loans in a crisis). Many of these individuals and corporations invested those loan proceeds in the real estate market. Because the cajas had not released their information to the government, the extent of their real estate exposure was unknown. The instability of Spanish banks has led to low investor confidence in the Spanish market. Many investors have pulled out of the Spanish banking market or have refused to invest in the ailing cajas, hindering the Spanish recovery.
VII. Spain’s Survival is Crucial to the Eurozone
While the economic survival of every Eurozone country is important, Spain plays a special role for two reasons. First, it serves as a model for weaker countries. Portugal, Italy, Ireland, Greece, and Spain have often been discussed together during the financial downtown. Greece, Ireland, and now Portugal have requested bailouts from the EU. However, because it has a larger economy and less problematic public debt, analysts consider Spain to be in a better condition than the others. The fear is that if Spain defaults on its sovereign bonds and requires a bailout, investors will lose faith in the ailing economies and will pull more money out of them, worsening their conditions further. Those that have not yet requested a bailout will then require one, and those in recovery (those that have received bailouts) will stall.
Second, Spain is also representative of a larger entity—the Eurozone. Spain is a founding member and is often associated with the more powerful France and Germany. If Spain is unable to pay back its sovereign bonds, analysts and investors fear the entire Eurozone will be in jeopardy. Because many Eurozone countries have struggling economies, they are importing much less. This is taking a toll on the larger, export-driven economies like Germany. If countries like Spain continue to struggle, the countries with stronger economies may face problems as well. For example, if Germany’s economy deteriorates, the interest rates on its own sovereign bonds may increase, making it more difficult for Germany to pay back its sovereign debt. This could trigger financial instability in the country.
VIII. Spain’s Financial Future
The future financial position of Spain is unclear. However, some outcomes are more likely than others because of Spain’s current economic position and the purpose and status of the EMU.
A. Spain Leaves the Eurozone
Spain could pull out of the Eurozone and return to its own currency, the peseta. However, if Spain even suggests leaving the Eurozone, many fear that depositors will move their funds to safer locations, causing a damaging run on the country’s banks. To prevent this, Spain would most likely implement capital controls and limits on bank withdrawals to slow the drain on the banks, but these measures would restrict commerce. Upon stabilization of its monetary policy, Spain could devalue the peseta, promoting exports and decreasing imports.
This plan is unlikely because integration into the Eurozone is complete, and Spain would probably not risk losing more funds from its banks. The technical difficulty itself is daunting: reintroducing a national currency, reprogramming the monetary system, printing money, and minting coins. The risks associated with pulling out of the Eurozone are too great, and Spain is unlikely to take this drastic step. Although Spain and other countries may regret joining the Eurozone because of their lack of control over their own monetary and foreign exchange policy, it seems there is no turning back now.
B. Spain Toughs It Out
Spain could simply tough the crisis out. Both the Spanish government and Spanish citizens would have to cut back on spending. The unemployed would continue to receive fewer benefits from the government as the government implements measures to decrease government spending. The government would most likely have to exert greater control over private debt (like that of the cajas) to avoid an EMU bailout. Not receiving a bailout (if a bailout should become necessary) would be painful in itself. However, by showing that the country is willing to endure tough austerity measures to avoid defaulting on its loans, Spain might bolster investor confidence in its future. Although this would mean many difficult years ahead for Spain, it would avoid a bailout and the EMU austerity measures that come with it and would remain a member of the EMU.
C. Second Euro
Some analysts have suggested the introduction of a “second euro” as another potential solution to the European debt crises. In this approach, the Eurozone would create another common currency alongside the euro that would support a struggling country’s transition from the euro to the new currency, and then possibly back to the euro. Supporters contend that allowing struggling countries to abandon the euro for a new “debt euro” might lessen the pain for the banks and the ECB and prevent the euro from depreciating rapidly.
The euro would trade alongside the second “debt” euro for a period of time, allowing the larger, stronger countries to continue business as usual without worrying about the struggling countries bringing down the value of the euro. Once the economies begin to recover, they could transition back to the Eurozone or back to their national currency.
Most economists find this plan unfeasible. The strategic planning and cooperation barriers between nations already struggling seem impossible to overcome. Struggling nations face the same difficulties as they would if they were to revert to their original currencies, including logistical issues and runs on their banks. The likelihood this plan takes effect is extremely low.
D. EMU Bailout…Or Not
Many are worried that Spain will require a bailout like Greece. One factor pointing to a Spanish bailout is Spain’s rising bond interest rates. Even though they are still lower than those in Greece, Ireland and Portugal, they are almost twice as high as Germany’s. High interest rates signify low investor confidence that Spain will be able to pay back its government debt. Investors require higher interest rates because the risk of default is greater. If Spanish interest rates get too high, issuing bonds to repay current debt will be virtually impossible because Spain will not be able to afford paying the high interest rates. These issues signal that Spain may be the next in line for a European bailout.
Nonetheless, others are more optimistic that Spain may not need a bailout, pointing to the differences between Greece and Spain. For example, Spain’s public debt (the debt of the Spanish government) is currently much more manageable than Greece’s was when Greece required a bailout. Spain’s public debt is around 60 percent of GDP, whereas Greece’s was around 140 percent. This could change, however, if Spain were required to assume the private sector liabilities from the cajas to reduce further economic losses and disruption, which would then increase Spain’s public debt.
Other analysts compare Spain’s financial situation to Ireland’s to support the argument that Spain will not need a bailout. Like the Spanish banking system, Irish banks also lent heavily to the real estate market. To deal with the real estate crisis, the Irish government, using taxpayers’ money, has injected billions of euros into its banks, and partly or fully nationalized its three largest banks. However, Spain’s economy is larger, and Spain’s real estate losses are smaller relative to its economy. Additionally, in comparison to the Irish banks, Spain’s three largest banks are in relatively decent shape. The cajas, on the other hand, are still in trouble. To resolve the financial crisis without a bailout, Spain must find another way to handle the cajas and their real estate debt.
IX. What Is Happening Now?
Spain has begun to implement regulatory changes. It passed a new law requiring that cajas reinforce their capital by September 2011 or face partial nationalization. The government has given the cajas time to find new investors or merge with other banks. However, if they are unable to recapitalize, the government will take them over.
Mergers have already begun, and there are now 17 cajas as opposed to 45 before the crisis. The Spanish government is strongly “encouraging” (by threatening nationalization) the cajas to recapitalize on their own by attracting private investor capital. Uncertainty regarding Spain’s financial future, resulting in low investor confidence, will likely prevent a complete recapitalization by private investors, and the cajas will probably have to tap into other government resources like the Fund for Orderly Bank Restructuring mentioned below.
The cajas are complaining that reform efforts are moving too quickly. They fear the efforts will most likely lead to the end of the cajas through nationalization or through mergers with larger listed banks. Although the cajas are complaining, it does not appear the government is concerned with their survival, but only with the recovery of the Spanish financial system as a whole. So far the government has overhauled regulations to allow the cajas to become joint-stock companies and list themselves on the market. New regulations will also require the cajas to be more transparent in their lending practices. Some analysts fear the cajas have covered up some of their losses and the government still is not aware of the full extent of the damage.
A new law also requires that a financial institution have enough equity to cover at least 8 percent (and up to 10 percent in some cases) of the bank’s “risk-weighted assets.” Risk-weighted assets are the assets of bank, such as loans, measured by their credit risk. These moves are meant to protect financial institutions by requiring them to hold more capital if, for example, they make risky loans. The goals set in place by the law must be met by September 2011, or the banks will face nationalization. Some cajas (those with concrete plans to begin trading publically) will have more time to allow them to find private investors to raise capital.
The Spanish government also created the Fund for Orderly Bank Restructuring (“FROB”) in June 2009. FROB’s purpose is to provide funds to manage bank restructuring. The Spanish government guaranteed €9 billion in capital, but FROB has the capacity to loan up to €99 billion to banks for restructuring efforts. However, to tap into these funds, banks must follow the rules laid down by the government, and banks eventually must repay the FROB loans. Banks have been slow to request these funds. Some waited until mid-2010 to begin the mergers required by FROB to receive funds. By March 2011, FROB had only disbursed about €12 billion.
In order to cut government spending, the Spanish government has begun implementing austerity measures to slow the increase in the government deficit. For example, it has announced that it was cutting a monthly subsidy for the long-term unemployed. Spain also cut public wages by 5 percent, froze salaries and pensions in 2011, cut a government benefit for new mothers, and raised the retirement age from 65 to 67. These reforms also apply to regional governments, which hire almost half of all public workers and control health spending. While there have been protests by workers’ unions regarding these measures, the opposition did not compare to those that immobilized cities across France in 2010 when President Nicholas Sarkozy increased the retirement age from 60 to 62.
The entire EU is also taking steps to solve the current problems as well as prevent another crisis from occurring. The EU created the European Financial Stability Facility (“EFSF”) in 2010 after the IMF and Eurozone countries bailed out Greece. The EFSF is an entity designed to issue up to €440 billion of debt on capital markets. The funds received from the issuance will provide loans to EU member states in financial trouble. If a country receives a loan from the EFSF, it will be subject to strict austerity measures such as tax and pension reform, decreases in public wages, and privatization of some industries. EU member states will guaranty the EFSF’s bonds. However, once a member state receives a loan from the EFSF, it is not required to guaranty loans made to other countries. Clearly this could lead to problems if too many countries request loans.
The EFSF is scheduled to expire in 2013, at which time it will be replaced with a permanent crisis mechanism called the European Stabilization Mechanism (“ESM”). The ESM will provide loans to a member state that is threatened with severe economic difficulties and will require borrowers to follow austerity measures similar to those from the EFSF. The ESM’s purpose is to avoid any future crises in the Eurozone.
The European Commission has also adopted a legislative package designed to prevent future economic crises and reform enforcement of the Stability and Growth Pact. This legislation requires closer monitoring of members’ fiscal policies. Warnings, and possibly fines, will be issued if a member state has deviated from the policies. The fines will be returned to the member if the deviation is corrected quickly. Perhaps most important, the legislation sets out minimum requirements for members’ fiscal policies. It also orders more frequent surveillance. If during surveillance, a severe fiscal imbalance is discovered, the European Council may make recommendations and enact an “excessive imbalance procedure.” The member state would then have to provide a plan of action to correct the imbalance, and the European Council must approve the plan. Finally, if a member repeatedly fails to act on these imbalances, it will have to pay a yearly fine equal to 0.1 percent of its GDP. These measures are a significant step toward tighter regulation of member states’ fiscal policies and attaining the goals and purposes of the Pact.
As of now, these policy changes still do not appear to be calming investors’ worries. Moody’s, a well-trusted credit rating agency, downgraded Spain’s public bonds in March 2011, causing heavy stock market losses because a lower credit rating suggests to investors that buying Spanish debt has become more risky. On the same day of the downgrade, the Spanish government issued a statement that it will only need to provide about €20 billion in new capital to the ailing banking system (a figure it has maintained for about a year). However, other analysts estimate this amount to be anywhere from €40 to €120 billion. While a spokesperson for Moody’s commented that the agency did not consider Spain as risky as Ireland, there is still too much uncertainty in Spain over the cost of recovery.
It is also important to note that while many EU members are suffering financially, EU countries are still joining the Eurozone. Estonia completed its integration into the Eurozone in the midst of the financial crisis. While some critics of the euro say that Estonia and the other countries on track to follow (like Latvia and Lithuania) have nothing to lose, their integration is still a sign of faith in the future of the Eurozone. Other members of the EU, like Poland and Hungary, have promised they would join the Eurozone but do not seem to be in a hurry to do so anytime soon. These nations will most likely wait to see how the Eurozone crisis is resolved before committing to the euro.
Spain still remains in a dire financial position. However, the Spanish government and the EU are working hard to ensure its recovery and stability. Spain found itself in a unique situation because of its real estate market and the actions of the cajas. When the real estate market collapsed, it brought the entire Spanish economy down with it. While the Spanish government perhaps should have acted sooner, it is acting now and making necessary changes to bring about recovery. Spain still may not see increases in employment or growth for many months, but Spain’s important position within the Eurozone and the resiliency of its government and people suggest that Spain will survive this financial downturn and will hopefully learn from its mistakes. The EMU will also learn from the mistakes made and will change its regulatory scheme to prevent future crises.
Estrada, J.F. Jimeno & J.L. Malo de Molina, The Spanish Economy in
EMU: The First Ten Years, Banco de España, 2009, available at http://www.bde.es/informes/be/ocasional/do0901e.pdf.