The plan to bail out Spain's banks with up to $125 billion in aid buys European policymakers time to try to save the euro and eases deep fears in global financial markets.
The deterioration of Spain's banks and the pressing need for a rescue was threatening to bankrupt its government. That would likely cause far more pain for Europe than the financial messes in Greece, Portugal and Ireland, smaller economies that have received bailouts.
Investors need all the reassurance they can get. They're already worried about what will happen when Greek voters go to the polls June 17. The Greeks could elect a government that will refuse to live up the terms of a $170 billion bailout. That could force the country to exit the euro — an outcome that would raise fears that another, bigger European country might be next.
"A significant part of this (bailout for Spanish banks) has to do with ring-fencing Greece," says Jacob Kirkegaard, a research fellow at the Peterson Institute for International Economics in Washington. "This is enough to prevent added market contagion."
Spain on Saturday asked the 17 countries that use the euro currency for money to rescue its banking system. European officials responded by offering to provide up to $125 billion to rebuild Spanish banks' capital, their financial bulwark against losses on bad loans.
Europe's troubles also are causing economic problems for the United States and developing countries such as China and Brazil, which rely on Europeans to buy their exports. So the plan unveiled Saturday eases pressure on President Barack Obama and the world economy as well.
"This move will come as a relief to the Obama administration as it suggests that European leaders are finally beginning to take significant actions to ease the intensifying pressure on the euro zone's peripheral economies" such as Spain and Portugal, says Eswar Prasad, professor of trade policy at Cornell University.
Spain had been resisting pressure to seek outside help for its banks, which have been overwhelmed by bad real estate loans. But leaders became increasingly concerned that any fallout from Greece's upcoming elections would rock markets, further hurting Spain's financial sector. The exact amount Spain needs won't be clear until outside accountants complete an audit of its banks by June 21.
Unlike the other European countries to receive bailouts, Spain did not have to agree to deeper cuts in its government budget to secure the help. More austerity likely would have pushed Spain, already suffering from near-25 percent unemployment, deeper into recession.
"You don't want an economy of that magnitude going down the tubes," says Daniel Drezner, a professor of international politics at Tufts University in Medford, Mass. Spain has the world's 13th-biggest economy, more than four times the size of Greece's. It is the fourth-largest economy in Europe.
In recent weeks, jittery investors had demanded higher interest rates on Spanish bonds, making it clear that Spain would not be able to borrow enough money in the markets for its own bank bailout. The rising fears come at a time when nearly half the countries that use the euro are in recession. At 11 percent, unemployment in the euro zone is at the highest level since the single currency was introduced in 1999.
European economic troubles pinch U.S. businesses. U.S. companies send 22 percent of the goods they export to Europe and already have more than $2 trillion invested in factories, offices and businesses there. A bigger fear is that Europe's financial troubles could cross the Atlantic. When banks lose confidence in each other, they refuse to lend each other money, causing a credit crunch that can wreck economies on both sides.
"Anything that calms European markets is good for the United States," says Tufts' Drezner.
The Spanish deal also gives European policymakers more time to strengthen the single currency. They are already talking about creating a "banking union" with a centralized regulator, a bailout fund and a European Union-wide deposit insurance backstop.
"Spain's decision to seek a bailout for its banks buys some temporary breathing room for the Eurozone," Cornell's Prasad says.
But Europe's troubles aren't over.
Europe still needs to find a way to stimulate economic growth across the continent so that European countries can begin to grow their way out of their debt problems. And the eurozone countries must pull closer together politically and economically, agreeing to more standardized policies limiting government debts and strengthening bank regulation.
Meantime, other big countries continue to struggle with big government debts and wounded banks.
"You don't know if three months from now it's going to be Italy" lining up and asking for a bank bailout, Drezner says.
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