In the past, every time European leaders have huddled together and announced a plan to douse the latest fire in Europe, the financial markets have usually been placated for a brief while — say, a few weeks or months. Then another crisis flares up, and everyone starts panicking again.
That didn’t quite happen. As you can see from the chart below , the calm lasted about 4 hours and 40 minutes. As markets opened on Monday, Spain’s borrowing costs (in orange) dropped for a brief while before skyrocketing well above the worrisome 6 percent level. Italy’s borrowing costs (in gray) have also jolted upward. Investors are skittish about lending both countries money, because they’re worried about getting repaid:
So why didn’t the Spanish bailout reassure anyone? The line from most analysts is that the deal didn’t, as Wolfgang Munchau puts it, “render Spain’s position in the eurozone sustainable.” Under the agreement, Europe will lend the Spanish government up to $125 billion. A Spanish government agency will use that money to buy partial stakes in Spanish banks, giving the banks more capital — similar to how the United States recapitalized its banks with TARP. (Spain’s version, by the way, is called “FROB,” the Fund for Orderly Recapitalization of Banks.)
Trouble is, the Spanish government itself already has a high debt load — about 81 percent of GDP. That figure is expected to soar above 90 percent of GDP if Spain takes the full $125 billion loan. Given that Spain is now slogging through a recession that’s being exacerbated by large austerity measures, those debts are looking fairly unsustainable.
“The eurozone,” Munchau notes, “must recognise that some form of debt relief, or default, will be inevitable.” In other words, there are only two ways this can end: Spain is likely either going to need actual aid from the rest of Europe to fix its banks — rather than more loans — or it will end up defaulting on its debts. And if Spain defaults, the country is big enough that it could drag down the rest of Europe with it.