If the EU and the ECB bail out Portugal, they are almost certain to leave Spain, and the fate of Europe, at the mercy of the IMF.
At €500 billion (£430 billion), the price tag would be the largest since the aftermath of the Lehman bankruptcy, when the Troubled Asset Relief Programme sucked in $700 billion (£440 billion).
The economic and political consequences of a Spanish bailout, like Lehman, would be global and incalculable.
The arithmetic is brutally simple. The European authorities and the IMF have bailed out Greece to the tune of a third of its GDP. The EU contributed 75% of the €110 billion loan. The IMF lent 25%.
Through the European Financial Stability Fund (EFSF), the EU and the IMF are expected to lend Ireland a third of its GDP, or €80-90 billion – again, in the same proportions. As Portugal’s GDP is similar to Ireland’s, any loan is likely to be similarly large.
“The economic and political consequences of a Spanish bailout, like Lehman, would be global and incalculable”
Even before a Portuguese bailout, the EFSF will have only €350-360 billion available – not even enough to cover three quarters of a Spanish bailout. After a Portuguese bailout, it would only be able to contribute a half of the total, or €240-260 billion.
However, the arithmetic worsens when you consider that Spain, Greece and Ireland have guaranteed €72 billion of EFSF funding, which presumably would be ignored in the event they are bailed out.
Discounting those figures, the EFSF would have only €170-190 billion at its disposal – in other words, it would hold a minority stake in a joint bailout with the IMF.
Such an outcome would be a disaster for the EFSF. Its aim is not just to bail out failing eurozone countries, but to reform them in ways that are acceptable to the eurozone, not necessarily to the international community, which has different objectives. (article continues below)
The international community, for instance, would have fewer compunctions about reintroducing the Spanish peseta alongside the euro if it felt leaving the single currency was in Spain’s long-term interests.
It would also be more willing to negotiate an opt-out of any arduous European Union regulation if it thought Spain’s economy might benefit.
To preserve the eurozone’s sovereignty, the EFSF needs an extra guarantee of at least €200 billion from countries which do not need a bailout.
Unfortunately, the only country that could afford it would be Germany. France and Italy are hobbled by deficits – as is, among Ireland’s lenders, Britain.
“In Germany, the legality of bailouts is already in doubt, as its citizens agreed only to a eurozone without bailouts”
The EFSF would require France and Italy merely to guarantee new funds, rather than take them out of their budgets. But the new liabilities would leave their credit ratings and finances at risk.
In Germany, however, the legality of bailouts is already in doubt, as its citizens agreed only to a eurozone without bailouts.
Politicians and markets have blamed Germany for its no-bailout proposals, but in reality they may be the only way of appeasing the courts at home, as well as voters.
If Germany is required to disburse funds formally, rather than simply guaranteeing loans through the EFSF, that could rule out any majority European investment in Spain.
In the midst of massive European deleveraging, the eurozone would then have to negotiate its future with the IMF.
It is possible Spain’s austerity measures may save it. But, alternatively, they may leave it looking like Ireland.
Without a growth plan, Spanish cuts may reduce spending in some areas. But they will also increase benefit costs and hit tax revenues from the private sector.
Spain may have a lower public debt to GDP ratio than Greece or Ireland. But its bond yields will still almost certainly rise as it supplies the markets with debt, at the same time as investors flee peripheral eurozone countries.
Overall, Spain is a global top 10 economy with 20% unemployment, non-existent and falling growth and a budget deficit of 9-11% of GDP, alongside a huge and partly insolvent banking sector.
In the circumstances, to dismiss the Lehman comparison would risk complacency.