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Lack of detail on Spain rescue spooks investors - Eyes now on Italy

Published:Wednesday | June 13, 2012 | 12:00 AM

Investors continue to find more questions than answers in Spain's decision to seek help for its ailing bank sector and tap a €100 billion (US$125 billion) euro area bailout fund.

World stock markets were mixed Tuesday as enthusiasm for a European plan to rescue Spain's teetering banks turned to scepticism.

The country's borrowing costs rose sharply Tuesday for the second day in a row while stocks seesawed as markets fretted about whether the new €100 billion lifeline is enough to contain the 17-country single currency union's debt crisis, and whether private investors in Spain might not see their debts paid off.

"EU leaders continue to give their best impression of blind men groping around in the dark for a solution to the debt problems afflicting Europe," said Michael Hewson, senior market analyst with CMC Markets.

The interest rate - or yield - on Spain's 10-year bond rose to 6.63 per cent, close to the 7.0 per cent level that forced Greece, Ireland and Portugal to ask for more rescues of their public finances, according to financial data provider FactSet.

Stocks slipped early on Madrid's IBEX-35 index, then turned to positive territory were up 0.9 per cent in midday trading.

The bank rescue package was announced Saturday by finance ministers from the 17-country euro area, but no amount has been set for how much Spain's banks will receive. Investors are also becoming increasingly worried that private bondholders could be placed lower in the pecking order of debt repayments if money from a new Eurozone rescue fund is used in the bailout.

It is not yet clear where the euro area bailout loans will come from.

If the money comes from the existing Eurozone rescue fund, the European Financial Stability Facility, its repayments will have the same priority as all the other private bond investors. However, if the funds are to come from the new bailout facility, the European Stability Mechanism, its bond repayments will be given a higher priority than everyone else's - which could mean that other debt would be less likely to be paid off.

That could make bondholders less willing to buy Spain's debt or demand a higher interest rate to compensate for the added risk of losses.

Spain will wait for the results of two independent audits of the country's banking industry before saying how much of the €100 billion it will tap.

The bailout loans will be paid into the Spanish government's Fund for Orderly Bank Restructuring, which would then use the money to strengthen the country's teetering banks.

Spain needs €40 billion

In a report released late last week, the International Monetary Fund estimated Spain needs around €40 billion to prop up banks hurting from an unprecedented real estate boom that went bust.

Investors also want to know whether Spain will ask for a safety margin of extra money to cushion itself against further shocks, such as a deterioration in the economy.

While Spain's bailout is designed to prop up its banks, investors are also worried that the Spanish government might eventually be forced into asking for a bailout to help it pay its way.

Recession-hit Spain, which has the Eurozone's fourth-largest economy with unemployment of nearly 25 per cent, may be too big for the Eurozone's rescue funds to handle.

Spain is also getting punished because of fears Greek elections on Sunday will hand a victory to the radical left-wing Syriza party, campaigning on a pledge to refuse to comply with terms of that country's bailout package.

This could eventually push Greece out of the euro, further destabilising the currency group.

Once it became clear that the rescue money for Spain's banks would not solve that country's problems, investors have turned their attention to Italy, whose economy is larger than Spain's.

Italy didn't suffer through a real estate bust, so its banks are in better shape. But like nearly half of the countries in the euro, its economy is shrinking, making it difficult for the government to chip away at a mountain of debt

"Although Italian banks are relatively sound compared to the Spanish counterparts, without the heavy weight of toxic real estate bubble and are much less exposed to the government bonds, the real question is whether the country can grow itself out of the recession," said Anita Paluch of Gekko Global Markets.

Italy's government on Monday confirmed that the country's recession is deepening. The economy contracted at a quarterly rate of 0.8 per cent in the first three months of the year, the worst contraction in three years and double Spain's rate.

- AP