Analysis : The ever-diminishing returns from Europe's bailouts

NEW YORK Mon Jun 11, 2012 4:58pm EDT

NEW YORK (Reuters) - So much for the relief rally.

After bouncing overnight on news that Europe had stitched together a $125 billion rescue for Spain's banks, gains for global stocks and the euro fizzled.

Bailouts for debt-strapped countries have provided a short period of comfort for investors, one that quickly gets eroded by fear about Europe's vicious circle of slow or no growth and growing debt burdens. On Monday, the speed of that reversal was quicker than ever.

Greece's first bailout in 2010 sparked a healthy 1.3 percent rally in the benchmark Standard & Poor's 500 stock index on the following day, but subsequent rescues fostered more muted responses.

The reaction after Spain's bank bailout has been the most downbeat of the lot, particularly given the size of the package and the speed with which gains were wiped out. U.S. stocks fell into negative territory within an hour of Monday's opening bell and then continued dropping.

"Even the most inconsolable and bearish analysts were taken aback at how decisively markets rejected this bailout," said Richard Franulovich, currency strategist at Westpac Securities.

U.S. stocks .SPX fell 1.3 percent, and the euro shed 0.2 percent, while Europe's leading index of blue-chip shares .STOXX50E and Spain's IBEX 35 .IBEX declined.

The four prior bailouts -- for Greece and Ireland in 2010, Portugal in 2011 and Greece again in 2012 -- showed the euro's rallies fade within a month, while stocks were mixed, based on various factors.

In the credit default swaps market, where investors take out insurance against the risk of sovereign default, the pattern has been similar. The cost of buying insurance against Greek, Irish or Portuguese default tended to drop after the first two weeks as investors took the bailout news as a sign of relief, only to rise back to pre-bailout levels or higher within a month.

After initially falling, the cost of insuring $10 million of Spanish government debt against default rose to 595 basis points, or $595,000 per year for five years, financial information firm Markit said. That is just off a record high.

Investors eager for a fix that involves more European Central Bank support and a common European bond market say Europe's piecemeal approach to the crisis is scaring markets.

"We've been getting what I call 'bread crumbs,'" said James Dailey, portfolio manager of TEAM Financial Asset Management. "What we need is a comprehensive European solution. Until we see something massive from the ECB, it's not addressing the issue. The problem is not liquidity, it's solvency."

VICIOUS FEEDBACK LOOP

Investors worry that higher borrowing costs for Spain, Italy and others will shut these governments out of international capital markets entirely.

Yields could rise further if a Greek election next weekend produces a government that opts to abandon the euro rather than stick to fiscal austerity, or if Spain suffers another downgrade.

Markets also fear that the bank rescue will add some 10 percent to Spain's debt-to-output ratio, which is expected to near 80 percent by the end of the year.

The end result could be one in which European Union leaders are forced to follow the bailout of Spanish banks with one for the Spanish government.

"For the Spanish economy as a whole, there has been no debt relief," Franulovich said. "This is what happened to Ireland. The banks are in healthier shape today, but the sovereign is in real trouble."

In fact, a report by Spain's central bank showed Spanish banks were the main buyers of Spanish sovereign debt last year, essentially making the government dependent on the banks it is now trying to help.

"The Spanish government bails out Spanish banks, and Spanish banks bail out the Spanish government," Nobel Prize-winning economist Joseph Stiglitz told Reuters. "It's voodoo economics. It is not going to work, and it's not working.

Spanish 10-year government bonds had one of their worst days in two months on Monday. The yield rose to 6.51 percent, a clear sign that the market lacks confidence in the measures taken.

"Inevitably, the markets have started to look beyond Spain to other vulnerable members of the euro zone," said Gavan Nolan, Markit's director of credit research, due to fear that other countries will seek similar rescues for their banks.

Of most consequence is No. 3 euro zone economy Italy, which has the world's third-largest sovereign debt market. Italy's CDS widened to 550 basis points on Monday.

Jack Ablin, chief investment officer at Harris Private Bank in Chicago, said the ever-growing crisis should convince policymakers to think bigger in addressing the crisis.

"Investors are getting tired," he said. "There's only so much plaster you can put on a crumbling wall."

(Additional reporting by Tiziana Barghini; Editing by Martin Howell and Lisa Von Ahn)

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Comments (12)
OgilvyBack wrote:
These crises will never stop until central banking has been dismantled around the world and the endless printing and lending of phony (fiat) money is stopped once and for all.

Jun 11, 2012 6:02pm EDT  --  Report as abuse
tt0077 wrote:
Insanity – doing the same thing over and over and expecting different results. (Albert Einstein)
I have a question. Is there a successful Catholic nation in the world? Please name one.
The Illegals come to this nation to escape the opression, ignorance, and failure of the nation that they come from. They came to escape from Catholic nations. Then, when here, they keep the very thing that caused the failure of their nation. The Catholic church is the common link to all of these failed nations. This is insanity! This is not a R and D problem, it is a Catholic problem. The Catholics are screwing up all of government so they can conquer the US just like they have every nation south of the US. Catholics do not compromise, they do not negotiate. Calif. has been in deadlock, and Catholic for 20 years. The US govt is in deadlock for 5 years. (30 percent of congress is Catholic, and that makes a bloc that stops everything. (NO BUDGET) There have been attempts to control the border, no go. There have been attempts to stop illegal aliens, no go. In a thousand years there has not been a successful single Catholic nation. The Constitution is secular (no religion). Keep it that way.
The bible does not trump the Constitution. The vatican does not rule the white house. (yet).
There are more Catholic Ds, than Rs. Vote all Catholics out to restore the Constitution.

Jun 11, 2012 6:05pm EDT  --  Report as abuse
lucky12345 wrote:
Germany should just bring back the Mark and leave the EURO, done end of story…
Just reading the article makes you wonder why the effort to “save the banks” when the stock market is crashing… You would think governments would be focusing on reducing government debt and not looking for more handouts!
The longer you have the ECB and IMF creating money out of thin air, the longer you will have this problem. It’s been 3 years and counting with no end in sight. Germany cannot afford to bail out the PIIGS and why should they? The EURO was a nice experiment which has failed, sorry but that’s the way it is…
The EU is a good idea, the EURO is not. Hell will not freeze over if the PIIGS dump the EURO. Politicians will look foolish, but they should be used to that by now…

Jun 11, 2012 6:08pm EDT  --  Report as abuse
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