Initial Relief Over Spain's Bailout Fades To Worry

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Financial markets did not show much enthusiasm for the European Union's plan to rescue Spanish banks. While stock markets across Europe managed to hang on to small gains, the interest rate Spain has to pay to borrow actually went up.

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Financial markets were also underwhelmed today by the EU's plan to bail out Spanish banks. As NPR's John Ydstie reports, initial relief in the markets faded quickly.

JOHN YDSTIE, BYLINE: Spanish bonds had a burst of strength shortly after markets opened, sending interest rates on Spanish government debt sharply lower. But by afternoon European time, investors had reconsidered. And the interest rate they demanded to hold 10-year Spanish debt shot, back up to more than 6 and half percent. Nariman Behravesh, chief economist at IHS Global Insight, says that's partly because there are still a lot of questions about the bailout.

NARIMAN BEHRAVESH: And very importantly, what Spain is going to do next, in terms of cleaning up the mess that it has in its banking system. So far, it's been very slow to clean up that mess; to restructure its banks, to - you know, to write down the loans.

YDSTIE: Behravesh says writing down the loans is not as easy as it may sound because a lot of the Spanish banks' debt holders are in Germany, and not interested in experiencing losses. And while the bailout is aimed at shoring up Spanish banks, it comes from the EU as a loan to the Spanish government. That's what investors are most worried about, says Behravesh.

BEHRAVESH: What this bailout does is, in effect, it increases Spanish government debt. So it's not a costless bailout for Spain.

YDSTIE: Behravesh says the bailout could boost Spanish government debt by around 10 percent. Peter Boockvar, equity strategist and portfolio manager at Miller Tabak, says that's the basic problem. Even if the bailout money adds capital to Spanish banks, a huge part of the banks' assets are Spanish government bonds. And, Boockvar points out, those bonds fell in value today after the bailout was announced.

PETER BOOCKVAR: So while Spanish banks may soon have more capital, if the Spanish sovereign bond market deteriorates further, well, that's going to impair the Spanish bond holdings of the Spanish banks.

YDSTIE: And, he says, that sets up an inevitable downward spiral. Boockvar says the markets did gain last week, when a deal between the EU and Spain was first telegraphed. But that enthusiasm evaporated today as reality set in.

BOOCKVAR: The market likes bailouts. They like the short-term putting out of fire. But as we've seen in - whether it's in the U.S. or afterwards, in Europe over the past five years - is that it doesn't really solve the long-term problem of too much debt, not enough growth.

YDSTIE: Boockvar says it's a short-lived Band-Aid, largely aimed at getting the markets past the Greek elections on Sunday. The bailout will be useful if Greek voters support parties that reject their austerity program. That would increase the odds of a messy Greek exit from the euro.

BOOCKVAR: At least the Spanish banks have this backstop so we can hopefully, contain any Greek issue to within Greece.

YDSTIE: Jim Paulsen, chief equity strategist at Wells Capital Management says, the Spanish bank bailout announced today is far from the final step in ending the euro crisis. But Paulsen says he's beginning to view the dangers of Europe less as a financial contagion that could bring down the world, and more like simply a drag on growth.

JIM PAULSEN: And what really is going to matter is if the U.S. economy's holding together or not - because if it is, then you got a pretty cheap market here.

YDSTIE: And the U.S. market got even a little cheaper today for buyers who might be tempted as all the major stock averages fell.

John Ydstie, NPR News, Washington.

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