Spanish interest rates near crisis levels

The Stock Exchange main display is reflected on a Bankia sign in Madrid, Monday, May 28, 2012. Shares in Spanish bank Bankia, one of the banks hardest hit by Spain's real estate collapse over the past four years, fell 28 per cent on opening in Madrid on Monday, the bank's first day back on the stock exchange following its announcement Friday that it would need Euro 19 billion ($23.8 billion) bailout to bolster its defenses.(AP Photo/Daniel Ochoa de Olza) Daniel Ochoa de Olza

(MoneyWatch) Interest rates on Spanish bonds hit crisis levels today despite Madrid's increasingly desperate efforts to reassure investors. Investors are reacting to Friday's collapse of Bankia, the nation's 4th largest bank, and the announcement that Catalonia, Spain's most prosperous state, needed government help because it could no longer borrow money to pay its bills.

European stocks turned lower today as Spanish 10-year bond yields climbed to 6.47 percent, its highest in 2012. Compare that with 10-year German bunds, which pay 1.36 percent, or the U.S. 10-year Treasury note, at 1.75 percent -- those 5 extra percentage points of yield are what investors demand for the risk of lending money to the Spanish government.

On Friday, Bankia told the government it would need a $24 billion bailout from the government. Over the weekend Bankia's President, Jose Ignacio Goirigolzarri, said that the bank would not need any aid in addition to the funds it had requested. He said the bank was prepared to sell a large portfolio of real estate and a "significant package" of companies to make itself solvent. It currently holds an estimated $40 billion in toxic assets derived mainly from the burst real estate bubble. Putting those assets up for sale would be likely to lessen their value by further depressing Spain's already collapsed real estate market.

Prime Minister Mario Rajoy says the government will use its own debt to fund Bankia and thereby avoid having to borrow more money on the bond markets. This extremely unusual plan would have Madrid issuing Spanish-government-guaranteed debt to Bankia in return for equity, with the bank then able to deposit the bonds with European Central Bank as collateral for cash.

This problem, though, has been eclipsed by the Catalonia regional government's request of aid from the national government. The region, which represents about one fifth of the Spanish economy, can no longer afford rates on the bond market and wants Madrid to guarantee its bonds. The region has more than $16.46 billion in debt to refinance this year.

Unfortunately Catalonia's request is in danger of putting the national government into the same circumstances. Its interest rates continued to climb closer to 7 percent, the level that forced Greece, Portugal and Ireland to ask for international bailouts. Rates on Italian bonds have also risen. Spain has the world's 13th largest economy -- far too large for any rescue operation. Catalonia's economy alone is almost the same size as Portugal's.

The bad news in Spain overshadowed developments in Greece, which gave investors some cause for optimism. Weekend opinion polls strengthened hopes that Greece might stick with the euro and austerity measures.

The likelihood of Greece leaving the eurozone had been growing steadily since early May, when political parties opposed to the harsh terms of the country's financial rescue received unexpectedly high support in polls. A Greek exit would extend financial turmoil in the country and spread financial difficulties to other nations using the euro.

The May election results were so splintered that it left Greece without a coalition government. Another election has been set for June 17.

The Associated Press contributed to this report

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    Constantine von Hoffman is a freelance writer and writing coach. His work has appeared in outlets such as Harvard Business Review, NPR, Sierra magazine, Brandweek, CIO, The Boston Herald, TheStreet.com, CSO, and Boston Magazine.

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