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EU scrambles to halt rise in Spanish bond rates

(Money Watch) With Spain's bond rates continuing to rise toward the breaking point, officials desperately searched for workable plans to rescue the nation's failing banks. Today's reports of aproposed European "banking union"came even as the ECB rejected an earlier bailout plan from Madrid. A banking union would oversee and, if necessary, bail out failing institutions.

On Friday Bankia, Spain's 4th largest bank, collapsed and told the government it needed a $24 billion bailout. Over the weekend Prime Minister Mario Rajoy had proposed the novel idea of 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.

Today the European Central Bank rejected the idea, saying it would be a form of "monetary financing," or central bank funding of governments, explicitly banned by the EU.

Meanwhile, the EU's governing body called for a "banking union" that would allow the 17 nations using the Euro to share the burden of bank failures. The European Commission plan would boost cross-border banking management and burden-sharing and counter the continent-wide unraveling of cooperation. The commission also said that it might consider letting the euro zone's new rescue fund directly boost the capital of banks in an effort to stop bailouts from pulling down governments' own finances.

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Last week the EU began said it would study the idea of so-called "Euro-bonds," which would be based on the entire region's economic strength instead of just that of an individual nation. Germany and other nations with healthy economies oppose these bonds because it would raise their borrowing costs. Even if they went along with the idea it -- like the banking union plan -- would almost certainly take too long to implement to have any impact on the current situation.

The interest rate on Spanish 10-year bonds, a key indicator of market confidence in a country's ability to pay its debt, shot up a quarter of a percentage point (a big move for bonds) Wednesday to 6.67 percent. This matched the all-time highs it hit during the worst of the EU financial crisis late last year. Ireland, Portugal and Greece all sought international bailouts when their interest rate hit 7 percent. The size of Spain's economy -- the world's 13th largest -- means any such rescue effort is impossible.