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Spain bailout offers calm before more storm

(MoneyWatch) Spain's decision to ask for $125 billion to bail out its banks will be a short calm before the EU financial crisis returns to a full storm.

This week Greece will once again be the focal point, with tomorrow's government bond auction, followed by a critical election next Sunday.

On Saturday, Spanish Finance Minister Luis de Guindos announced that the European Union will loan Spain up to $125 billion to funnel to banks that need capital. This is a radical reversal from Madrid's earlier statements and makes the nation the fourth and largest EU economy to require rescue funds.

In his statement de Guindos tried to cast the loan request as an attempt to aid Europe and not just Spain, saying, "The Spanish government is determined to do its best to protect the stability of the euro." He also stressed that the conditions attached to the loans "will be imposed to banks, not to Spanish society, nor to its fiscal or economic policy."

Madrid has imposed severe budget cuts to deal with an economy reeling from the collapse of a massive real estate bubble. That collapse has left much of its financial institutions with debts much greater than their assets. The situation came to a head three weeks ago when Bankia, the nation's fourth largest bank, asked the government for a $24 billion bailout. Although Prime Minister Mario Rajoy said he would not seek a bailout, rising interest rates and the debt crisis of Spain's regional governments left him with no choice.

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It is still unknown if the bailout will be large enough. While an IMF study released Saturday said the banks would need $50 billion in outside aid, a report from Fitch Ratings released on Friday said the banks need $126 billion to recapitalize, roughly $86 billion of which would have to come from abroad. This is a huge increase from Fitch's previous total estimate of $37 billion. The true amount will likely not be known until an independent audit of the banking system's condition is released at the end of the month.

Despite this, the agreement will likely calm the markets in the run-up to the critical Greek elections next Sunday.

Greek voters must decide if they wish to remain in the EU, which many see as essential for the nation's future. However, doing this means accepting the terms of an international bailout which has devastated the nation. Even the organizations behind the bailout - the EU, IMF and European Central Bank - admit its terms offer scant hope for improving Greece's economy any time soon. (Sunday's vote is being held because elections last month failed to give a majority to parties either for or against the bailout.)

Tomorrow Greece will hold a bond auction, the results of which will indicate how international lenders expect the election to go. Higher yields will show increased greater concern that the bailout will be rejected, although it is difficult to see how much higher yields could go. Greece currently has to pay 29 percent interest on 10-year loans and 24 percent interest on 20-year loans. The rate on 1-year loans is nominally 1,143 percent, but no 1-year bonds have sold since March, putting the effective interest rate at infinity.

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