In a beautiful poem called “The Capital,” W. H. Auden talks about rich people “waiting expensively for miracles to happen.” That is what is happening in all the capitals of Europe now, nowhere more so than in Madrid. Spain’s economy carries two impossible burdens. It has the most overregulated labor market in Europe, a legacy of the Franco era that the long-ruling Socialist party (PSOE) fought to defend. This generates spectacular levels of unemployment: 24 percent for all workers, 51 percent for young people. Second, Spain’s resources have been misallocated on Europe’s biggest housing bubble. Precious little of the capital that flowed into Spain over the past two or three decades can now be redeployed to make anything anyone would conceivably want to buy.
So only good news from somewhere else will get Spain out of its present economic mess, and there was not much of it last week. A lackluster Italian bond auction was followed by the worst U.S. employment report in more than a year, and those bracketed the announcement by the Bank of Spain that investors had taken
$121 billion (about 10 percent of GDP!) out of the country in the first three months of this year. That raised the specter of a bank run. Spain’s bond yields have risen to 6.6 percent, on the eve of a big bond sale.
What has got Spain into so much trouble? All along, the country has had trouble meeting its budget targets. It ran a deficit of 8.5 percent of GDP under the spendthrift PSOE prime minister José Luis Rodríguez Zapatero. The new Popular (conservative) leader Mariano Rajoy, who replaced Zapatero in December, announced he would not be able to bring debts down to 5.3 percent as promised. Historically, countries can collapse when public borrowing and spending on this scale persists. As a point of comparison, the U.S. budget deficit was
8.7 percent last year.
That is the gradual way Spain fell into crisis. The sudden way is that the International Monetary Fund revealed several weeks ago that a large banking group called Bankia had been manipulating its books, overstating the market value of its loans. The sins were not quite as bad as those of Greece, but the Spanish economy is larger and the hour is later. Spain has said it will inject about $24 billion into the bank, but European banking authorities have warned that the government will only jeopardize its own finances by doing that.
Bankia is not as distant from the government as it looks. It is the legacy of the system of cajas, provincial banks started in the 19th century, that came to make up more than half the country’s finance system. They were traditionally community-oriented, like savings and loans, and many were even linked to the church. But the particular way they went bad has more in common with the story of Fannie Mae and Freddie Mac than with our S&Ls. Because of their mission for community improvement, the cajas wound up immensely useful to the national political parties, which stacked their boards with political hacks who know nothing about economics.
Vicente Cuñat and Luis Garicano, two distinguished economists at the best Spanish economics blog, Nada es gratis (roughly, “No such thing as a free lunch”), wrote a fascinating essay two years ago correlating the performance of banks with the provenance of their chairmen. Their conclusion: “Cajas whose chairman was previously a political appointee have had significantly worse loan performance.” The cajas of both parties were dangerously overextended even before the world financial crisis began in 2008.
Bankia, as it happens, is a problem of Rajoy’s ruling Popular party. It grew out of the merger of Caja Madrid with six other small savings banks in late 2010. Madrid is a fief of the Populares. Bankia’s director was, until recently, the former Popular economics minister and IMF managing director Rodrigo Rato. There is a perception that Bankia’s brass has been stonewalling investigations into the bank’s finances.
Yet it is not certain that Rajoy’s government is in jeopardy. The scandal is more bipartisan than one might think. This is partly because the prominent Socialist Miguel Ángel Fernán-dez Ordóñez, the departing governor of the Bank of Spain, endorsed a plan a few weeks ago to recapitalize Bankia by drawing on a hitherto untapped source: the pensions and savings of half a million private citizens. Those investments have lost 70 percent of their value in the meantime. The Bankia scandal thus manages to combine the crony capitalism of the banks linked to Ireland’s longtime ruling party Fianna Fail and the malevolent hocus-pocus of Enron.
Believe it or not, the directors of the European Union have a solution to the Spanish banking crisis. It involves handing over to the directors of the European Union the authority to run the Spanish banking system. Last week, José Manuel Durão Barroso, the (Portuguese) president of the European Commission, called for a “banking union” with a bailout fund. Mario Draghi, the (Italian) head of the European Central Bank, backed Europe-wide banking oversight. Both of them seemed to be talking about establishing a Brussels-based equivalent of the FDIC—which would involve giving European bureaucrats more access to all Europe’s national treasuries—but they left the details vague.
The vaguer the better. Since the bank-and-government-debt crisis began in Greece two years ago, Europe has set up a number of structures to provide liquidity to troubled banks: First there was the European Financial Stability Facility. Now there is the planned European Stability Mechanism. It’s one-for-all-and-all-for-one. Should a country get into trouble, the rest of Europe will back it up.
Unfortunately, most bailout plans envisioned Spain among the bailers, not the bailees. It is becoming apparent that the list of countries that will not under any circumstances need a bailout has fallen to just a handful: Germany, Finland, Austria, the Netherlands, and Luxembourg. For Brussels, the debts of Europe’s mismanaged countries must now be “integrated.” This is a euphemistic way of saying that Europe’s well-managed countries must pay them.
Christopher Caldwell is a senior editor at The Weekly Standard.