For weeks, public opinion in Europe has focused on the Presidential election in France, seen as a pivotal moment for Europe and for the future of the euro zone. But the obsession with France has already ebbed, and with stunning speed. It should not have come as a surprise. Speculating about a possible shift in the balance of power in Europe quickly recedes when the periphery of the continent is under attack. So, instead of musing about their bilateral relationship, leaders in Paris and Berlin quickly refocused their attention on the situation in Spain and Greece. For now, squabbling over the meaning of the word “growth” has subsided, leaving Greece and Spain in the spotlight.
In the past few days we witnessed a replay of what the euro zone went through in late October of last year. The Greek Prime Minister at the time, George Papandreou, first agreed to meet new, tough European conditions, and then jeopardized the latest bailout deal for his country by announcing that he would put the whole thing up for a referendum. And here we are again. The current political impasse is the consequence of the Greek vote, which produced a clear majority in support of the euro, but no majority in support of austerity. When the leader of Syriza, the leftist party, lashed out at the country’s bailout program, European officials in Brussels and leading members of the German government questioned Greece’s ability to stay in the euro zone. Back in October, their sobering message was exactly the same. At the time, putting fear into Greeks did the trick. The government in Athens stuck to the agreement and Greece stayed in the euro. This time around, the Greek left gambled on the hope that French President-elect Francois Hollande might come to their rescue and lend his support to their anti-austerity calls. It was a miscalculation on the Greek side. The appeals from Athens were met with silence in Paris. While going to press, it appears that the prospect of a pro-euro and pro-austerity coalition in Athens is still in the cards, albeit with a narrow majority of seats in Parliament. If, on the other hand, new elections are necessary, pollsters predict a stronger showing for traditional, pro-euro parties. To avoid being caught on the wrong foot again, European leaders have decided to meet at the end of this month. The official purpose of the meeting is to prepare their June summit on “growth”, but in reality it will provide an opportunity to discuss the situation in Greece and Spain.
Madrid now faces similar conditions to those that forced Ireland to seek protection under the umbrella of the European rescue program. Like Ireland, Spain is weighed down by a struggling banking sector filled with a toxic mix of home loans and corporate debt. The attempt by Spanish authorities to consolidate the smaller savings banks known as “cajas” into bigger financial organizations, such as BFA Bankia, has failed. As they have discovered, putting together many zombie banks does not result in one healthy financial institution. In a last minute attempt to save Bankia, the Spanish government this week injected capital into the bank to try and avert its collapse, while knowing full well that this could be just the tip of the iceberg. Not unlike the U.S., the real estate sector in Spain has proven to be a powerful drag on the wider economy. Most analysts agree that it will remain depressed for some time. Real estate-backed assets could force the Spanish banking sector to its knees, unless written down or transferred into a new entity, such as a “bad bank.”
During the recent spring meetings of the International Monetary Fund (IMF) and the World Bank only a few weeks ago, European officials were pressed by the IMF to urgently deal with the Spanish banking sector. At the time, Europeans had come to Washington determined not to take the blame for the woes of the global economy. Their message was that Europe was doing its homework, and that, despite its current weakness, even the Spanish economy was rapidly regaining competitiveness. The Germans, in particular, resisted calls to use bailout funds from the European Financial Stability Facility (EFSF) to recapitalize banks directly without routing the money through the Spanish government. EFSF head Klaus Regling, along with German government officials, insisted that Spain first needed to ask for assistance and only then, with strict conditions attached, would the EFSF be able to intervene.
But of course Spain wants to avoid the stigma of being subjected to a bailout program, and it is desperately trying to sort things out on its own. Can it succeed? Not if the Spanish economy does not grow. With most of the euro zone’s economy in recession, even Germany’s willingness to allow its economy to slightly overheat will not be enough to offset the Spanish crisis. In all likelihood, the UK, Spain, Italy and France will continue to be a drag on the European economy for some time to come, which will prolong the recession. Germany alone will not be able to break this vicious cycle, even if it is now much more willing to amend some of its own principles of fiscal and price discipline. For most Europeans the outlook remains gloomy. There is much more pain ahead. Welcome back to crisis management.