Rescue loans for Spain's banks buys Europe time

WASHINGTON (AP) ? A $125 billion plan to rescue Spain's banks won't solve Europe's debt crisis or ease the pain of double-digit unemployment across the continent.

But it is likely to calm financial markets and buy time for European policymakers to work with other weak economies threatening the stability of the 17-nation eurozone.

Europe still has plenty of troubles to address in the three other countries that have already received financial help ? Greece, Portugal and Ireland. In Greece, voters could elect a government next week that will refuse to live up to the terms of the country's $170 billion rescue package. Portugal is combating a toxic combination of high debts and 15 percent unemployment. Ireland is cleaning up a banking mess a lot like Spain's. Then there's Italy, the eurozone's third-the largest economy, where debts are piling up as the economy stagnates.

"We still have some pretty fundamental problems to solve," says Nicolas Veron, senior fellow at the Bruegel think tank in Brusssels. "We need more radical solutions than this one."

Germany, worried that it will get stuck with the bill for any ambitious schemes, has rejected several ideas for easing the crisis. It has been reluctant to ease the terms of previous bailouts to reduce the pain of austerity on Greece, Portugal and Ireland. And it has resisted calls for the creation of joint "eurobonds" that would raise money and spread responsibility for repayment across the eurozone.

Likewise, the European Central Bank has been reluctant to intervene to jolt the eurozone economy. Last week, it passed up an opportunity to reduce interest rates. And it has been reluctant to flood the economy with money to push down interest rates the way the U.S. Federal Reserve has.

But the plan to lend gobs of money to Spanish banks eases an immediate crisis in the euro's fourth-largest economy. The deterioration of Spain's banks and the pressing need for a rescue was threatening to bankrupt its government. That would likely cause far more pain for Europe than the financial messes in Greece, Portugal and Ireland.

Investors were already worried about what will happen when Greek voters go to the polls June 17.

If Greece reneges on the strict austerity measures that come with its rescue package, it could be forced to abandon the euro. Greece's departure from the Eurozone would likely cause financial chaos across Europe: Greek debts would go from being denominated in sturdy euros to being denominated in Greek drachmas of dubious value.

Worse, a Greek exit from the euro would raise fears that another European country such Portugal or Italy might be next.

"A significant part of this (bailout for Spanish banks) has to do with ring-fencing Greece," says Jacob Kirkegaard, a research fellow at the Peterson Institute for International Economics in Washington. "This is enough to prevent added market contagion."

Spain on Saturday asked the 16 other countries that use the euro currency for money to rescue its banking system.

Spain has not yet said how much money it would seek. But the Eurozone finance ministers said in a statement Saturday that they were prepared to lend up to ?100 billion.

"This move brings into sharp relief the enormous amount of money that will be needed to cordon off the rest of the euro zone periphery in the event of a Greek meltdown," says Eswar Prasad, professor of trade policy at Cornell University.

The rescue loans will be sent to the Spanish government's Fund for Orderly Bank Restructuring (FROB). The fund would then use the money to strengthen the Spanish banks' capital, their bulwark against loan losses.

Spanish Prime Minister Mariano Rajoy said interest rates on the loans will be considerably lower than the rate near 7 percent that Spain has been forced to pay recently on the international debt markets, a level that forced the other countries to seek bailouts.

It is not yet clear whether the money will come from the eurozone's current ?440 billion ($550 billion) rescue fund, the European Financial Stability Facility, or its new ?500 billion ($625 billion) European Stability Mechanism.

Spain had been resisting pressure to seek outside help for its banks, which have been overwhelmed by bad real estate loans. But leaders became increasingly concerned that any fallout from Greece's upcoming elections would rock markets, further hurting Spain's financial sector. The exact amount Spain needs won't be clear until outside accountants complete an audit of its banks by June 21.

Unlike the three other European countries that have received financial help ? Ireland, Portugal and Greece ? Spain did not have to agree to deeper cuts in its government budget to secure the help.

Working in Spain's favor is the fact that its public debts aren't especially high. They amounted to less than 69 percent of its gross domestic product at the end of 2011, lower than powerhouse Germany's 82 percent.

Spain has already agreed to government belt-tightening. More austerity likely would have pushed Spain, already suffering from near-25 percent unemployment, deeper into recession.

"You don't want an economy of that magnitude going down the tubes," says Daniel Drezner, a professor of international politics at Tufts University in Medford, Mass. Spain has the world's 13th-biggest economy, more than four times the size of Greece's. It is the fourth-largest economy in the Eurozone.

In recent weeks, jittery investors had demanded higher interest rates on Spanish bonds. If Spain had tried to borrow money in the bond market to rescue its banks, investors would have balked at providing it.

The rising fears come at a time when nearly half the countries that use the euro are in recession. At 11 percent, unemployment in the euro zone is at the highest level since the single currency was introduced in 1999.

Europe's weakest countries aren't all alike.

Spain and Ireland, like the United States, were crushed by a collapse in the housing market, which left their banks with huge losses on housing loans. The Irish government was forced to slash government spending to pay for a bank rescue. The austerity has pinched the economy; Irish unemployment exceeds 14 percent.

Greece ran up vast budget deficits it couldn't sustain and smothered its economy in regulations designed to protect favored industries.

Italy and Portugal are desperately in need of economic growth that will provide the tax revenues they need to pay their bills.

The Italian government of Prime Minister Mario Monti is committed to raising taxes, cutting spending, fighting tax evasion and promoting competition in many professions, from cab drivers to pharmacists. But the budget cuts threaten to undermine Italy's economy, which is already in recession. Under the terms of its earlier bailout, Portugal is making deep spending cuts, which have made its recession deeper and more painful.

The troubles in Europe also are causing economic problems for the United States and developing countries such as China and Brazil, which rely on Europeans to buy their exports. So the plan unveiled Saturday eases pressure on the United States and the rest of the world economy as well.

European economic troubles pinch U.S. businesses. U.S. companies send 22 percent of the goods they export to Europe and have more than $2 trillion invested in factories, offices and businesses there.

A bigger fear is that Europe's financial troubles could cross the Atlantic. When banks lose confidence in each other, they refuse to lend each other money. Credit dries up, depriving economies of the fuel they need to grow. A financial crunch can wreck the economies on both sides of the ocean as it did in 2008.

"Anything that calms European markets is good for the United States," says Tufts' Drezner.

And anything good for the U.S. and world economies is good for President Barack Obama's re-election hopes.

"This move will come as a relief to the Obama administration as it suggests that European leaders are finally beginning to take significant actions to ease the intensifying pressure on the euro zone's peripheral economies" such as Spain and Portugal, says Cornell's Prasad.

The Spanish deal also gives European policymakers more time to strengthen the euro 10 years after the single currency was introduced. They are already planning to create a "banking union" with a centralized regulator, a bailout fund and deposit insurance that covers savers across Europe.

Europe still needs to find a way to stimulate economic growth across the continent so that European countries can begin to grow their way out of their debt problems.

Despite the bank deal, Spain's grinding economic misery will get worse this year, Prime Minister said Sunday. "This year is going to be a bad one," Rajoy said Sunday in his first public comments about the rescue.

The conservative prime minister added that the economy, stuck in its second recession in three years, will still shrink by 1.7 percent this year, even with the help. More Spaniards will lose their jobs, he said.

Analysts also say the eurozone countries must pull closer together politically and economically. They need to agree to more standardized policies limiting government debts and strengthening bank regulation.

Critics complain that the Spanish plan, like an Irish rescue before it, rescues banks but leaves taxpayers responsible for repaying the bailout loan.

Bruegel's Veron says bank owners and investors should absorb some of the losses when banks run into trouble. He wants to see Europe develop a more standardized way of dealing with shaky banks and closing them down when necessary.

Michael McGrath, a spokesman for the Irish opposition political party Fianna Fail, expressed dismay that Saturday's bank plan would leave Spain's government holding more debt and reinforce the idea "that ordinary citizens have to carry bank losses."

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Svensson contributed from New York and AP Business Writer Sarah DiLorenzo contributed to this report from Paris.

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