Spanish Collapse Threatens Eurozone

Spain has switched gears from calling for help with some banks to an overall sovereign bailout and the new tack has investors and financial analysts question the stability of the Eurozone. Some wonder whether Germany will stop forking over money to its struggling neighbors, although to do so would be tantamount to giving up on any possible success on the European financial system’s lasting cohesion. Everyone agrees that small bailouts will not work, and that nothing at all will work without exercising fiscal restraint, but no one seems to be able to offer up a feasible plan. For more on this continue reading the following article from Money Morning.

The market red ink Monday around the globe is the result of a usual suspect - Spain.

These days, if someone even sneezes in Madrid, Barcelona, or Córdoba (one of my favorite places, actually), investors go into intensive care all over the world.

This new Spanish influenza has been wiping out paper value from one end of Europe to the other. This morning came word that many of the regions in the country will need help. Attention is now directed from focused support for banks to wider calls for a sovereign bailout.

And that is where the whole matter can turn nasty. Word is that we should now expect some Italian cities to be requesting money in the near future. Seems California and Pennsylvania are not the only locations where cities can go bankrupt.

The accord reached at the end of June by the Council of Europe (the EU member heads of government) to bail out Spanish banks is already derisively referred to as "bailout lite." As the beer commercials attest, this is going to be "less filling."

Unfortunately, it is the heavier version that Europe now needs.

Germany: Eurozone Debt Crisis Savior

Brussels will now have to come up with another, weightier approach.

The problem with all of this, of course, is that at some point the bellwether of Europe will say "enough is enough" and drag its heels on any further largess to disobedient southern cousins.

If Germany throws in the towel, the Eurozone is in real jeopardy.

Some pundits are already talking about such a reaction. Yet there are positively no indications that Berlin is moving in that direction, at least not yet.

The reason is simple - so simple that most doomsayers simply overlook it.

If Spain or Greece goes under, it is not only one economy that has been thrown under the bus. The cross-border held debt and the continent-wide investment and capital programs will be pulled down as well.

Some in Europe may not like it, but it took decades to reach the point where the EU is largely operating on an integrated currency and banking system. There is no way to break up without destroying the last 30 years of joint action.

Talk about a messy divorce where the family china is thrown about...

The Importance of Fiscal Restraint

Europe needs a genuine bailout in return for strictly enforced fiscal and monetary restraint.

The basis for this is already in place, as part of the anticipated approach adopted in late June. In return for the money, there needs to be collective control of commercial banks.

Now, for those who bemoan the fact that this is an interruption of free-market economics, let me simply point out that it was the unfettered transfer of credit, augmented by insufficient bank reserves and indifferent oversight regulations, that got them where they are in the first place.

Regulatory intervention is not the best way to establish market equilibrium. But there are times when it is required. And this is certainly one of those times.

The current call for sovereign bailouts, and we will see more of this as we move forward, misses the mark. Fiscal restraint coming from the central government and monetary restraint issuing from the central bank are essential. Yet they must be contained in a broader longer-term solution that provides some political shelter for those officials making the decisions.

These are not stupid or callous people. These are elected and appointed administrators restrained by a system that has gone awry. There is a very public price to pay for bucking it. Coverage needs to come from Brussels. We can discuss the academic nuances of economic systems and plot hypothetical courses in the best of all preferred worlds.

Unfortunately, Europe is living in this world.

Collective frustrations aside, more concerted and centralized control over the continent's banking system is the likely outcome. Remember, when all is said and done, the overwhelming majority of the European wealth that needs to be protected is not carried around in pockets or stuffed in mattresses. It sits in bank accounts.

Europe needs to be remembered for more than its castles and picturesque, yet closed, town public squares.

This article was republished with permission from Money Morning.