LITTLE ROCK — Europe’s debt crisis flared on Monday as fears intensified that Spain would be next in line for a huge government bailout.
A recession is deepening in Spain, the fourth-largest economy that uses the euro currency, and a growing number of Spain’s regional governments are seeking financial lifelines to make ends meet.
The interest rate on Spanish government bonds soared again Monday in a sign of waning market confidence in the country’s ability to pay off its debts.
The prospect of bailing out Spain is worrisome for Europe because the potential cost far exceeds existing emergency funds. Financial markets are also growing uneasy about Italy, another major economy with large debts and a weak economy.
Stocks fell sharply across Europe and around the world. Germany’s DAX plunged 3.18 percent. Britain’s FTSE dropped 2 percent and France’s CAC 40 fell 2.89 percent. The Dow Jones Industrial Average dropped 101.11 points, or 0.8 percent, to 12,721.46. The euro slipped just below $1.21 against the dollar, its lowest reading since June 2010.
The interest rate on Spain’s 10-year bond hit 7.56 percent in the morning, its highest level since it joined the euro in 1999. Economists consider interest rates on government debt higher than 7 percent unsustainable.
Concern over Spain increased Monday after the country’s central bank said the economy shrank by 0.4 percent during the second quarter compared with the previous three months.
“Domestic demand fell more sharply than in the prior quarter,” while exports showed a “moderate recovery,” the Bank of Spain said.
The government predicts the economy won’t return to growth until 2014 as new austerity measures hurt consumers and businesses.
On top of that, Spain is facing new costs as a growing number of regional governments ask federal authorities for assistance. The eastern region of Valencia said Friday that it will need a bailout from the central Madrid government. Over the weekend, the southern region of Murcia said it may also need help.
Spain has already requested an emergency loan package of up to about $125 billion to bail out its banks. But that aid hasn’t quelled markets because the government must repay the money. It had been hoped that responsibility for repayments would shift from the government to the banks. But that shift is a long way off - a pan-European banking authority would have to be created first and that could be years away.
Spain is not the only European nation to unnerve markets.
Greece is still struggling with a mountain of debt and international creditors will visit the country today to check on the government’s attempts to revamp the economy. There is concern that officials from the European Commission, European Central Bank and the International Monetary Fund will find that Greece is not living up to the terms of its bailouts and could withhold future funds.
Italy has also been caught up in fears that it may be pushed into asking for aid. Italy’s economy is stagnating and markets are worried that it may soon not be able to maintain its debt burden of $2.3 trillion - the biggest in the eurozone after Greece. Interest rates on Italy’s government bonds rose steeply Monday while its stock market dropped 2.76 percent.
The collapse in stock prices in Italy and Spain prompted regulators to introduce temporary bans on short selling - a practice where traders sell stocks they don’t already own in the hope they can make a profit if the stock falls in price.
Ireland, Greece and Portugal have already taken bailout loans after they could no longer afford to borrow on bond markets. Yet the economies of those countries are tiny compared to Italy and Spain. Analysts say a full bailout for both could strain the other eurozone countries’ financial resources.
Pascal Lamy, director of the World Trade Organization, said after a meeting with French President Francois Hollande that the situation in Europe is “difficult, very difficult, very difficult, very difficult.”
Eurozone finance ministers on Friday signed off on the $125 billion in aid for Spain’s banks and said about $36 billion would be made available right away. But that incremental step cuts little ice with investors.
If Spain’s borrowing rates continue to rise, the government may end up being locked out of international markets and be forced to seek a financial rescue.
On Saturday, Spain’s Foreign Minister Josi Manuel Garcma Margallo pleaded for help, saying that only the European Central Bank could halt the panic. But the central bank has shown little willingness to restart its program to purchase the government bonds of financially troubled countries. The central bank has already bought about $240 billion in bonds since May 2010, with little lasting effect on the crisis.
The central bank has also cut its benchmark interest rates to a record low of 0.75 percent in the hope of kick starting lending. Yet many economists question how much stimulus this provides as the rates are already very low.
There has been speculation the central bank could eventually have to follow the Bank of England and the U.S. Federal Reserve and embark on a program of “quantitative easing” - buying up financial assets across the eurozone to increase the supply of money. That could assist governments by driving down borrowing costs as well.
But such a plan is fraught with potential legal trouble for the central bank - a European treaty forbids it from helping governments to borrow.
In the case of Greece, the country is dependent on foreign bailout loans to pay its bills. A cutoff of aid over its inability to meet the loan conditions would leave it with no source of financing - and could push it to exit the euro so it can print its own money to cover its debts.
Germany’s economy minister, Phillip Roesler, said the prospect of Greece leaving the euro was now so familiar it had “had lost its horror” and that he was skeptical Athens would meet conditions for continuing rescue money.
Information for this article was contributed by David McHugh of The Associated Press, Michael Birnbaum of The Washington Post and Angeline Benoit of Bloomberg News.
Front Section, Pages 1 on 07/24/2012