Spain sees borrowing costs rise despite bank bailout plan

LONDON — Skepticism over a bailout plan for Spain’s flailing banks drove the country’s borrowing costs Tuesday to their highest level since Madrid adopted the euro, adding to fear that Europe’s stubborn economic and financial crisis is entering a dangerous phase.

The recent offer of as much as $125 billion from Spain’s European partners to shore up its banking sector was supposed to calm markets, not unsettle them. But following what has become a pattern, investors’ initial confidence quickly evaporated as they started examining the fine print of Europe’s latest stopgap measure to combat its 2 1/2-year-old debt crisis.

Investor concern now centers on whether Spain’s public debt will balloon if it accepts emergency loans to recapitalize the banks. Also, private holders of Spanish debt are worried that the deal will be structured in such a way as to give Madrid’s official creditors — essentially other European governments — priority in getting repaid.

Those worries, plus a credit-rating downgrade for 18 Spanish banks, helped push up the interest rate on 10-year Spanish bonds to 6.8% Tuesday, perilously close to the 7% that forced Greece, Ireland and Portugal to accept international bailouts. The difference with those countries is that, though Europe can afford to help save Spanish banks, analysts fear it would not have the resources to rescue the Spanish government.

European leaders are “basically hoping that the markets will see the validity of their approach,” said Julian Callow, chief European economist for Barclays Capital. “Unfortunately, we’re in territory where things start to become quite unstable.”

Spain’s banks are weighed down with billions of dollars in bad property loans from the country’s burst real estate bubble. Until last week, the government of Prime Minister Mariano Rajoy insisted that Madrid could solve the problem on its own and would not require outside assistance.

But in an interview, one of his ministers publicly acknowledged the need for help from its European neighbors, complaining that Spain was being shut out from raising money on the bond markets because of high interest rates. Last weekend’s announcement by Spanish officials of a bank bailout package of as much as $125 billion was designed to relieve the pressure on Madrid and bring down its borrowing costs, but the opposite has happened.

In addition to Spain’s woes, European officials and investors are casting a wary eye on Sunday’s election in Greece. The hard-left Syriza party that has pledged to repudiate Athens’ bailout agreement has a strong shot at winning more seats in the Greek Parliament than any other party.

That could hasten a Greek departure from the 17-nation Eurozone and send investors rushing for the exits in bigger economies such as Spain and Italy, which would throw the survival of Europe’s shared currency into doubt.

“If one of the 17 countries is brought to collapse … the fire will become unquenchable and will not be limited to Greece and the southern countries,” Syriza’s leader, Alexis Tsipras, told reporters Tuesday. “It will break up the Eurozone, and that will not be in anybody’s interests.”

Even if parties in favor of Greece’s rescue package can join together to form a government, they are likely to try to renegotiate some of the bailout’s terms. The country is in its fifth year of deep recession, and Greeks are angry over brutal austerity cuts that have led to a rise in unemployment, hunger, homelessness and even suicide.

But Germany and other northern European countries warn that there is no room for Athens to slack off on its commitments.

Greece’s basket-case economy has caused major trouble for its close neighbor Cyprus, whose banks have large exposure to Greek debt. There is speculation that the Cypriot government could follow in Spain’s footsteps within two weeks and request a bank bailout, which would make it the fifth Eurozone nation to seek help.

The Cypriot banking sector is considered small enough that Europe’s bailout fund should be able to muster the necessary aid.

henry.chu@latimes.com