The financial strength of one hinges on the other, and right now both are struggling for survival.
The Spanish economy, the fourth-largest among the 17 countries that use the euro, is suffering from the aftershocks of a real estate bust that has devastated banks and families. Unemployment is almost 25 percent and the economy is forecast to shrink 1.7 percent in 2012.
At the request of the Spanish government, euro countries offered up to $125 billion in rescue loans for Spanish banks on June 9.
Spain made the formal petition for the aid on Monday, but the terms of the loans — including the size and interest rates — have yet to be agreed. They are expected to be made public by July 9 and will likely be discussed at a European Union leaders’ summit that starts Thursday in Brussels.
The bank bailout, however, has only made investors more nervous about Spain’s financial condition.
Although Spanish banks will agree to pay back the loans with interest, it is the Spanish government that is on the hook if they cannot. In effect, the bank loans will be treated as government debt. And as the country’s debt load rises, so does the interest rate it pays to borrow money, a sign that the pool of investors hungry for Spanish bonds is shrinking.
One group of investors that isn’t shying away from Spanish government bonds is Spain’s banks. The amount of Spanish government debt owned by Spanish banks — yes, the same banks that are about to receive billions in emergency loans — is rising fast.
“It is as if the government were buying its own debt,” says Alejandro Varela of Renta4, a Madrid-based brokerage. “It is like a dog chasing its own tail.”
With Spain’s economy enduring its second recession in just three years, analysts say the odds are rising that the government will need a bailout of its own. The yield on the country’s 10-year bonds surpassed 7 percent last week, the level that pushed Ireland, Portugal and Greece to the breaking point. On Monday, the yield was 6.57 percent.
Two-thirds of Spain’s government bonds are owned by the country’s banks, pension funds and insurance companies. That’s up from 50 percent at the end of last year. By comparison, only 38 percent of French government bonds are held by domestic banks and other financial firms.
In Spain the sharp increase in such a short period signals that foreign demand is falling fast as the country’s economic outlook worsens.