SPAIN MUST NOT BECOME A "ROACH MOTEL" / THE FINANCIAL TIMES COMMENT & ANALYSIS ( A MUST READ )

Spain must not become a “roach motel”

Mohamed El-Erian

June 6, 2012

After resisting for months, Spain has made an explicit plea for bank aid from its European neighbours. The immediate objective is to recapitalise struggling banks and minimise the risk of disruptive deposit withdrawals. A major challenge is to avoid this emergency funding turning Spain into a long-term ward of the European state, a phenomenon that has already occurred in the three countries to have already received bail-outs – Greece, Ireland and Portugal.

Having botched prior attempts to stabilise its banking system – whether it was the domestic approach based on mergers or the attempt to access a back door to the European Central Bank – Spain now looks set to tap European funds. This would probably be combined with a more detailed commitment to a domestic economic plan emphasising both budgetary adjustment and structural reform.




This use of an external balance sheet would provide the theoretical possibility of rupturing the disruptive feedback loop between weak banks and deteriorating sovereign creditworthiness. But before we all let out a huge sigh of relief, it is important to understand why Spain for so long resisted what seems to be an obvious response to its banking problems.

So far, emergency European funding has been impossible to exit, like a “roach motel”. Rather than act as a catalyst for crowding in private capital needed to restore growth, and financial viability, public money has provided the private sector with the possibility to exit programme countries at a much lower cost; and exit it did. As a result, governments have become highly dependent on official aid to cover their budget needs, meet interest obligations and roll over maturing debt; and domestic companies have been starved of the oxygen that is so critical for investment and job creation.

No wonder, growth and solvency remain so elusive for the programme countries, including in Ireland and Portugal where citizens have been generally supportive of their governments’ policies. The possibility that the counter factual — i.e., no access to external emergency financing — could have yielded a worse outcome is no excuse for repeating the mistake in Spain. Indeed, this is more than just in the country’s self interest. Given its size and crucial role in any revived eurozone (along with France, Germany and Italy), Europe cannot afford Spain to be a long-term ward of the state.




Success requires, first and foremost, a common understanding and vision of what a stable eurozone would look like in three to five years. Increasingly, this speaks to a smaller and less imperfect union, anchored by the big four and including only countries that are both able and willing to deliver on the revamped joint obligations being discussed in official circles — namely, reinforcing monetary union with proper fiscal and growth compacts and enhanced political integration.




This critical contextual step would allow for the immediate implementation of measures to stabilise Europe, including through the establishment of a regional bank deposit scheme. It would provide far greater assurances to the ECB that, this time around, its emergency facilities (including another longer term refinancing operation and an enhanced security purchase program, along with strengthened regional fiscal transfers) have a better prospect of being a bridge to a sustainable European destination — something that continues to elude an institution that has already expanded its balance sheet to 30 percent of aggregate gross domestic product.




Finally, Spain would need to agree to a proper domestic policy mix. This involves not only avoiding the mistake that Greece made in agreeing to a series of unrealistically-designed and technically-flawed programmes but also enabled to make difficult upfront decisions about the best form of burden sharing (something that Ireland was not allowed to do by its European partners).

Given the increasingly delicate situation of the eurozone – from Greece’s bank jog and election uncertainty to the tensions at the very core between France and Germany – governments do not have many more chances to get all this right. And the rest of the world has a vital interest in a better response to what now constitutes a major risk to already tenuous growth and employment prospects.