The Spanish Bailout Is Still a Fail-Out

Europe has a problem. Its firefighter doesn't have water in his buckets. He has kerosene.

Just ask Spain. It only took 48 hours for Europe's €100 billion bailout of Spain's banks to backfire, massively so. Now things are getting much worse even faster.

After surging on Monday, Spanish borrowing continued its vertical action on Tuesday. The chart below from Bloomberg shows the yield on Spain's 10-year bond. It briefly hit a euro-era high, before subsequently retreating a bit to 6.7 percent.


Remember, the Spanish bank bailout was supposed to reduce the government's borrowing costs to interrupt the doom loop in Europe between weak sovereigns and weak banks. The reverse has happened.

And isn't just Spanish 10-year bonds, either. Spanish 2-and-5-year bonds have also felt the pain. The Spanish government relies on these shorter duration bonds to fund itself, so that's particularly bad news. Still, yields aren't quite in the danger zone that they were last November that would spur further ECB action. But they're certainly on the wrong track. And, worryingly, they're on the wrong track in Italy too. Contagion stinks.

Why is the bailout driving up borrowing costs? On Monday, we laid out four questions that had investors worried. First, what was the interest rate on the bailout loan. (Remember, Spain isn't getting money for free; Spain is getting money for cheaper than it can borrow). Second, how much will the bailout add to Spain's government debt load? Third, will the bailout loan be senior to other creditors? And fourth, will the money come with strings attached?

The market was roughly hoping the answers to these questions would be: not much, not much, no, and no. Those aren't the answers the market has been getting.

We still don't know what the interest rate on the loan is, but here's what we do know. It will add roughly 10 percentage points to Spain's debt-to-GDP ratio, assuming that the economy doesn't collapse further. It will be senior to all other debt, after the IMF. And the so-called Troika of the European Commission, ECB and IMF will manage it -- meaning it comes with strings very much attached. German finance minister Wolfgang Schaüble clarified these last two points -- the second of which the Spanish government had disputed -- on Tuesday. Everybody's worst fears have been confirmed.

In other words, Spain will have more debt, that debt will be riskier for private investors, and the debt will be harder to pay back thanks to Troika oversight. Other than that, how was the bailout, Mrs. Lincoln?

I'm not saying now would be a good time to panic, but I wouldn't blame you if you did. To paraphrase Keynes, Europe has blundered in the workings of a machine, the working of which they do not understand. Unfortunately, it's our problem too.