NEW YORK SHARES

Spain battled to contain fears of financial collapse Wednesday, scrambling to fund a major banking rescue as its debt risk premium rocketed to a euro-era record.

The interest rate on Spain's 10-year bonds shot to 6.703 percent -- unsustainable over the longer term -- as the nation fought to avoid being the next victim of the eurozone crisis.

When compared to safe German debt, investors in Spanish bonds were demanding an additional 5.39 percentage points, a premium that easily crashed through euro-era records set each day of this week.

Stock prices skidded across the world on fears Spain would need a rescue and the European single currency plunged to $1.2389 -- a low point last seen in July 2010.

Bank of Spain governor Miguel Fernandez Ordonez shook investors by announcing he would depart June 10 -- a month before his term was due to end.

The central bank chief, who said he was leaving early to give his successor time to take the reins, had sought in vain a hearing in the lower house of parliament to explain stricken lender Bankia's woes.

"Nothing is more important now than regaining confidence because without that we cannot resolve any of our problems," Ordonez told the Senate on Wednesday.

But he also said there were risks to Spain's plan to slash the public deficit from 8.9 percent of economic output last year to 5.3 percent this year and 3.0 percent in 2013.

In a recession with 24.4 percent unemployment, the state faces "downward risks" to its revenue forecasts and the threat of higher-than-expected expenses, for example for unemployment benefits, he warned.

"It is not an exaggeration to say that Spain is staking a great part of its future on achieving these fiscal targets," he said.

In Brussels, Economic Affairs Commissioner Olli Rehn said that if Spain reined in regional government deficits and presented a "solid" two-year budget, then the deficit deadline could be extended to 2014.

Spanish banks, hugely exposed to a property market that crashed in 2008, are at the heart of market concerns.

Prime Minister Mariano Rajoy's conservative government this month instructed banks to set aside 30 billion euros in 2012 in case property-related loans go bad, on top of 53.8 billion euros demanded under February reforms.

Hardest hit lender Bankia has asked the government for 19 billion euros in capital in addition to 4.465 billion euros invested by the state earlier this month to salvage its books.

But no-one seems clear about where the money will come from, especially when debt markets are charging exorbitant sums to lend to Spain.

"Some sort of attempt to rescue Spain is likely and it is likely to come in July," said Barcelona-based economist Edward Hugh.

Spain would attempt to cling on until Greek elections were over and the European Stability Mechanism, a permanent rescue fund, was operational, he predicted.

The cost of recapitalising the banks would be 150-200 billion euros, he estimated, assuming that lenders were obliged to make additional provisions for home mortgages.

"My short term feeling is that they will somehow get through the summer at least and keep on going but at any moment the whole thing could buckle," Hugh said.

Economy Minister Luis De Guindos said the state-backed Fund for Orderly Bank Restructuring (FROB) would issue bonds to raise capital, which it could then inject into Bankia.

He denied a Financial Times report which said the European Central Bank had rejected a Spanish proposal to put newly issued government bonds into Bankia, which could then use them as collateral to borrow from the ECB.

The ECB also issued a statement denying it had taken a position or been consulted on the plan.

But the government failed to quash the concerns over Spain's financial sector.

Centre-right daily El Mundo this week said three other banks, CatalunyaCaixa, NovacaixaGalicia and Banco de Valencia, could need another 30 billion euros in public funds to meet new regulations.

Yet another lender, Banco Popular, whose bonds have been downgraded to junk bond-status, said this week it was in talks to sell its Internet banking business in a scramble for cash.

AFP

The eurozone is confronted with the prospect of "financial disintegration" and should use its new bailout fund to recapitalise distressed banks directly while embarking on a transnational banking union, the European commission said today.

Delivering more than 1,000 pages of diagnosis and policy prescriptions on the dire condition of the European economy and how to try to end almost three years of euro crisis, the commission also talked up the merits of eurobonds or pooling of eurozone debt, a proposal gaining in traction but strongly resisted for now by the biggest economy, Germany.

With international attention focused on Spain wrestling with an escalating banking crisis, the commission was surprisingly critical of Mariano Rajoy's attempts to chart a way out of an extreme predicament – recession, soaring national debt, a ballooning budget deficit, the highest unemployment in Europe, and the banks sitting on tens of billions of toxic assets from the bust property bubble.

"The policy plans submitted by Spain are relevant, but in some areas they lack sufficient ambition to address the challenges," the commission's Spanish report card said.

On banking regulation, administrative reform, labour market changes, growth and competitiveness policies, "the national reform programme does not contain any specific plans for addressing the challenges".

Tax system reforms, meanwhile, were going "in the opposite direction" to that recommended by Brussels.

"Spanish banks still have large exposures to the real estate and construction sectors (amounting to about 10% of total consolidated assets in December 2011). Over a half of this exposure is already problematic and may eventually rise further as developers prove unable to sell their assets and make repayments," the commission said.

Overall in the eurozone, the sovereign debt crisis of the past 30 months had fostered "a very dangerous" degree of "interdependence of weak banks and weak sovereigns".

The European Central Bank's intervention last December, throwing a trillion euros of cheap three-year loans at European banks over a period of three months, had brought a respite. But the commission said that this was merely temporary and that investors' confidence was again evaporating. Despite the liquidity help, the banks were failing to lend, raising the chances of a credit crunch in Europe wrecking growth prospects and causing unemployment to rise from current 15-year highs.

"At this stage, there is no clear-cut evidence that the deleveraging process has become excessive or disorderly with disruptive consequences on the real economy. Nevertheless, the heterogeneity across member states is large and the aggregate picture may hide different situations at country level," the commission said.

Given the gravity of the situation, the commission, whose recommendations are to be put to a summit of EU leaders in Brussels at the end of next month, outlined a quantum leap in fiscal and economic union going beyond the scope of the EU's Lisbon treaty and which would require a new EU charter.

While also hedging its bets, the commission stressed the merits of eurobonds, a eurozone banking union, deploying the European Stability Mechanism (ESM) – the permanent bailout fund being made operational in July – for direct loans to banks rather than to governments, as required by the ESM treaty.

"Additional reforms to economic governance may be considered to complete the institutional structure of monetary union," the commission said. "The changes made so far have in some cases touched on issues traditionally tied to national sovereignty. In some instances, they appear to have exhausted the scope of action possible under the [Lisbon] treaty … The question remains as to whether stronger co-ordination of economic policies will be sufficient or whether there needs to be progress towards closer integration of economic policy-making. The crisis experience has underlined the importance of this issue."

The commission said that there were signs of banks deleveraging, retreating behind national borders and divesting their foreign subsidiaries.

"To counter this trend of financial disintegration, more co-ordination at European level is required in supervision and crisis management frameworks. More specifically, closer integration among the euro area countries in supervisory structures and practices, in cross-border crisis management and burden sharing, towards a 'banking union' would be an important complement to the current structure of monetary union."

"To sever the link between banks and the sovereigns, direct recapitalisation by the ESM might be envisaged," it added. The proposal is again fiercely resisted by Berlin, but supported by the new French president, François Hollande, by Washington, and is also gaining support at the European Central Bank.

Talking up the advantages of eurobonds, the commission sought to appeal to German reservations by stating that "the net effects of common issuance will be positive only if the potential disincentives for fiscal discipline can be controlled".