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Portfolio > Mutual Funds > Bond Funds

Spain Gets Extension as Bonds Suffer; Germany Denies Plans for Joint Bonds

By Marlene Y. Satter

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Spain, thought to be in danger of needing a bailout if Portugal was rescued, was granted a reprieve on its bank support system.

On Sunday, according to a Reuters report, European Union (EU) regulators approved a six-month extension for the system until June 2011, saying, "The Commission found the prolongation of the measures to be in line with its communication on state aid to overcome the financial crisis."

That approval did nothing, however, to help Spain’s bonds, which on Monday saw spreads move to a euro-lifetime high against their German equivalents. The markets, spooked by fears of contagion despite the approval of an Irish bailout package on Sunday, punished nations it saw as potentially next in line for rescue.

Despite the nation’s relative economic health compared to weaker countries in the euro zone, Spain weighs heavily on investors because of its status as the euro zone’s fourth largest economy. Despite the fact that its banks are in better shape than those of Ireland, it is seen as being in potential bailout country due to its close economic ties with Portugal. Its size means that, if it did need rescue, the European Financial Stability Facility (EFSF) would take a huge hit—far more than the 85 billion euros being devoted to Ireland’s rescue.

The other concern driving bond spreads is worry over the potential for “haircuts” —bondholders being called upon to share the losses of countries in bailout mode. Reuters reported that on Sunday euro zone officials announced approval of the beginnings of a permanent debt resolution mechanism. As it currently stands, the agreed-on plan calls for rescues to be considered on a case-by-case basis, with no certainty that bondholders will have to accept haircuts. That did not help Spain’s bonds on Monday, however.

There had also been talk of a joint euro zone bond issue, with the idea supported by Jean-Claude Junker, the Eurogroup president. In theory such a bond issue would help weaker countries in the euro zone. A report in the German magazine Focus on Saturday cited an unnamed official as a source for a decision by Berlin to stop fighting such a plan.

German officials denied the report, saying that such joint borrowing would be seen as stronger countries within the euro zone taking on the debt obligations of weaker ones. Deputy Chancellor Guido Westerwelle, who also serves as Germany’s foreign minister, was quoted by Reuters as saying, “"Our government is against common European bonds because we don't want Europe becoming a transfer or liability union.” He added, "Those who don't look after their economy at home have to know it will have consequences.”

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