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Spanish Banks Downgraded as Cyprus Seeks Bailout

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The troubled eurozone continued to experience turmoil as Moody’s downgraded 28 Spanish banks and Cyprus requested a bailout that could amount to more than half its economy. Other eurozone countries continued to pressure Chancellor Angela Merkel of Germany not just on her opposition to a more robust fiscal union in the currency bloc, but also her insistence—along with Finland and the Netherlands—that they be given priority in repayment above investors. In Greece, the new finance minister quit, citing health issues.

Bloomberg reported Tuesday that Moody’s Investors Service dropped the ratings of 28 Spanish banks from one to four notches, some to the junk level, citing Madrid’s sovereign debt and continuing issues with bad real estate loans. While the country’s two largest banks remained classed as investment grade, Banco Santander saw its long-term debt rating fall to Baa2 from A3 and Banco Bilbao Vizcaya Argentaria (BBVA) saw its rating drop to Baa3, down from A3.

In a statement, Moody’s said, “Today’s actions follow the weakening of the Spanish government’s creditworthiness, as captured by Moody’s downgrade of Spain’s government bond ratings to Baa3 from A3 on 13 June 2012, and the initiation of a review for further downgrade.” The agency added that the “downgrades of the long-term debt and deposit ratings also reflect the lowering of most of these banks’ standalone credit assessments.”

Cyprus, with troubles of its own, asked for a bailout Monday. With the third smallest economy in the eurozone, Cyprus’ problems are nonetheless substantial; it is so heavily exposed to the Greek economy, Reuters reported, that it may have to seek as much as 10 billion euros ($12.5 billion) in emergency financing, more than half its annual economy of 17.3 billion euros.

It is thought that the island country tried first to seek financial assistance from China or Russia to avoid having to adhere to the challenging requirements imposed by the eurozone on bailed-out countries. In a statement, the government said in part that its need was due to “negative spillover effects through its financial sector, due to its large exposure in the Greek economy.”

Government spokesman Stefanos Stefanou said that, despite his homeland’s request for eurozone assistance, it would still try to negotiate a loan from another source. In a Huffington Post report, Stefanou said, “One doesn’t preclude the other. Our efforts to secure a bilateral loan will continue.” This was confirmed by Finance Minister Vassos Shiarly. Earlier Monday, Fitch Ratings had downgraded Cyprus to junk.

As European Union leaders prepared for a summit meeting beginning Thursday, France, Spain, Italy and Germany planned last-minute talks for Tuesday evening in advance of discussions about management of the debt crisis and closer fiscal union among eurozone countries. Reuters reported that the impromptu session was so last-minute that one finance minister’s press staff only found out about it on Tuesday morning. Merkel is likely to find herself facing off against the other leaders as they seek to convince her of the wisdom and necessity of closer fiscal ties, although the very meeting itself is an attempt to smooth over a very public breach between her and the other three countries’ heads during last Friday’s meeting in Rome.

On Monday Merkel said again that she did not support such measures, characterizing any sharing of debt or bank liabilities as “economically wrong and counterproductive.”

However, Italy, France and Spain have not yet given up and are apparently pinning much hope on the last-minute gathering. Economy Minister Pierre Moscovici of France was quoted saying, “Tomorrow there is a meeting, which will be very important, between [French President] Francois Hollande and Angela Merkel, and this evening I will receive the finance ministers … along with the European Commissioner.”

Merkel is also under pressure from European leaders to give way on insisting that Germany, along with AAA-rated Finland and the Netherlands, receive priority in repayment over investors. According to two European officials, so far the three countries have stood their ground on the matter, insisting that official loans of up to 100 billion euros to Spain to be repaid to them first should there be a default. That puts bondholders at a disadvantage.

Last week finance ministers from the three countries held firm; now the issue passes to Merkel and other government leaders who have already been forced to back down on previous efforts to elevate taxpayers above investors for repayment purposes.

“This is one of the focal points for market anxiety about the Spanish bailout,” Nicholas Spiro said in the report. Spiro, head of Spiro Sovereign Strategy in London, added that this insistence on asserting seniority “undermines the credibility of the bailout. This is partly what is fueling ‘bailout creep’ in Spain—the fact that the price Spain is paying for this new bailout, due to its flawed structure at present, is a price that is too high.”

Jim O’Neill, chairman of Goldman Sachs Asset Management, said in the report that the solution to the crisis could be relatively easy. “The euro crisis is in some ways mind-bogglingly simple to solve … because it isn’t economics, it’s politics,” he was quoted saying. “If Angela Merkel and her colleagues stood there together with the rest of the euro area … and if they behaved as a true union this crisis would be finished this weekend.” Greece is still struggling just to keep a handle on its new government. After the new prime minister, Antonis Samaras, was hospitalized for eye surgery that will cause him to miss the first summit meeting of EU leaders since his election, his choice for finance minister experienced his own health crisis and tendered his resignation.

The minister, Vassilios Rapanos, collapsed on Friday and was hospitalized for nausea and dizziness. On Monday he sent a letter of resignation to Samaras from the hospital. The letter said in part, “The state of my health isn’t at the state that would allow me to fully and adequately exercise my duties. I regret that I will not be able to accept in the end your honorable proposal.”

Rapanos was not yet sworn in, but his action leaves the country without a finance minister on the eve of a vital meeting, possibly handicapping Samaras in his efforts to renegotiate the terms of Greece’s bailout. Although President Karolos Papoulias will lead the delegation that will represent Greece at the summit, Samaras will speak by phone in advance of the meetings with EU heads.

In addition, according to Fotis Kouvelis, head of the Democratic Left Party and part of Samaras’s governing coalition, he, Samaras and Evangelos Venizelos, who heads the Socialists, will go to Brussels when Samaras has recovered.