Spain's big debt problem isn't in Madrid

09/16/2011 2:02 pm EST


Jim Jubak

Founder and Editor,

The risk in Spain falls mainly on the plain—or at least mainly outside of Madrid.

The problem in Italy is a feckless central government that would probably find putting on its shoes in the morning a challenge—except that it wears Prada loafers.

In Greece the problem is a central government that for decades has thought spending taxes was okay even if you didn’t actually collect them.

In France the problem is a central government that is committed to letting French banks avoid facing the problems in their portfolios. (Mark bad debt to market? Moi?)

In Spain, however, the big problem, however, is regional governments that thought moving responsibility for spending from Madrid to regional governments was a great idea but that don’t seem to have heard of fiscal responsibility in meeting a budget.

As Leo Tolstoy wrote (well, he would have if he worked for Goldman instead of writing those novels), Fiscally sound countries are all alike; fiscally reckless countries are all reckless in their own way.

This week Fitch Ratings tagged the budget deficit problems at Spain’s regional governments as a key reason for the company’s negative outlook on currently AA+ rated Spain. The country’s regional governments account for more than a third of Spain’s public spending, including spending on health care and education, and with an economic slowdown cutting tax revenues, especially from real estate transactions, some of the country’s largest regional governments are in deep holes. Fitch this week cut the ratings for five of Spain’s regional governments, including economically central Catalonia. According to the Bank of Spain, the debt burden at the country’s regional governments rose to 12.4% of GDP in the second quarter from 11.6% in the first quarter.

In other words the problem is still getting worse. Spain’s 17 semi-autonomous regions ran a budget deficit equal to 1.2% of GDP in the first half of 2011, according to the Spanish Finance Ministry.

Those numbers pose two big problems for Madrid.

First, budget cuts in the regions as governments there struggle to get their deficits under control will slow the national economy. Spain’s plan to reduce the national budget deficit to 6% of GDP in 2011 from 9.2% of GDP in 2010 relies on economic growth of 1.3% in 2011. With every economy in the EuroZone slowing, the last thing Spain needs is an internal regional slowdown too.

Second, with bond buyers more skittish than my cat William, Spain’s regional governments are having trouble selling bonds. For example, even as early as June Banco Santander managed to sell only half of a $1.5 billion covered bond offering backed by loans to Spanish regional governments.

Nothing in all of this to suggest that Spain is on its way to a default—the Spanish government has done a good job of reducing its deficit and forcing its weak regional banks to recapitalize or merge—but more than enough to keep pressure on Spanish interest rates.

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