Spain's debt crisis takes a big turn for the worse--and European markets plunge

07/20/2012 1:46 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Forget about yesterday’s votes by Germany and Italy to approve a permanent rescue fund that that could ride to the rescue of Spain (and maybe Italy if it didn’t run out of cash first.)

Today it’s time for markets to panic on truly terrible news out of Spain.

It’s hard to say what’s worse in the markets’ estimation, new projections from Madrid that the economy will contract rather than expand in 2013. Or news that the regional government of Comunitat Valenciana is asking Spain’s central government for a bailout of as much a 3 billion euros.

Spain’s IBEX 35 index is down 5.82% today. Italy, Spain’s partner in this stage of the debt crisis, shows a 4.38% drop in the FTSE Milan index. France and Germany are faring better, a relative term today, with a drop of 2.14% in the French CAC 40 index and 1.9% in the German DAX. The Spanish 10-year bond hit a euro-era high at 7.27%, way over the red danger line. The euro is down almost 1% against the dollar to $1.2165.

Why so much worry?

The cuts in the government’s projections—the Spanish economy is now expected to contract by 0.5% in 2012 instead of expanding by 0.2%--mean the country will have to find even more budget cuts and more tax increases than planned in order to keep the budget deficit promises it made to secure 100 billion euros in rescue funds for its banks from EuroZone members. That won’t be easy for a government already facing intense opposition—including massive street demonstrations today—to its attempts to implement 100 billion in budget cuts sand taxes over the next three years.

The news that Valencia has asked the central government for a bailout couldn’t come at a much worse time. Valencia and Catalonia are the two regional governments facing the biggest budget deficits but in total Spain’s regional governments need to raise 15 billion in the second half of 2012 at a time when they are locked out of the bond markets. Madrid has set up an 18 billion euro bailout fund for the regional governments but every euro that has to be spent out of the central government’s pocket to bailout regional governments just adds to Madrid’s own crisis.

The fear this morning is that while European parliaments have been taking their usual slow path to approving a measure to help Spain through the last crisis, a new crisis has emerged that will force Spain to ask for a Greek-style bailout. And EuroZone leaders are not prepared for that.

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