06/11/2012 11:30 EDT | Updated 08/11/2012 05:12 EDT

Spanish stocks slump, bond rates jump on first day of trading after bank bailout announced

MADRID - A €100 billion ($125 billion) plan to rescue Spain's banks failed to restore confidence in the country's financial future, with stocks and bonds unable to hold on to early gains on Monday.

The rate on Spanish 10-year bonds — a measure of market trust in a country's ability to repay debt — rose to 6.47 per cent at the close of trading after having dropped to 6 per cent in the morning. A 7 per cent rate is considered unsustainable in the long term and has in the past pushed other countries to seek national bailouts. The IBEX-35 stock index, which had surged 6 per cent on the open, closed 0.5 per cent lower.

Initial investor optimism was overshadowed by concerns that Spain's ability to make interest payments on its debt could be strained by taking on so much new debt via the rescue package.

The rescue for Spain's banks was portrayed by Spanish and European officials as a bid to contain Europe's widening recession and financial crisis that have hurt companies and investors around the world. Providing a financial lifeline to Spanish banks was designed to relieve anxiety on the economy.

Spain had been criticized for being too slow to set out a roadmap to resolve its problem. European business leaders and analysts have stressed that Spain had to find a quick solution so that it was not caught up in any market turmoil sparked by the June 17 Greek elections. There are concerns that anti-bailout left-wing party Syriza could become the largest party in the Greek parliament, putting the country's membership in the eurozone at risk. Investors are also worried that Italy could be next to seek a bailout. The country's recession is deepening, increasing pressure on Premier Mario Monti's government, which is struggling to fend off its debt crisis.

"Plenty of risk still remains in place, with question marks over the ability of Spain to repay the debt, especially, if the country fails to get back on the growth path, the outcome of the upcoming Greek elections and the perception of situation in Italy," Anita Paluch of Gekko Global Markets wrote.

Eurozone finance ministers said Saturday they would make the loan of up to €100 billion available to the Spanish government to prop up banks laden with non-performing loans and other toxic assets after the collapse of a real estate bubble. Recession-hit Spain has yet to say how much of this money it will tap while it waits for the results of two independent audits of the country's banking industry. The bailout loans will be paid into the Spanish government's Fund for Orderly Bank Restructuring (FROB), which would then use the money to strengthen the country's teetering banks.

In a report it released late last week, the International Monetary Fund estimated Spain needs around €40 billion. Investors now are very eager to know how much Spain asks for to strengthen its banks and how large a safety margin of extra money it take to cushion itself against further shocks, such as a deterioration in the economy.

"Markets will certainly ask the question about whether a second bailout might be required and the margin for error between the sort of euro40 billion the IMF is saying and the euro100 billion ceiling in terms of what we heard," said Mark Miller of Capital Economics in London.

He added that with the bailout, Spain's debt-to-gross domestic product ratio — which was a relatively low 68.5 per cent at the end of last year — could shoot up to the 90s next year. And bond yields will remain high.

If the ratio gets up to Greek levels of 120 per cent or so, and 10-year yields back to the near-7-per cent levels of a few weeks ago, "then people will ask that question about a second bailout," Miller said.

Another issue is whether the European money comes with strings attached for the government, and not just an obligation for banks to restructure. When the bailout was announced on Saturday, Spanish Economy Minister Luis de Guindos said the rescue would not force any new austerity measures on the government.

Speaking to reporters Sunday, Prime Minister Mariano Rajoy avoided using the term 'bailout' to describe the aid, calling it instead a credit line without the strict austerity conditions that have accompanied bailouts for Greece, Portugal and Ireland.

However, on Monday the European Union made clear the money is more than just a loan. Besides being paid back with interest, there will be strings attached for the Spanish government.

"When people lend money, they never do it for free. They want to know what is done with the money," said Joaquin Almunia, the European Competition Commissioner.

"I am not talking about just the obligation to pay back the money, but also some other kind of terms," he told Cadena Ser radio, adding that these remain to be determined.

The economy ministry later released a statement saying the package entails "the necessary conditionality for the financial sector" but no new fiscal consolidation or structural reforms beyond those the government has already embarked on.

The loan will be supervised by the European Commission, the European Central Bank and the IMF, Almunia said.

A European Commission spokesman, Amadeu Altafaj, told Spanish state television that this troika will have people on the ground overseeing the restructuring of the Spanish financial sector.

He noted that last month the European Commission recommended Spain undertake further reforms such as speeding up the phasing of a higher retirement age — it is to go from 65 to 67 — and raise VAT sales tax. The newspaper El Pais quoted EU officials Monday as saying these changes and others are part of the conditions that come with the bank rescue package.

Adding to the gloomy mood on Monday, Fitch ratings agency downgraded Spain's two largest international banks Banco Santander and Banco Bilbao Vizcaya Argentaria (BBVA) from A to BBB+.

The agency said the reasons for the downgrade were primarily because Spanish sovereign debt ratings had been downgraded to BBB- from A- on June 7 and also due to forecasts that Spain's faltering economy would remain in recession throughout this year and also in 2013 "compared to the previous expectation that the economy would benefit from a mild recovery in 2013."


Harold Heckle in Madrid contributed to this report.

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