MADRID — Spain's borrowing costs broke through another record Thursday after a credit ratings agency downgraded the country's ability to pay down its debt amid rising fears a bank bailout may not be enough to save the country from economic chaos.
The interest rate – or yield – on the country's benchmark 10-year bonds rose to a record 6.96 percent in intraday trading Thursday, its highest level since Spain joined the euro in 1999 and close to the level which many analysts believe is unsustainable in the long term.
The ratings agency Moody's downgraded Spain's sovereign debt three notches from A3 to Baa3 Wednesday night, leaving it just one grade above "junk status".
Moody's said the downgrade was due to the offer from eurozone leaders of up to (EURO)100 billion ($125 billion) to Spain to prop up its failing banking sector, which the ratings agency believes will add considerably to the government's debt burden.
The lowered score means that even fewer investors will buy Spanish debt, because organizations like pension funds are mandated to avoid assets with such low creditworthiness.
Spain won't immediately collapse if the rate hits 7 percent, but reaching that point would affect it at Tuesday's scheduled debt auction.
"The clock is definitely ticking," said Michael Hewson, an analyst with CMC Markets.
The bank bailout is intended to recapitalize the Spanish banking system and calm Europe's debt crisis. Instead, investors seem unnerved by the government taking on extra debt and have pushed Spanish bond yields – a measure of market jitters – higher all week.
Economy Minister Luis de Guindos called for calm, saying that Spain "had a road map" on how to resolve the crisis.
Meanwhile Foreign Minister Jose Manuel Garcia-Margallo compared sharing the common currency to sailing in a ship, "If the Titanic sinks, it takes everyone with it, even those travelling in first class," he said.
Moody's said the Spanish government's ability to raise money on global markets was being hindered by high interest rates, a situation which had led it to accept eurogroup funds to recapitalize debt-burdened banks.
Some details of what the bailout might look like began to emerge Thursday. European officials are considering liquidation – selling off a bank's assets – as part of the plan to prop up the Spanish banking sector, a spokesman for Competition Commissioner Joaquin Almunia said.
"Liquidation is always looked at," said Antoine Colombani. "We prefer to liquidate when it's cheaper for the taxpayer."
This action was rebutted in a statement Thursday by the Spanish government's Fund for Orderly Bank Restructuring (FROB).
The fund said it had "no plans to initiate insolvency proceedings or wind up any credit institution under its management or control."
Since a weekend agreement to save the banks involves first lending the money to Spain, there are concerns that taxpayers are ultimately on the hook for the banks' bad decisions. Also, investors are worried that the deal raises Spain's debt and deficit levels.
Eurostat, the European statistics agency, said Thursday that it was unclear how much the country's deficit would rise because it depended on how it lent the money on to the banks. Part of that decision will depend on the interest rate the banks are given. If it's too low, it could be considered more a gift than a loan and would count against the deficit.
Colombani said that under one plan being considered, the minimum for the rate would be 8.5 percent. Eurostat did not immediately respond to questions about whether that would be high enough to avoid having the loans count against deficit.
One group of investors has initiated legal action at Spain's National Court to probe whether former directors at Bankia SA acted lawfully when selling shares in an entity that not long after asked the government for (EURO)19 billion in aid.
Lawyer Juan Moreno Yague said he had opened proceedings on behalf of investors to get a judge to investigate if directors had "presented false accounts to ensure that shareholders invested in a company they knew was in fact bankrupt."
The Spanish government's erratic response to the crisis has irritated European Union leaders, Spain's leading newspaper El Pais said on its front page Thursday.
The paper said Rajoy has come under criticism in EU circles for presenting the bailout as a "light" measure and a victory for Spain and the euro, leading to an outcry for similar treatment by other austerity-saddled bailout countries such as Portugal and Ireland, which have had to struggle with heavy, externally imposed fiscal controls.
Speaking to the German parliament in Berlin on Thursday, Chancellor Angela Merkel insisted: "Spain is implementing the right reforms."
"The Spanish Prime Minister is doing this with great courage and great determination," she added.
Merkel again welcomed Spain's move to apply for European funds to recapitalize its banks. "We know banks must be reasonably capitalized to do keep the economy afloat, that is the lesson from 2008, 2009," she said.
"The faster Spain gets the application done, the better," she said.
Spain's benchmark stock index, the IBEX-35, closed up 1.2 percent Thursday in Madrid, according to financial data provider FactSet. The 10-year bond yield eased in the afternoon and closed at 6.87 percent, still a euro-era closing record.
Daniel Woolls and Jorge Sainz in Madrid, Juergen Baetz in Berlin and Sarah DiLorenzo in Brussels contributed to this report.