Moody’s warns it may downgrade Spain

December 15, 2010, 5:12 PM UTC

It looks like Europe is about to get interesting again, and not in a good way.

Moody’s warned Wednesday it may downgrade Spain’s credit rating, citing its heavy refinancing needs in coming months, the weakening state of its small banks and the debts run up by local governments.

Rain in Spain

The comments sent European stocks modestly lower and weakened the euro against the dollar. It fetched $1.33 Wednesday morning, down from $1.34 a day earlier.

The move comes as investors continue to edge away from the bonds issued by weaker European governments such as Spain and Portugal on fears that the euro zone will break apart. Spain sold 2.5 billion euros in bonds on Tuesday, but had to pay a full percentage point more than it did a month ago for the privilege.

Rising borrowing costs threaten to strangle any chance of a recovery in an economy already dazed by 20% unemployment in the wake of a housing and construction boom that was perhaps, propotionally, three times the size of the one in the United States.

Moody’s statement Wednesday comes just three months after it stripped Spain of its gold-plated triple-A rating, citing the weak economy and problems at banks. The rating agency this week raised its estimate of Spanish banking sector losses by some 70%.

Meanwhile,  the debt incurred during the bubble continues to loom over an economy that has yet to find a new growth strategy. The Intenational Monetary Fund said in July that Spain will need to sell some $300 billion in debt in 2011 simply to roll over and repay existing commitments as they come due.

The question now is how soon Spain may be forced to seek a bailout from the IMF and the European Union. European ministers are meeting this week to discuss the fiscal crisis sweeping the Continent and  how they might respond.

But leaders of the biggest economy, Germany, have mostly been unwilling to discuss expanding bailouts of weaker states. Their take on things is understandable and perhaps, from a rational standpoint, long overdue.  But a full fledged crisis in Spain, to which German banks have $217 billion of exposure, could put that stand to the test.