Why Don’t the Markets Reward Spain, Ireland for Confidence-Building Measures?

Sunday's election in Greece was supposed to deliver a catharsis . Either the markets would rally in relief of pro-bailout parties won. Or they'd collapse in fear if an anti-bailout party won. But the reaction thus far has been a shrug. Why?

The big fear is that the Greeks would upset and fail to live up to commitments. That's still an open question, although the (muddled) election results seem to have forestalled an eminent exit. But there's a larger fear. What about countries that have steadfastly labored to meet their commitments to bondholders and other creditors, stuck to the austerity programs — and yet the market still treats them like junk?

Take Ireland. The island nation's desire to seek a bailout had nothing to do with runaway public-sector spending. Rather, it had everything to do with its private-sector banks running amok. Ireland's banks lent way too much indiscriminately, and borrowed from bond investors around the world. Come the housing bust, rather than let bank bondholders suffer the way bondholders of privately held industrial companies would, Ireland's taxpayers stepped up and assumed the debts. This massive transfer of wealth from Ireland's taxpayers to bondholders around the world swelled the public debt to the point where Ireland needed a bailout. In exchange for taking cash from the European Central Bank, the International Monetary Fund and the European Union, Ireland agreed to get its deficit under control by slashing spending, raising taxes and generally inflicting misery on its own citizens. The theory: The bond markets would reward Ireland for taking such action and enable it to borrow more cheaply in the future.

That hasn't happened. Ireland has stuck to its commitments, by and large. The country's voters even heartily expressed their desire to stay in Europe in an election a few weeks ago. But the yields on its debts haven't come down. Far from it. So Ireland has taken the bitter medicine, gone out of its way to appease bondholders — and the reaction is to be treated like a country in danger of defaulting.

It's a similar story to Spain. Here's another country in which a banking and real estate collapse has taken a huge toll on the real economy (unemployment is nearly 25 percent) and on government finances. In Spain, as in Ireland, the public stepped up to bail out banks and their stakeholders. As in Ireland, the government didn't have sufficient resources or borrowing capacity to do so on its own. So Spain sought help to recapitalize its banks. Meanwhile, Prime Minister Mariano Rajoy has remained steadfastly committed to reducing budget deficits as a percentage of gross domestic product, even in the face of mounting economic woe. So how is the bond market rewarding Spain? Yields on its 10-year bonds have spiked above 7 percent.

Why haven't the confidence-building measures instilled confidence? Well, we can always blame Greece. After repeated bailouts and elections, Greece has yet to give the world a decisive answer as to whether it can (or wants to) meet its financial obligations. And it could be that the cloud of uncertainty hovering over Greece is carried westward by prevailing winds.

There's another explanation. Maybe the moves that the financial establishment deems as vital to building economic confidence actually help to kill it. Forget for the moment about Greece. In Ireland and Spain, harsh austerity measures have done very little to restructure the domestic economies and jumpstart growth. But they've done an awful lot to make people pessimistic about the future. Young Irish people are emigrating in search of work. In Spain, virtually every macroeconomic indicator is heading south. And that means its banks' credit problems are likely to get worse before they get much better.

Daniel Gross is economics editor at Yahoo! Finance.

Follow him on Twitter @grossdm; email him at grossdaniel11@yahoo.com.