Greek Crisis Spreads as Spain’s Debt is Downgraded

BY jbreslow  April 28, 2010 at 4:03 PM EDT

Spain on Wednesday became the third European nation in two days to see its debt rating downgraded, heightening investor angst about a spiraling fiscal crisis on the continent.

The ratings agency Standard & Poor’s slashed its rating of Spain by one notch after downgrading the debt of both Greece and Portugal on Tuesday. The Spanish downgrade sent shares in Europe plummeting to a seven-week low.

“We now believe that the Spanish economy’s shift away from credit-fueled economic growth is likely to result in a more protracted period of sluggish activity than we previously assumed,” S&P analyst Marko Mrsnik wrote.

With investors increasingly on edge about the health of the continent’s economies, officials from the European Union and the International Monetary Fund sought to reassure markets they were moving to contain the Greek debt crisis.

“It’s completely clear that the negotiations between the Greek government, the European Commission and the IMF need to be sped up now,” German Chancellor Angela Merkel said.

Greece has requested a 45 billion euro aid package from the EU and the IMF, however the package must still be approved. The longer leaders debate, the more investors worry other nations will be unable to pay back their loans. As Planet Money points out:

“This creates a positive feedback loop: Nervous investors charge higher interest. That leaves countries further in debt, which in turn makes investors even more nervous and leads them to demand even higher interest rates. As governments spend more to service their debt, they must reduce spending elsewhere. That, in turn, can choke off economic growth — and economic growth is necessary for countries to dig themselves out of debt.”

A sovereign default by a smaller EU member such as Greece “would be a body blow to the euro’s standing but it need not spell the end of the currency,” says The Economist. “However, that might not be the case if the problems spread further afield.”

Of course, it may already be too late, according to Simon Johnson. “Everything you knew or thought you believed about the European economy – and the eurozone, which lies at its heart – was just ripped up by financial markets and thrown out of the proverbial window,” he writes.

The crisis is no longer just about Greece, Spain or Portugal, Johnson said. Rather, it is about “stabilizing the macroeconomic situation without resorting to more unconditional bailouts …We again find ourselves approaching the point when the financial sector will scream: rescue us all or face global economic collapse.”