Euro zone bailout for Spain hobbled by technicalities

By Jan Strupczewski

BRUSSELS (Reuters) - In its scramble to get ahead of the sovereign debt crisis and shore up Spain's struggling banks before Greek elections, Europe may well have succeeded in tying itself in knots.

While a positive move in principle, the euro zone's offer to lend Spain up to 100 billion euros ($125 billion) to recapitalize its banks could even worsen its problems because of growing doubts about the wisdom of holding Spanish debt.

After the briefest of relief rallies, investors have already cast their verdict, pushing 10-year Spanish borrowing costs to their highest level since the launch of the euro on Tuesday - not the impact euro zone ministers were hoping for.

The uncertainty stems from where the currency bloc is going to source the money to lend to Spain.

It can either lend from its temporary bailout fund, the European Financial Stability Facility, or from its permanent rescue fund, the European Stability Mechanism, which is scheduled to come into force next month.

The crux of the problem is the different legal standing of loans made from the 440-billion-euro EFSF and those that will be made from the ESM, which once fully capitalized will have 500 billion euros.

Germany, France, the Netherlands and other wealthier euro zone countries want the loan to come from the ESM, which has 'preferred creditor status', meaning it must be paid back before other creditors such as private investors.

No surprise then that those investors are heading for the exit having seen the losses handed to creditors as part of Greece's second sovereign bailout.