Pressured by other EU governments, Spain has asked the EU for $156 billion in aid to bail out its banks. European leaders say this amount well exceeds what is needed, but they are miscalculating.
As with Greece, the aid package is likely too little to permanently quell investor fears Spain's banks will collapse, and conditions imposed by Germany could make Spain's situation worse.
Spain's predicament is wholly different from Greece and Italy -- its government is hardly inclined to spend too much.
Prior to the global financial crisis, Spain enjoyed a boom in tourism and home construction as richer northern Europeans sought vacations and second homes in its sunny climate. Robust construction and tourism drove growth and provided Madrid with adequate taxes. Unlike Rome and Athens, it enjoyed persistent budget surpluses.
Foreigners invested in Spanish bank securities, and the latter financed a hotel and housing boom. In the wake of the financial crisis, loans defaulted and Spanish banks were stuck with non-performing real estate loans.
Unlike the Federal Reserve in the United States, Spain's central bank cannot print money to mop up bad loans, and the European Central Bank is not empowered to bail out banks and impose reforms. Hence, Spain's national government had to borrow euros in international bond markets to save its banks.
With real estate loans totaling more than $885 billion, or about 65 per cent of GDP, the cash that must be raised is simply beyond the borrowing capacity of the Spanish government
The IMF estimates Spain's banks need $50 billion in new capital, and as much as $125 billion to write off bad loans. Moreover, as we have learned from the U.S. crisis, first estimates of losses are likely conservative -- those numbers will grow.
Madrid's borrowing costs may drop on announcement of the $157 billion package, but international capital markets will soon conclude it is too small, and Spain's government and banks will again face prohibitive borrowing rates.
In addition, Germany and other northern creditor states would like to impose strict restructuring conditions on Spanish banks -- prescribing mergers and restructuring and winding down the weakest banks.
Outside meddling in this process could further weaken Spain's banks and economy by resulting in unnecessary absorption of its bank by Germans, Dutch and others financial institutions -- forced sales could make Spanish banks targets of opportunity for bigger EU banks.
Historically, Spain's banks have been well run and effectively regulated. Spain's current fix is much like Florida or Nevada after the big Wall Street banks inflated U.S. housing values by underwriting irresponsible mortgages through networks of unscrupulous mortgage brokers.
Simply, Spain's resort industry, home values and banks are collateral damage of the wider global crisis and European recession. Indeed, the IMF, in a detailed report published on May 30, found the core of Spanish banking sound, regulation generally effective, and needed restructuring well underway.
Spain does not run its banks the way Italy and Greece ran their national finances, and it doesn't need German meddling in its financial institutions.
The IMF has noted the need for greater clarity for recapitalization strategies, bank restructuring timetables and certain improvements in bank oversight, but Spain is not running a loosely-regulated Third World financial system.
As Germany is the largest country donor to the bailout fund, its interests and reservations are understandable. However, it would be better to empower the ECB to back up the $157 billion bailout allocation, much as the Federal Reserve backed up the TARP, and for the ECB to oversee use of the funds and implementation of IMF recommendations.
Peter Morici is an economist and professor at the Smith School of Business, University of Maryland.