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Spanish Prime Minister Mariano Rajoy attends a meeting with members of Spain's centre-right People's Party (Partido Popular) at the senate in Madrid June 5, 2012. (ANDREA COMAS/REUTERS)
Spanish Prime Minister Mariano Rajoy attends a meeting with members of Spain's centre-right People's Party (Partido Popular) at the senate in Madrid June 5, 2012. (ANDREA COMAS/REUTERS)

Euro zone should consider lending money directly to Spain’s banks Add to ...

Spain’s banking crisis -- even more than the political crisis in Greece -- may prove to be the Eurozone’s undoing. Urgent action is needed.

Yesterday Spanish officials hinted they would like Germany to come to its aid and allow euro zone rescue funds to lend money directly to its banks, which are overburdened with bad property debts.

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This is an idea worth considering. The situation in the fourth largest economy in the 17-nation European currency bloc is critical, and the risks of contagion are huge.

The government of Prime Minister Mariano Rajoy is reluctant to appeal directly for help from Europe’s bailout fund because then it would have to agree to a formal rescue program, with stringent conditions -- and this would be politically difficult in a country already undergoing austerity measures.

Unlike Greece, Spain did not have a government deficit before the 2008 recession and did not lie about its financial books. Its economic woes were caused by a property boom, thanks in part to the single currency. When the bubble burst, the country was left a fiscal hole it could not repair and severe banking problems that it attempted to paper over, rather than undertake a painful restructuring. As a result, weak banks, especially the cajas, or savings and loans unions, were pushed into mergers with somewhat sounder institutions. The unfortunate result was a more frail and vulnerable banking system in which the markets had no confidence. Last month the government nationalized Bankia, a merged and undercapitalized group of seven savings banks.

Mr. Rajoy has committed to structural reforms and the harshest spending cuts in Spain's history. However, the debt crisis is only worsening, as the cost of borrowing internationally continues to increase against a shrinking economy and 25% unemployment.

If euro-zone countries injected funds into Spain’s banks, it would solve the immediate problem, increase confidence and help Spain undertake the necessary longer-term structural makeover to put its banks and economy on a sounder footing. A more closely integrated banking regulatory system for euro-zone countries would improve the ability of Spain and other members with battered economies to weather severe financial-sector storms in future, and help prevent similar crises while reducing the risk of contagion to healthier banks in Europe and around the world.

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