Global markets may have now priced in a full-blown default by Greece, or even the country's exit from the euro zone. But they haven't factored in a financial meltdown in Spain, and that is where the new focus is shifting.
Spain would be a much bigger problem than Greece, just as a matter of size. It has debt of some 735-billion euros, of which 175-billion euros matures this year. In comparison, Greece's debt amounts to about 300-billion euros.
Spain is working on a new plan to bolster its failing bank industry and Prime Minister Mariano Rajoy says the government will detail new financial reforms this Friday.
But the bearish economist Nouriel Roubini says Spain's problems cannot be fixed from within. In a Financial Times editorial on Wednesday, he argues that the country needs direct capital injection from the EU bailout fund.
The problem is that both sides are resistant to the move. Germany, already burned by Greece, doesn't want to give more money without strict fiscal controls. And Spain doesn't want to give the EU control over its banks, Mr. Roubini says.
Instead, it looks like the Spanish government will step in at the last minute to rescue the banks, which could bring the state "to its knees." The country can't do it alone because Spain would have to enact unrealistic spending cuts and tax hikes to pay for the recapitalization, which would quash any chance of an economic recovery.
The world has seen this act before, Mr. Roubini writes with his colleague Megan Greene.
"The corrosiveness of banking sector uncertainty for investor confidence in Spain is reminiscent of Ireland in 2009 and 2010. Spain's austerity-recession feedback loop is similar to the process that fed the economic contraction in Greece and Portugal."
Spain not only needs a bailout, but the time to generate economic growth, which is a tall order without lower interest rates from the European Central Bank and a weaker euro, they added.
Spain may be forced to exit the euro zone in just three years, Mr. Roubini said Wednesday in an interview with CNBC, adding that Greece would be out by next year at the latest.