The bailout tab keeps mounting, yet Europe keeps foundering.
The weekend rescue of Spain's banking sector is a bust in the markets. Cyprus is expected to join Spain, Greece, Ireland and Portugal in seeking aid. And economists are fast looking to Italy as possibly next in line.
The rapid response to Spain's growing financial woes marked a new phase in the crisis that has engulfed the euro zone for more than two years because, suddenly, the fourth-biggest economy in the union was at stake. But, after an initial round of applause Monday, it fell flat.
Euphoria gave way to despair in stock markets, and Spanish and Italian bond yields climbed again, a warning sign that Madrid and Rome could face much more trouble borrowing money.
Though investors were skeptical, other observers hailed the rescue package.
Prime Minister Stephen Harper used a conference in Montreal to underscore his position that Canada should not pump money into rescuing Europe's troubled economies.
"I'm genuinely encouraged by the agreement that was concluded this past weekend among members of the euro zone to stabilize the Spanish banking situation," Mr. Harper said. "It's the type of action taken by the Europeans themselves that Canada favours."
The Spanish bailout was initially cheered as a welcome example of the European Union moving fast to forestall a disaster in the making, sparing banks from certain disaster, in stark contrast to the halting or inadequate efforts to stem the crisis elsewhere. Greece required two bailouts and one massive debt-crunching exercise, yet is still deep in recession and may leave the 17-member monetary union.
While the expected €100-billion ($128-billion) capital injection from either, or both, of the EU's bailout funds – the European Financial Stability Facility or the European Stability Mechanism – will include a cushion, there are fears Spain's banking crisis is so severe that the amount might not cover the rot. The banks, especially regional savings banks, are clogged with dud real estate loans from Europe's biggest housing and construction bust.
Investors fear Spain's housing bust, a slow-motion bank run that could turn into a stampede and other economic troubles could trigger yet another request for international financial assistance.
The rise in Spanish and Italian bond yields illustrates that markets remain unconvinced that either country can return to health in a hurry. Italy and Spain are the euro zone's third- and fourth-largest economies and are considered too big to save should they find themselves shut out of debt markets, as Greece, Ireland and Portugal did, and as Spain almost did last week.
"We view this as a positive near-term development for Spain, and in particular for its banks," Goldman Sachs senior European economist Andrew Benito said in a research note. "But it does not solve Spain's overall fiscal and macroeconomic challenges, which remain substantial."
At the same conference where Mr. Harper appeared in Montreal, the International Economic Forum of the Americas, Bank of Canada Governor Mark Carney also welcomed the agreement, which he said was a further sign of Europe's resolve.
"Recent experience demonstrates that when mutual confidence is lost, the retreat from such an open and integrated system can occur rapidly," Mr. Carney added. "A return to nationally segmented markets would reduce both the systemic resilience and more importantly the financial capacity of the system, a capacity that is necessary for investment and growth."
Some economists put the potential losses on the banks' real estate loan books at about €150-billion. Theoretically, the €100-billion injection, combined with existing provisions, should be enough to cover potential real estate losses.
But Carlo Mareels, an analyst with Royal Bank of Canada's investment arm in London, said there could be surprises, given that "there are other parts of the loan book to consider and the macro backdrop doesn't provide for a comforting environment."
The bailout is not an unqualified win for Spain because the loans will land on the books of the Spanish government, substantially increasing its debt to gross domestic product.
Société Générale economist James Nixon said the bailout, equivalent to about 9.5 per cent of GDP, will push the debt to 90 per cent of GDP in 2013. He said the extra debt "should not undermine Spain's solvency; it may yet significantly exacerbate Spain's funding difficulties."
With files from Bertrand Marotte and Ingrid Peritz in Montreal