EU Bailout No Solution for Spanish Banks

NEW YORK (TheStreet) -- Pressured by other European Union governments, Spain has asked the EU for 100 billion euros 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 that 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 nonperforming real estate loans.

Unlike the Federal Reserve, 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 euro in international bond markets to save its banks.

With real estate loans totaling more than 660 billion euros, or about 65% of GDP, the cash that must be raised is simply beyond the borrowing capacity of the Spanish government.

The International Monetary Fund estimates Spain's banks need 40 billion euros in new capital, and as much as 100 billion euros 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 100-billion-euro 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.