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Spain's banks, especially the cajas, are in desperate trouble due to that country's real estate boom and bust. The banks hold large quantities of mortgages and loans to developers that are seriously underwater, a fact that the banks have been very slow in recognizing - as is almost always the case. Don't recognize the losses, you can perhaps benefit from a miracle turnaround in the market in the future. Recognize them, you are out of business immediately.

Spain's government has responded by forcing the banks to write down their mortgage assets, and to raise more capital. The problem is that capital is a buffer against possible future losses; you can't get anyone to contribute capital to pay for losses already realized. So where is the money going to come from? Because private capital is not going to fund past losses, the only real candidate is the Spanish government, but it has agreed to stump up only 15 billion Euros, far short of the 50 billion Euros that market participants deem necessary. But Spain, with nearly 25 percent unemployment rate and an ongoing recession (with a forest decline in its economy of 1.8 percent this year) is unable to fund the amount necessary to bailout the banks. Its bond yields already top 6 percent.

Which means that the money has to come from outside . . . the ECB or the European Stability Mechanism. But the Germans have already made it clear they are not going to permit the use of ESM funds. Much more ECB support is also unlikely.

So how is this going to work, exactly?

Spain is also ordering the banks to dump their bad real estate loans into asset management companies (an expedient that the Chinese have used on multiple occasions). But that can lead to fire sales (if the asset management companies dump the assets) which exacerbates the underlying problems. And this just moves the losses around. It doesn't eliminate them.

So Spain is in deep trouble, and there is no obvious way out.

All this is happening, moreover, at a time when Greece is spinning out of control again, and quite predictably. There was no way to commit the Greek electorate to adhering to any deal negotiated with Europe. And they are quite clearly rebelling at the idea, confronting Europe with the choice between a Greek exit from the Euro and shoveling more money down the rat hole. There are already reports that the Troika is willing to make concessions on the recently negotiated bailout deal, concessions that will almost certainly have to be followed by more concessions, and yet more.

This all resembles a disaster like Chernobyl,or a plane crash, where there are cascading failures. Perhaps one of them would be containable, but multiple failures-especially those that feed back on one another-are far, far more difficult to manage. I keep looking for a way out. Not seeing it.

Source: The Banks In Spain Swirl Mainly Down The Drain