Spain nationalized its largest real estate lender Wednesday night and plans to announce an overhaul of the country's entire banking system Friday.
The country is scrambling to prevent its troubled banks — weighed down by property debts — from sabotaging the whole economy. The Spanish government has only to look northward to Ireland to see what could happen if it fails.
Lessons From Ireland
If Spain is the weakest link in the eurozone now, banks are the weakest link in the Spanish economy. They're also the biggest landlords in the country, after the housing bubble burst and sparked a wave of foreclosures.
Banks are drowning in unpaid loans and properties they'd have to sell at a loss. But that creates another problem, says economist Javier Diaz-Giménez of Spain's IESE Business School.
"If you mark them down to market, these losses wipe out your capital and might force you to go bankrupt," he says.
Diaz-Giménez says that was the case with Bankia, the country's fourth-largest bank overall, but the biggest in real estate. Spain took a controlling stake in Bankia on Wednesday, and others could follow, when the government announces reforms Friday.
They're likely to include creation of a so-called "bad bank" — a government holding company that absorbs toxic assets from other banks.
"Remove this stuff from my balance sheet. I don't want this to be my problem. And the way you do it is you have to sell it to somebody at some price," Diaz-Giménez says. "Determining the fair value of the assets is the key thing."
That's where Ireland had trouble in 2009. Like Spain, it had a massive property boom and bust, and the government nationalized banks' assets, which turned out to be worth even less than it thought.
So Ireland ended up needing an E.U. bailout — something Spain wants to avoid. It's hiring an outside auditor to value banks' assets.
Fernando Fernandez, an economist at Madrid's IE Business School, says there is one major difference Spain can take heart in.
"Ireland actually did nationalize the three largest banks, which were basically 90 percent of the financial system. Here, all in all we're talking less than 30 percent of the financial system," Fernandez says. "So there's a major part to the financial system in Spain that is healthy, that is solvent, that is liquid, that has no problem."
Gambling On Bank Bailouts
Spain is trying to enlarge that healthy part of the banking sector to keep credit flowing — to people like Jorge Mellado, a 26-year-old lawyer who wants to buy a house, but can't get a mortgage. Austerity means he's paying higher taxes for fewer benefits. And he's miffed that his tax money is now going to rescue the banks.
"If you put public money into the banks, you have to put public money into other companies," he says.
Mellado's law firm, by contrast, says it can't afford to pay him more than $1,300 a month. He lives with his parents.
Spaniards are already sacrificing, and the government will have to sink deeper into debt to finance these banking reforms. The price tag for taxpayers could reach $65 billion — many times what's been cut from health and education. Economist Diaz-Giménez says people realize it's a gamble.
"If Bankia resuscitates, which it might, then the Spanish public will make a little profit," he says. "And if Bankia fails, the Spanish taxpayer will be rightly, very upset."
Americans may still debate whether the 2008 U.S. bank bailout was right. But Washington's finances were robust enough to ensure against possible losses.
That may not be the case in Spain, with borrowing costs rising and the economy set to shrink this year. The timing isn't perfect, but Spain may not have much more time if it doesn't act now.