Spain’s premier Mariano Rajoy has been betrayed. Nobody should be entirely surprised if he and the Spanish arch-nationalists in his circle offer a condign riposte, and bring down the entire temple on the heads of the creditor powers.
He bit the bullet and agreed to the highly intrusive terms of a €100bn eurozone rescue for the Spanish banking system on a specific understanding: that the ESM bail-out fund would ultimately take over the burden by recapitalising Spain’s banks directly.
This deal has been breached. Can we believe anything that the Chancellor of Germany, the prime minister of Holland, and the prime minister of Finland say from now on? The EMU rescue edifice is built on sand.So the question now is how will Spain respond.
Regular readers know that, just like Iceland, Spain's only choice is to adopt the Swedish Model for handling a bank solvency led financial crisis.
The adoption of the Swedish Model preserves the real economy in Spain and sets the stage for a recovery.
Like Iceland, Spain needs to require its banks to absorb losses today that are the equivalent of what they would absorb if the banks go through the long drawn out process of default, bankruptcy and foreclosure.
This protects the real economy and reduces the debt in the financial system to a level that the borrowers can afford.
To insure that the banks recognize all of their losses, Spain also needs to require its banks to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.
With this information, market participants can determine which banks are capable of generating earnings and rebuilding their book capital levels and which banks need to be closed.