Solutions must be contemplated in relation to the magnitude of the problems for which they're destined. And the open-ended problem of the Spanish banking system was, until Saturday, certainly complicated. Despite provisions made in recent years, its solvency was seriously in question. This happened for two reasons: the excessive amount of bad real-estate loans on the balance sheets (the original cause of the financial crisis unleashed in the United States), and the prospect of low to no growth in the Spanish economy. Neither the defaulting of debtors nor the value of assets that act as collateral will move in a favorable direction in the coming months if demand in Europe isn't reactivated. It will be necessary, therefore, to get more capital for the banks. And to get it from private sources has been, in recent months, little short of impossible.
The option of it being European credit (from the Financial Stability Facility) that injects capital into the banks will offer the advantage that the Spanish treasury would not find itself increasingly obliged to resort to primary market debt issuance. That these funds should be given directly to the banking system, even if that's via the Fund for Orderly Bank Restructuring (FROB), will offer the advantage that it will be the banks, not public budgets, that will take on lenders' demands, the "conditionality" that Europe will impose.
Regarding the fundamental problem, then, we have removed one unknown: the origin of the bailout money. There are other questions, including the diligence with which the government will now move forward and the amount that will ultimately be requested and conferred from these funds.
Following this decision, the intensity of the "diabolical loop," which I have written about before -- the mutual reinforcement between declining bank solvency and devaluation of public debt -- may be softened. As for whether the bailout funds will be sufficient, and how they'll be distributed among the most exposed banks, that will depend on whether this decision will effectively contain the crisis, as is necessary. Now all that's left is to control what the banks do with these funds. Given everything, the solution could have been worse.
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