The doomsayers are rubbing their hands, sure that they are about to win the match. The possibility that is bringing shudders to the streets of Madrid and offices in Berlin alike – that a major EU country will ask for a bailout – looms ever closer. Spain’s President Mariano Rajoy denied Monday for the umpteenth time that Spanish banks need any rescue from abroad, but the hole in Bankia is pushing the country a little closer to the abyss.

Even before it was known that the state would have to pump a further € 19,000 million into Bankia, several experts were warning that, however painful it would be, the government would have to ask for money from outside Spain’s borders to recapitalise the country’s banks. “It should have done it long ago,” says Daniel Gros, CEPS researcher, “but better late than never.”

“Spain looks likely to enter some form of a troika program this year as a condition for further European Central Bank support for the Spanish sovereign debt or Spanish banks,” noted Citi’s chief economist William Buiter a couple of months back.

Many mysteries in the equation still have to be cleared up. Not just if Spain will finally take the next step. There’s also the worry about what system would be put in place if savers let themselves be carried away by panic, or if it’s possible to avoid contagion, which would spread right away to Italy, and later to France and Belgium.

Last summer the EU leaders took two decisions that paved the way for the temporary fund – officially the European Financial Stability Fund (EFSF) – to help avert the collapse of a large part of the Spanish banking sector. First, it increased the endowment fund from 440 to 780 billion euros, though the effective capacity of the loan remained at 440 billion. A month later, the focus broadened: the support mechanism could also be used to recapitalise banks via loans to states.

“It is indeed a bona fide intervention”

The problem is that the stream of money would go primarily to the government, which would assume the debt, and that the government would then direct it toward the banks. This implies conditionality: an intervention with all the consequences, with compensatory measures like those imposed on Greece, Ireland and Portugal.

It would then matter little that it would be a ‘Rescue Lite’ – to save the banks, not the state – because Europe, by stressing the requirement for firm restructuring plans, could slap conditions on such aspects as fiscal policy, public services, privatisation or management of the bailed-out institutions.

Perhaps most worrisome, though, is the possibility that Spain will be unable to fund itself in the markets for no one knows how long. “You can give it many different names, but it is indeed a bona fide intervention,” sums up a high-ranking source in the Community.

This opens the door to a scene somewhat reminiscent of Ireland: the paternal government supports its banks, but the hole is too big to fill and the country finds itself led down the road to outside intervention. “If money could go directly to the banks [an option quashed by Germany], they would be the ones who would have to return it,” explains Professor Santiago Carbó.

“Bank runs throughout the periphery”

“Europe should monitor and supervise the rescued banks, which could be the start of the banking union. But we can’t kid ourselves; this won’t happen until the European Stability Mechanism is ratified,” adds Guntram Wolff of the Belgian think tank Bruegel.

The European Stability Mechanism is to take over from the EFSF on July 1 as Europe’s permanent bailout fund. Not only will it be more powerful (with half a billion euros of fresh money), it will also be more flexible. But it still has to be ratified by many of the Member States before it enters into force. A delay in the schedule, with Spain on fire, would be a catastrophic signal.

What would happen if the Spanish government were finally forced to dip into the rescue fund? Harvard professor Kenneth Rogoff answers: “If the eurozone and the ECB fail to take unequivocal and speedy steps, there’ll be bank runs throughout the periphery and devastating capital flight. To avoid this, banks must be provided with liquidity.

"The eurozone should move several rungs up the ladder of fiscal union with Eurobonds. We will see exceptional measures, which until very recently were unthinkable – but that has happened every time Europe has been on the verge of an accident.”