Euro Crisis Series: Spain's Economic Arsonists

The fact that the markets lack confidence in Madrid is partly a result of the inability to coordinate economic policy and to explain the reasoning behind measures taken by the government. But that government is headed by Señor Rajoy. Never since Franco's death in 1975 has a prime minister lost his luster as quickly as Rajoy. The taciturn notary, who wears a beard and rimless glasses, and was voted into office eight months ago with an absolute majority, now enjoys the confidence of only a fifth of Spaniards in polls.

If Spain does indeed require the full program of a European bailout, at an estimated cost of least €300 billion, and if the feared "men in black" from the troika, consisting of the European Commission, the ECB and the International Monetary Fund, assume control, it will put an end to Rajoy's political career. A prominent former party member is already calling for early elections. For too long, the prime minister believed that his mere presence at the head of the government was enough to ensure that Spain would stop "being a problem and become part of the solution."

On three occasions, he had to correct deficit targets Spain had agreed to with Brussels. Rajoy has also made the rigid labor market more flexible. He has increased taxes and streamlined government ministries. He has set a debt ceiling of 1.5 percent of GDP for the autonomous regions, and he has also forced them to cut an additional €10 billion in education and healthcare spending

But German Chancellor Angela Merkel, Brussels and the investors did not acknowledge his efforts, the premier says privately. Rajoy himself predicts another bad year before the structural reforms can take effect, and that growth should not be expected until 2014.

And now the government also wants to weaken the social safety net -- a culture shock in a society that has always emphasized solidarity with the family. As a result, even fathers and grandmothers have joined the protests. The Spaniards are unwilling to accept without complaint the notion that the weakest members of society are to be deprived of the social safety net, but they are expressing their displeasure without being aggressive. In Spain, unlike Greece, the demonstrations have remained nonviolent.

Shameless Lies

Perhaps what infuriates hundreds of thousands of people and drives them into the streets is not that they are being asked to make sacrifices, but rather the lies of the political class. Rajoy, who consistently emphasized during his campaign what an honest man he is, has exhausted the Spaniards' patience with sugarcoating and shameless lies, especially on the subject of banks.

Conservatives and Socialists alike consistently praised Spain's banking system as the best in the world. Rodrigo Rato, economics minister with the People's Party under José María Aznar, the prime minister who presided over the boom years, was considered the father of the Spanish economic miracle. He was also the one who liberalized building laws and boasted of giving all Spaniards access to the stock market.

After returning from the International Monetary Fund, Rato became president of the new industry giant Bankia in 2010. The banking group was created through a merger of seven ailing savings banks from regions with conservative governments.

In May, by Rato's own account, his fellow party members in the government forced him to resign. He is currently being investigated for accounting irregularities. Luis de Guindos, who served as state secretary under Rato and is the current economics minister, nationalized Bankia and installed a banker as Rato's successor. In turn, Guindos immediately demanded €23 billion from the government. As a result, Rajoy's only option was to request the loan from the European bailout fund, which he then celebrated as a personal victory.

He carefully avoided using the Spanish word for rescue, "rescate," insisting instead that this wouldn't cost taxpayers anything and that Brussels would not impose any conditions on Spain.

But he was wrong. The Spanish commissioner for competition in Brussels, Joaquín Almunia, a Socialist, made it clear to his fellow Spaniards that the government had to guarantee the aid for the banks. And now that they have realized how much the "favorable credit line," as Rajoy euphemistically calls it, is going to cost them, the Spaniards are outraged.

Forging a New Alliance

The executives of savings banks, which also talked low-income borrowers into taking out mortgages, will remain unscathed if these borrowers default on their mortgages. The same holds true for bankers who speculated with pensioners' savings.

Retirees who have been harmed as a result are protesting in their underwear in front of branches of Novagalicia Banco, a savings bank in the northwestern province of Galicia. They've written the words "You've stripped me completely" on their underwear. Naked firemen are protesting in the neighboring province of Asturias. In Seville, outraged citizens staged a bank robbery, but instead of pulling out weapons they stamped their feet and danced the flamenco.

Even more dangerous for Rajoy are the autonomous regions that are rising up against the government's stricter austerity programs. Many will have to raise fresh capital in the second half of the year. To meet this need, Madrid intends to make a so-called autonomous liquidity fund totaling €18 million available to the regions starting in September.

The eastern province of Valencia, a conservative stronghold, has announced that it intends to apply for at least €3.5 billion, while neighboring Murcia, also ruled by the conservatives, wants up to €500 million. Even the Catalans, who are normally so determined to gain independence, are now forced to ask Madrid for aid payments.

But Finance Minister Cristóbal Montoro says: "The government coffers are empty." Based on the projection that the Spanish economy would shrink by 1.5 percent this year, he had the parliament enact legislation that strictly caps the government budget for 2013. But the opposition fears that the austerity measures are not enough, and that the economy will continue to decline. Although the Euro Group of European finance ministers has given Spain until 2014 to reduce its deficit to 3 percent, Montoro does not want to allow the autonomous regions to relax their austerity goals.

Amid all this hardship, Prime Minister Rajoy is planning an act of liberation with the help of a newly forged euro axis stretching from Rome to Madrid to Paris. He has invited Italian Prime Minister Mario Monti to a meeting at Moncloa Palace on Thursday.

Together with his ally, Rajoy intends to work out a new strategy to apply pressure to Chancellor Merkel. It pits the southern and northern Europe against each other. On the same day, Draghi will have to explain to his colleagues on the ECB Council how his offer to print money is supposed to work.

Spain has made some very important decisions in the last few months, and it will continue to do so, says Rajoy. "Now it's up to Europe to apply the same amount of energy and make decisions just as quickly," he said.

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• Part 1: Political Bankruptcy in Madrid Adds to Woes
• Part 2: Unpopular Prime Minister