Spain Performs Its First Bank Rescue of the Current Crisis – and Probably Not the Last

The Bank of Spain is throwing a lifeline to one of the country’s smaller regional savings banks – Caja Castilla-La Mancha – in what appears to be the first in a series of such rescues. According to a Bloomberg report, the government announced this week that it will give the bank up to 9 billion euros ($12 billon) “to shore up the regional lender’s finances and protect depositors in the first bank rescue since 1993.” The government also replaced the bank’s management as part of its move.

The overall situation in Spain is dire, the report notes, with unemployment at 14% — the highest in the European Union – and “the economy is in the grip of its worst recession in half a century.” Not surprisingly, borrowers are defaulting on loans from banks like Caja Castilla-La Mancha in record numbers.

According to a report cited by finance blog Calculated Risk, Spain’s local-government-owned savings banks — or “cajas” — make up half the country’s financial system, and they are closely tied to the Spanish real estate market, which, as Universia Knowledge at Wharton has reported, suffered a significant correction in 2007 and has deteriorated since. As such, the Caja Castilla bailout is likely only the beginning of a much bigger trend.

As Edward Hugh noted in his Seeking Alpha column this week, the growing crisis in Spain has led to a vocal public debate on how to handle “broken banks.” (Sound familiar?) One solution would be to nationalize these entities, although the Obama administration has chosen a different approach, reported on in the current issue of Knowledge at Wharton. (See: “The $2 Trillion Question: Will Investors Buy the Government’s Toxic Asset Plan?”)