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Spain capital flight doubles as risk of European bailout rises (+video)

Capital flight from Spain has doubled to a new record and the country has demanded the European Central Bank recapitalize its teetering financial system, warning that the alternative is a broader bailout that could rock the European economy.

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Prime Minister Mariano Rajoy, who has been a willing adherent of German-led austerity, reached out to Germany and the US to press his case, privately and through the press, but there is no sign yet that the government's dangerous gamble – a full bailout is the inevitable outcome down the line if it doesn't get the money it needs now for its banks – will work out. Several officials also said Germany was receptive, but offered few details.

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“Spain is threatening with seeking a bailout to force the ECB to help it recapitalize its banks in order to give its measures more time to work. That is the negotiation,” says Roberto Ruiz Scholtes, UBS strategy director of wealth management research in Spain. “It’s a poker game that could also backfire if markets end up shutting out Spain from more credit for all its other problems. Spain could end up badly hurt.”

Burgeoning uncertainty about Spain's economic stability and the government's brinkmanship are precipitating fears of a prolonged recession in Europe, which are only compounded by concerns about a disorganized Greek exit from the eurozone.

Financial meltdown

The newest and most deadly symptom of the crisis was triggered by the government nationalization of one of the country’s biggest banks, Bankia, on May 9. A bedrock of the ruling conservative Popular Party, the bank reevaluated its 2011 results shortly after its seizure, and a tiny profit became a staggering black hole of nearly 24 billion euros.

Stockholders and investors cried fraud, but the government and Popular Party blocked attempts to investigate the Bankia meltdown. In fact, Spanish Central Bank Governor Miguel Angel Fernández resigned this week after the government gagged him when he tried to give his account to Parliament. 

Yesterday the ECB scolded Spain for being opaque about an issue with such sweeping implications beyond its borders. 

“When we are faced with dramatic recapitalization requirements, the reaction of governments is to underestimate the importance of the problem. This is the worst way to do things because in the end everyone ends up doing the right thing, but at the highest possible cost,” ECB governor Mario Draghi said.

He rejected Spanish pleas to inject money into Spanish banks, instead calling for an EU-wide financial agreement still under negotiation.

USB and other financial analysts calculate the Spanish financial sector will need around 50 billion euros to recapitalize. The government believes that stabilizing the banks will buy the country enough time for it austerity measures and economic reforms to begin pulling the economy back up, but some analysts express doubt about that strategy because Spain has not been transparent in the past.

“Spain’s is a piece-meal approach, but it’s failed in the past, and the government is still creating uncertainty over how much money it needs and how it’s going to get it,” said Mr. Ruiz Scholtes.

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