In Spain, public distrust feeds economic meltdown

Bailouts from Ireland to Greece have tested the eurozone's resolve to stay together, as has Germany's unwillingness to budge on its austerity-only recipe for struggling members. But the specter of a eurozone breakup transcends the travails of any individual country.

Spain's recent upheavals have underscored the bloc's main weakness: trust that leaders are not only acting wisely, but are also being transparent about their actions. Spain has become something of a test case for how public distrust can be a corrosive force as Europe scrambles to find solid economic footing.

The fate of Europe and the world's economy is at stake. Spain's cost of borrowing leapt to a record high of 7 percent in early June, despite a multibillion-euro rescue from Europe, because markets have lost the little faith they still had in its promises. Spanish authorities have warned that the situation was unsustainable. Markets have essentially shut their doors to Spain; and the consequences reach far beyond its borders, since Europe's bailout stash is unable to finance the needs of Europe's fourth-biggest economy, and a Spanish collapse could drag the eurozone down with it.

"With more credibility, things could have been different. But Europe doesn't have a clear solution and Spain has mishandled [the crisis]," says Rafael Myro, a professor at the Universidad Complutense de Madrid and an expert in foreign investment. "But the credibility problem is predominantly European. The fear the [European Union] will break up is bigger than the problem of any country."

Spain's crisis has been building for years, but it burst into the open when the government announced that its banking sector would need a rescue of as much as €100 billion (about $126 billion), revealing an unprecedented economic fragility. While the root causes are macroeconomic, the driving force behind this turn for the worse is the utter mistrust in Spain's leadership after a cascade of misinformation, contradictions, and coverups compounded by gridlock in the EU.

When the conservative government of Prime Minister Mariano Rajoy came to power in December with a landslide victory, he promised transparency and an end to false promises. He delivered harsh economic reforms demanded by Europe; and he insisted that, although Spain was in a recession, it could hold on until its reforms put the economy back on track.

But his government glossed over just how bad things were getting, using euphemisms (referring to the bank rescue as a credit line) and word-mincing that has left the international community – and markets – deeply frustrated.

"Rajoy lies about what's happening. One day he gives one figure, and the next he gives another," says Jorge Martínez, a retired office worker sitting a couple blocks from parliament. "Every day I trust our leaders less, regardless if they come from the right or left."

Now Spaniards are grappling with the fact that the picture of a rising global power which their leaders invoked for years was a mirage, and that Spain may be more like a bigger and more dangerous version of Greece than they thought.

According to a June 13 survey by the autonomous government polling institution Centre of Sociological Investigations, more than 90 percent of Spaniards say the economic situation is either bad or really bad, and nearly 40 percent expect the economy to worsen in the next year.

That pessimism is feeding back to the political class, which Spaniards cited in the survey as the most pressing problem after unemployment and the economy. Concerns about corruption and fraud are also rising, with 9 percent of Spaniards giving top billing to that.

"We thought we were a rich country and institutionally stable. The crisis has highlighted that is not the case," Dr. Myro says. "The difference between what we thought we were and what we are is political, economic, and institutional."

The unraveling of Bankia

Spain's plight is not over unsustainable debt levels or unwillingness to implement the necessary economic reforms, as in Greece. It already secured most of its credit obligations this year and implemented painful austerity measures.

Instead, the problem is citizens' plummeting trust in Spanish institutions. A catalyst was the botched government takeover of Bankia, formerly the country's third-biggest bank. It was formed by a 2010 merger of seven savings banks, most of them indirectly controlled by the conservative Popular Party currently in power.

In his inaugural speech in December, Mr. Rajoy said the nation's troubled banks wouldn't need a bailout – a message he stood by until May 9, when the government abruptly nationalized Bankia, which subsequently revealed it would need €24 billion ($30 billion) to recapitalize.

For the next month, the government denied the banks would need a European rescue, but didn't say where it would get the money to save Bankia and the rest of the sector. Meanwhile, the International Monetary Fund announced that by its estimates, Spain would need at least €40 billion ($50 billion) to keep banks afloat.

Finally, on June 9, the EU offered Spain up to €100 billion – about 10 percent of its gross domestic product.

Rajoy waited a day before explaining the deal; and when he did, he insisted on calling the funds a line of credit, not the bailout they were. Worse, he described the rescue as a victory for Spain and suggested economic growth would follow as credit recovered – even though similar rescues in other countries were almost always followed by additional austerity.

'Spain is the problem and Europe the solution'

Spain's response to the banking crisis has been the exact opposite of reassuring to Spaniards, and Rajoy and the ruling Popular Party's obfuscation is not limited to the bailout. For weeks they shielded government officials and executives of the rescued banks from questioning, despite an irate public's demand for answers. The ruling party also told Spain's Central Bank not to make any public comments.

It wasn't until after the public initiated a class action suit that the government requested an investigation. Spanish courts are now looking into possible fraud at Bankia, as well as criminal mismanagement in other rescued banks.

European leaders have blamed Spain for its handling of the banks. "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," European Central Bank president Mario Draghi said last month.

Unlike Greeks, whose fury has been directed at the EU, Spaniards see Brussels as the honest broker – albeit one in disarray – and their own government as the deceiver.

"Spain is strange that way. A common saying here is that Spain is the problem and Europe the solution," says José Álvarez Junco, a leading historian and an expert in social and political movements at Universidad Complutense de Madrid. "[The EU is] bureaucratic and not very transparent, but Europe will be more rational and impose better things than Spain."

Spain's democracy is more fledgling than many realize, making blows to its credibility particularly damaging.

"Our democracy had a good start," says Mr. Martínez, referring to the years that have elapsed since Gen. Francisco Franco died in 1975 after an almost 40-year dictatorship. "But it has degenerated. Political parties just think of themselves, not about the people. All of them. Proof of that is that they should all be coming together to save our economy, but instead they just keep fighting among themselves."

"There is a great deal of mistrust in politicians and institutions. There is serious damage," Dr. Álvarez says. "Spaniards realize this government offers few solutions, but the good thing is that there is no radicalism in Spain, no real effort to change the democratic system."

The distrust could catalyze a revival, pushing society to overcome its complacency, both economic and political, says Álvarez.

In 1898 the mighty Spanish empire lost the Spanish-American War and most of its colonies. The defeat spurred a period of vast political and social transformation, known as the "renovation."

"Then we also felt inferior; we suffered a collective depression. Back then, it was also the crisis of a rich country, and it led to a regeneration because everyone agreed things had to change." But Spain can't do this alone. Europe needs to step up, Álvarez says.

"They're concentrating on protecting the euro currency, but they've neglected everything else. What is happening is also the EU's fault for not stopping our governments [in] time."