Why is Spain causing so much pain?
Simply because it's so damn big. Its problems are quite similar to those the Irish had a few years ago. It's an otherwise generally healthy economy, poisoned by overexposure to a toxic housing market. It has huge amounts of public and private debt, just like Ireland, and it's having problems meeting its obligations.
The problem is, Spain's economy is $1.4 trillion in size -- about five times the size of Ireland's economy.
It might help to think about Spain like a homeowner, with a big house worth $1.4 million. Mr. Spain has a job, which brings in a certain amount of money each month, some of which he uses to make the mortgage payments on his hacienda. Over time, in order to fund his lifestyle, Mr. Spain has refinanced his home over and over, so that now he has no more equity in the place -- he has a full-on mortgage, equal to the value of the house -- $1.4 million. That's all fine when he has enough money coming in the door to make his interest payments, but as the bad economy starts to bite down, Mr. Spain's pay is cut, and cut again. Suddenly he finds he simple hasn't got enough money to make his nut, so he starts to use his credit card and any other loan source he can find to make those monthly payments. Pretty soon his situation is unmanageable, and he needs to go to his rich Uncle Dieter for help.
Uncle Dieter helped out Spain's cousin, Mr. Ireland, a few years ago -- in fact he basically bought his entire mortgage -- $112 billion (Ireland's economy is about $180 billion in size). So Spain figures he's good for it. But Uncle Dieter balks. He explains that he only helped Mr. Ireland because his mortgage was so small, and it was easy to pay down. If Mr. Spain's mortgage was about the same size, no problem. But a $1.4 million mortgage? That's simply way too much for Uncle Dieter to handle. It might break him.
Bad luck for Mr. Spain. His income is falling, he's having trouble making his monthly nut, and his rich uncle is not stepping up to help. And to make matters worse, the interest rate on his mortgage is going up because the bank can see he's becoming a bigger risk, day by day. So there's less money coming in the door, more money going out the door, and no one willing to help Mr Spain make up the gap in between.
So why not let Mr. Spain go bankrupt?
There are a couple of reasons. First, a great many non-Spanish banks have lent money to Spain, so if Spain goes bust, those banks are going to be out of the money and looking for help themselves. That will put great strain on the European financial system. Second, if Spain goes bust, it will likely have to leave the euro. And Spain is the fourth largest economy in the eurozone. It's not a marginal player like Greece -- it's one of the big dogs. Its departure would almost certainly break the euro and create havoc in the global economy. There's no way to know what kind of havoc that would cause -- this has never happened before -- but the repercussions will certainly ripple across the Atlantic and cause problems here in the U.S.