GOVERNMENTS SHOULDN'T BE RESPONSIBLE FOR BANK LOSSES

Conventional wisdom holds that Spain must rescue its banks from its tens of billions of euro worth of bad property loans. If Spanish banks failed, the thinking goes, Spain itself would be plunged into depression, the euro itself would face heightened risk of breakup imperiling the rest of Europe's economy too.

Saving Spain's banks won't fix the situation. Even if the banks have some money to lend, they won't lend it to people and small business who labour under the weight of a depressed economy. The banks will instead lend any extra cash right back to the government, which in turn will lend it right back to the banks.

The best thing for Spain-and for Europe- is to free itself from some of its oppressive debt. Luckily for Spain, its debt problem isn't that the government itself borrowed far more than it could ever afford to repay, as is the case in Greece. Rather, it was Spain's banks that borrowed far more than they could ever afford to repay, at least not without government help. Today Spain's banks owe global creditors about 48 percent of the nation's GDP.

The solution then, should be simple: let the investors who freely lent Spain all that money suffer the predictable consequences of that recklessness.

Spain with European help should restructure its banking industry so that bank bondholders and other bank creditors take their losses. Since Spain's bubble-era bank managers and owners botched the job, new managers and owners should take over. Spain should use Europe's money to protect only small depositors in its banks- nobody else. Such a step would strengthen Spain's economy. Banks, freed of their bubble-era mistakes could lend again. The euro, too, would be stronger, as a recovering Spanish economy could repay its national debt. The course that Europe and Spain are choosing instead offers only more desperation and desolation.

Governments in the EU should follow the example of the U.S. and direct their banks to develop plans for staving off collapse if they faced serious problems, and emphasize that the banks should not count on government help. Governments in the EU should tell banks to consider drastic efforts to prevent failure in times of distress, including selling off businesses, finding other funding sources if regular borrowing markets shut them out, and reducing risk. The plans should be feasible to execute within three to six months, and banks should make no assumption of extraordinary support from the public sector.