In late May, a group of bankers, government officials and accountants assembled at Spain’s finance ministry to make a painful decision: Bankia SA, one of the country’s largest and sickest banks, needed €19 billion, about $24 billion, of public funds to repair its tattered finances.
The problem was no one at the meeting knew where such a large sum would come from.
The answer is now here: Spain on Saturday said it would request an international bailout of up to €100 billion to help pay for the rescue of its banking sector. That, in turn, is fanning fresh fears about the future of the euro zone, where 17 countries share a common currency.
Spain is in this predicament because its banks made real-estate loans that went bad, but that is not the whole story. Spain also made a series of miscalculations in responding to its banking crisis. Government and industry officials repeatedly chose temporary fixes instead of major surgery in dealing with the country’s banks, betting that economic conditions would improve.
Last September, shortly after Bankia raised money from investors, then-Finance Minister Elena Salgado told Spanish lawmakers that Spain’s banking sector “now is prepared to overcome any test it might face in the future.”
Such short-lived confidence among European leaders has become a hallmark of the Continent’s financial crisis. In late 2008, for example, Ireland’s finance minister declared that he had saved the country’s insolvent banks with “the cheapest bailout in the world so far.” Two years later, that rescue bankrupted Ireland, forcing it to accept an international lifeline.
While Bankia is Spain’s biggest troubled bank, investors and ratings firms expect several other midsize Spanish banks to need help. Late Friday, the International Monetary Fund issued a report estimating that Spanish banks need at least €37 billion—and possibly double that.
Two years ago, the Spanish government mashed together seven troubled regional savings banks, known as cajas, to create Bankia. While the regional banks were saddled with souring loans and investments, government officials and regulators hoped the new entity would have the heft to survive.
Bankia became Spain’s third-largest bank by assets behind Banco Santander SA and Banco Bilbao Vizcaya Argentaria SA. It was holding €38 billion of Spanish real-estate loans—more than any other lender.
Bankia’s problems have their roots in Spain’s real-estate bust. The country’s savings banks—many controlled by politicians—lent heavily to developers and local governments. When the housing market began to tank in 2007, small banks were left with heaps of bad loans and investments. “Having politicians in management positions at the cajas was the real cancer of the Spanish banking system,” said Jordi Fabregat, a professor of finance at ESADE, a Barcelona-based business school.
Last spring, Bankia prepared a €4 billion public offering to raise capital. Warning signs were already flashing.
Some big Wall Street banks hired to work on the IPO encouraged Bankia executives to increase the deal’s size to as much as €10 billion, according to people familiar with the matter. The reason: Would-be investors were telling the banks that only such an amount would be enough to convince investors that Bankia was adequately capitalized.
Bankia management rejected that idea, these people said. Executives argued that such a large deal would erode the value of the stakes owned by existing shareholders—namely, the cajas. Frustrated investment bankers noted that the executives still carried business cards embossed with the logos of their local cajas, not Bankia.
As investment bankers fanned out to drum up interest among institutional investors in financial capitals around the world, they faced chilly receptions, according to people who worked on the deal. Investors were uncomfortable with Bankia’s exposure to risky Spanish real estate and were unwilling to put money into any Spanish institution. Until shortly before the IPO, Bankia didn’t even have a chief executive and was instead helmed solely by a chairman, Rodrigo de Rato, a former Spanish finance minister and IMF head.
In mid-June, less than two weeks before the IPO, Mr. Rato flew from Madrid to London to meet with prospective investors. During the flight, he received an unsettling message. One of the firms advising Bankia thought he should shelve the IPO due to the lack of interest, according to people familiar with the matter.
Mr. Rato spent much of the flight debating the pros and cons, these people said. He decided to plow ahead, worried that canceling the IPO would send a dangerously destabilizing signal about the health of not only Bankia but the entire Spanish banking sector.
But Mr. Rato and his advisers shifted tactics. Instead of focusing on the sophisticated international money managers that are the usual candidates to buy stock in newly listed companies, they switched their focus to Spaniards.
Bankia and several other large Spanish retail banks peddled the shares to hundreds of thousands of their customers at €3.75 apiece. Mr. Rato and top Spanish government officials worked the phones with wealthy individuals and business leaders, urging them to buy shares personally and on behalf of their companies. If Bankia’s offering failed, they warned, it could drag down the entire Spanish financial system.
Bankia managed to raise only €3.1 billion. Less than 2% of the proceeds came from investors outside Spain, according to people familiar with the matter. A couple of weeks later, the European crisis intensified. Banks across Europe saw their shares battered. But Bankia’s stock price remained fairly stable. Executives and Spanish officials interpreted that as a vote of confidence in Bankia’s strength.
That rosy interpretation, some officials now concede, was flawed. It instead reflected the fact that Bankia’s shares were largely held by retail investors who were slower than institutional investors to react to the escalating crisis.
Through a spokeswoman, Ms. Salgado declined to comment. The Bank of Spain’s governor, in its annual report released Friday, listed the progress made in financial sector cleanup since 2010, with 45 savings banks merged into 11 and new rules on loss-absorbing buffers, and said the worsening euro-area debt crisis was a reason the banks had needed additional funds.
Through a spokesman, Mr. Rato declined to comment.
On Nov. 20, Spanish voters ousted their government, replacing the socialists with the conservative People’s Party. Incoming Prime Minister Mariano Rajoy vowed to fix the country’s banking system, promising to require banks to beef up their reserves to cover bad loans.
As weeks passed, top Spanish bank executives started fretting to government officials that Bankia’s problems threatened to engulf the country’s entire banking sector.
In early February, Mr. Rajoy’s government unveiled its bank plan. It would force banks to set aside an additional €50 billion of reserves. Banks that didn’t have the money would be allowed to turn to the government bailout fund.
The Bank of Spain’s top regulator, Jose Maria Roldan, traveled to London and Asia in April trying to restore confidence in the country’s financial sector. He presented a 42-page slide show with the theme that the Spanish government had taken the steps necessary to address the banking sector’s weakness.
Mr. Roldan’s last stop was in Tokyo on April 25. Later that same day, the IMF delivered a severe blow to his pitch: a report warning that 10 Spanish banks were in danger, singling out Bankia.
By early May, panic was setting in. Customers were withdrawing funds from Bankia, worsening its health.
The illness threatened to infect other Spanish companies. Investors told senior bank executives in Madrid that they wouldn’t put money into any Spanish financial institutions until the government resolved the Bankia mess, according to people familiar with the matter.
At a May 3 dinner in Barcelona’s centuries-old Pedralbes Palace, European Central Bank President Mario Draghi told bankers and senior government officials that he was deeply concerned about Bankia, according to a person familiar with the matter.
The next day, the chairmen of three giant Spanish banks—Santander, BBVA and La Caixa—met with Finance Minister Luis de Guindos and delivered a similar message, according to people familiar with the meeting. They pushed him to quickly nationalize Bankia.
On May 7, under government pressure, Mr. Rato tendered his resignation as Bankia’s chairman. Days later, the government ordered banks to come up with another €30 billion of reserves to absorb future losses.
Seeking to get a handle on the true depth of Bankia’s problems, the finance ministry brought in a team to dive into its books. It found many of the bank’s assets hadn’t been marked down to reflect their true values, according to people familiar with the procedure.
In other cases, the bank had classified some loan portfolios as small-business loans when they should have been labeled as real-estate loans, these people said. It was an important difference, because real-estate loans are more likely to have lost value.
The potential losses quickly piled up. In the early hours of May 25, the team settled on a final tally: €19 billion. Before announcing the huge sum to the public, government officials privately acknowledged the possibility that the bailout’s size might force the country to seek external financial help.
A week later, on May 30, Spain’s borrowing costs neared record highs, with 10-year bond yields rising to 6.7%. The following week, Spain’s budget minister conceded that the country, locked out of international funding markets, might need to be rescued. That became a reality on Saturday. Bankia shares are now worth about €1 each—nearly 75% below their debut last summer.
Margarita del Campo, a 59-year-old civil servant in Madrid, bought €2,000 worth of Bankia shares in the IPO. As a longtime Caja Madrid customer, she says she trusted Bankia. Now her investment has shriveled to barely €500. “I used to believe in my bank,” she says, “but I don’t trust in a single one right now.”