FORTUNE — Investors initially cheered the news that Spain reached a deal for a 100 billion euro bank bailout, but that enthusiasm may not last once the details are digested. The deal, concocted in Madrid and Brussels over the weekend, amounts to a kind of shell game, whereby bank property losses are simply transferred from the banks over to the Spanish government’s weak balance sheet. Not only is this bailout likely to create public outrage in the streets of Spain, as it shamelessly socializes bank losses, but it will probably make it harder, not easier, for Spain to sell its debt at a low enough rate to fund itself.
Eventually, the Spanish government will need its own bailout, similar to what has already occurred in Greece, Ireland and neighboring Portugal. But with a GDP that’s twice as high as those three countries combined, a Spanish sovereign bailout could be the catalyst that either forces the eurozone closer together or smashes it apart.
Spain’s relatively new Prime Minister, Mariano Rajoy, maintained as late as May 29 that his nation did not need a bailout of any kind. He was confident that the reforms his conservative People’s Party (PP) had put in place since coming to power in November of last year were strong enough to bring confidence back to the nation’s shaky economy.
But while the PP pushed through some positive reforms, like establishing a formal debt limit and setting a budget deficit ceiling, it also continued some of the more questionable policies set in place by its socialist predecessors, most notably, the policy of forcing weak banks to merge. The belief behind this policy was that by being bigger, those weak banks, which were all carrying billions of euros worth of bad property loans on their books, would somehow cope better with their mounting losses after being smashed together.
That obviously was not the best way to deal with the nation’s bank woes. The market punished Spanish sovereign bonds as it became clear that the country’s banking system was teetering near collapse and the government did not have the means to take care of the issue on its own.
Swallowing his pride, Rajoy announced this weekend that his nation was “open” to receiving a bailout of its banking sector to the tune of 100 billion euros. The mechanics of the bailout still need to be ironed out, but we know roughly how it will work. The EU, through either one or both of its special bailout funds, the European Financial Stability Facility (EFSF) and/or the European Stability Mechanism (ESM), will transfer money to Spain’s own bailout fund, the FROB, which recently ran dry. From there the FROB will most likely inject capital directly into weak banks in order to fill the holes in their balance sheets caused by the massive decline in property values in the country.
The big problem with this deal is that the money being funneled to the FROB is going to be added to Spain’s already burgeoning debt load. That means that if it ends up needing all 100 billion euros, Spain’s official debt-to-GDP ratio, a measure of risk, would increase from a somewhat manageable 68.5% to a far more dangerous 77%. But traders who deal in sovereign debt note that Spain’s official debt-to-GDP ratio doesn’t give an accurate picture of its risk. That’s because it doesn’t take into account the billions of euros of off-balance sheet debts, which are obligations that are implicitly guaranteed by the Spanish government. Add in those off-balance sheet items and the nation’s debt-to-GDP ratio jumps from 68.5% to 87%, according to the Bank of Spain. Top it off with another 100 billion euros and the ratio jumps to around 96%.
Of course this assumes that 100 billion euros will be enough to save Spain’s banks. We truly won’t know how much the banks need until Oliver Wyman and Roland Berger, the consulting firms, release their independent assessment of the mark-to-market values of Spanish bank assets, which is expected around the 21st of this month.
Most analysts and traders are assuming that all developed properties will need to be reduced by a whopping 50%. But what is frightening is the value of the land being held by the banks. Hedge funds and vulture funds seeking to buy up distressed Spanish banking assets are offering 50 cents on the dollar for developed properties, but “wouldn’t even offer two cents,” for undeveloped land, according to a person with knowledge of the situation. Apparently a lot of the land being held by the banks is in remote areas of the country, like the landlocked province of Extremadura, which will probably not see much development anytime in the near future.
So if the independent auditors end up marking all Spanish land to zero, the banks would collectively need 40 billion euros from the FROB, according to Credit Suisse. That leaves 260 billion euros of developed land to mark down. When you offset that against current provisions and inject enough cash to ensure every bank has a tier one capital ratio of 10% then you are nearly at 100 billion euros. If banks are required to hold more capital, then it easily exceeds the 100 billion euro mark. This also assumes that the capital and deposit flight that Spain has seen recently comes to a halt. If it continues, the equity values of the banks would fall, requiring them to request even more money from the FROB.
This bailout is truly an exercise in absurdity. Instead of taking risk off Spain’s shoulders, the EU is actually saddling the sovereign with even more debt. Once the market has a chance to study this deal in depth, it will continue to demand a prohibitively high premium to hold Spanish bonds. As such, this almost guarantees that Spain will continue to be totally dependent on the European Central Bank to buy its debt. Eventually this system will break down, forcing the Spanish government to seek a bailout of its own from the EU and the IMF. The austerity and humiliation that would go along with a sovereign bailout may be too much for Rajoy and the rest of his cohorts to stand.
A more effective bailout would have been one where the EU collectively worked to lower Spain’s bank and sovereign debt burden by assuming all or part of it. This would spread risk among all 17-members of the euro zone and would free Madrid to once again issue its own debt at a reasonable price point. But for now, this bailout will serve as yet-another stop-gap measure in this seemingly never ending crisis.