The crisis in Spain may well prove more significant than the drama playing out in Greece, said the head of currency strategy at BNY Mellon, a leading assets management and securities services company.

Spain’s version of the Euro-area crisis is, of course, centred on the nation’s housing market and banking system. Not only have house prices fallen by 21.5 per cent since the peak in Q1 2008 but it is also clear that the pace of declines is starting to accelerate, said Simon Derrick.

Over the past year values have fallen by 7.2 per cent while over the first three months of this year they dropped by a robust 3.08 per cent, the fastest quarterly decline since Q4 1997. In line with this, monthly housing starts have collapsed from over 80,000 in October 2006 to a low of just 5,000 by December of last year.

Moreover, with an unemployment rate running at 24.4 per cent and an economy that fell back into recession in Q1 of this year, there is little to suggest that this situation will reverse itself at any time in the near future. As a result the International Institute of Finance has estimated that Spanish bank loan losses could hit 260 billion euros ($322 billion).

The most immediate impact of this has been a steady escalation in the level of concern amongst investors about the outlook for the Spanish banking system. This, in turn has seen the IBEX 35 fall over 36 per cent year-on-year and 23 per cent quarter-on-quarter (a pace of decline on a par with that seen during the depths of the financial crisis in 2008) to break decisively through the March 2009 lows.

Meanwhile the Madrid Stock Exchange’s sub index of banks and savings banks is down 44 per cent y/y and 30 per cent q/q, said Derrick.

Ultimately, however, all roads must lead back to the government at some point. The simple truth of this was highlighted by the fact that around 90 per cent of the troubled Bankia is now owned by the government and that the total amount injected into Spain’s banks since the crisis began now comes to more than 33 billion euros (the equivalent of around 3 per cent of GDP) - a little over half the amount that the IIF estimates will ultimately be needed by the industry.

Little wonder then that the cost of a 5-year CDS on Spanish sovereign debt stands at roughly the same level as that for the paper of Hungary and Jamaica.

'However, what is undoubtedly proving rather more worrying for the Spanish government has been the continued rise in the cost of its funding as investors have begun to worry about where the money for the bailouts will come from,' Derrick said.

'Indeed, the pace at which the 10-year yield gap between Spanish and German sovereign debt continues to widen out carries some uneasy reminders of the Greek market two years ago while our own iFlow data show continued outflows from Spanish paper (and accelerating inflows into Germany).'

While all roads must lead back through Madrid, it is also clear that the government now accepts that they can’t stop there but, instead, must head on to either the ECB or the European bailout mechanism.

This has been made all to clear both by very direct comments from Prime Minister Mariano Rajoy (when asked yesterday if he was in favour of modifying the bailout mechanisms to allow direct bank recapitalisations, he stated: “Many people are in favour of that, and I am as well”) as well as by the methodology being discussed for the latest bailout of Bankia.

Whether or not support is finally provided for Spain (either directly or indirectly) it seems likely that developments there will provide additional ammunition to politicians throughout the region that have argued that the current crisis-management regime simply isn’t working and for a shift to more “growth-oriented” policies.

However, in the absence of a renewed appetite amongst international investors for Euro-zone sovereign debt (which looks like a long shot at present), the financial support for such a policy shift would ultimately have to come from within the region, with the ECB the most likely candidate (either via a further LTRO, the SMP or quantitative easing).

Whether the board of the bank (or, at least, the members from the Bundesbank) will be prepared to countenance such a move remains very much open to debate, Derrick noted.