Premier Mariano Rajoy and his inner circle have allegedly accepted that Spain will have to call on Europe's EFSF bail-out fund to rescue the banking system, even though this means subjecting his country to foreign suzerainty.
Mr Rajoy denies the story, not surprisingly since it would be a devastating climb-down, and not all options are yet exhausted.
"There will not be any (outside) rescue for the Spanish banking system," he said.
Fine, so where is the €23.5bn for the Bankia rescue going to come from? The state's Fund for Orderly Bank Restructuring (FROB) is down to €5.3bn, and there are many other candidates for that soup kitchen.
Spain must somehow rustle up €20bn or more on the debt markets. This will push the budget deficit back into the danger zone, though Madrid will no doubt try to keep it off books – or seek backdoor funds from the ECB to cap borrowing costs. Nobody will be fooled.
Meanwhile, Bankia's shares crashed 30pc this morning. JP Morgan and Nomura expect a near total wipeout. Investors who bought the new shares at flotation last year may lose almost everything.
This all has a very Irish feel to me, without Irish speed and transparency. Spanish taxpayers are swallowing the losses of the banking elites, sparing creditors their haircuts.
Barclays Capital says Spain's housing crash is only half way through. Home prices will have to fall at least 20pc more to clear the 1m overhang of excess properties. If so, the banking costs for the Spanish state are going to be huge.
The Centre for European Policy Studies in Brussels puts likely write-offs at €270bn. We could see Spain's public debt surge into triple digits in short order.
As I wrote in my column this morning, the Spanish economy is spiralling into debt-deflation. Monetary and fiscal policy are both excruciatingly tight for a country in this condition. The plan to slash the budget deficit from 8.9pc to 5.3pc this year in the middle of an accelerating contraction borders on lunacy.
You cannot do this to a society where unemployment is already running at 24.4pc. Either Europe puts a stop to this very quickly by mobilising the ECB to take all risk of a Spanish (or Italian) sovereign default off the table – and this requires fiscal union to back it up – or it must expect Spanish patriots to take matters into their own hands and start to restore national self-control outside EMU.
Just to be clear to new readers, I am not "calling for" a German bail-out of Spain or any such thing. My view has always been that the Economic and Monetary Union (EMU) is a dysfunctional and destructive misadventure – for reasons that have been well-rehearsed for 20 years on these pages.
My point is that if THEY want to save THEIR project and avoid a very nasty denouement, such drastic action is what THEY must do.
If Germany cannot accept the implications of this – and I entirely sympathise with German citizens who balk at these demands, since such an outcome alienates the tax and spending powers of the Bundestag to an EU body and means the evisceration of their democracy – then Germany must leave EMU. It is the least traumatic way to break up the currency bloc (though still traumatic, of course).
The result of Europe's policy paralysis is more likely to be a disorderly break-up as Spain – and others – act desperately in their own national interest. Se salve quien pueda.
I fail to see how Spain gains anything durable from an EFSF loan package. The underlying crisis will grind on. Yes, the current account deficit has dropped from 10pc to 3.5pc of GDP, but chiefly by crushing internal demand and pushing the jobless toll to 5.6 million. The "unemployment adjusted current account equilibrium" — to coin a concept – is frankly frightening.
The FT's Wolfgang Munchau suggested otherwise last week, saying Spain's competitiveness gap has been exaggerated. I can see what he means since Spain's exports are growing even faster than German exports. But this is from a low base. It is not enough to plug the gap.
Spain is quite simply in the wrong currency. That is the root of the crisis. Loan packages merely drag out the agony.
A Spanish economist sent me an email over the weekend after the Bankia details came out saying:
"It looks like game over for the sovereign and the financial sector at the same time. Unless we get a Deus ex Machina, we'll be discussing much more seriously the benefits of a return to the peseta in no time."
It begins.
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