Protesters in Puerta del Sol in Madrid.Spain is special. Every European country these days seems to have its financial crisis. Spain has two.

One crisis stems from the by-now-commonplace mismanagement of the nation’s finances. The other stems from a collapsed real-estate bubble and all the financial strain that can cause. Having bled into each other, these crises have imposed financial burdens on Madrid far beyond anything it can deal with on its own. The strains are so severe, in fact, that not even the committed resources of the entire euro zone are sufficient to handle them, not alongside the other demands of Europe’s so-called periphery. Making matters worse, markets, noting the untenable nature of Spain’s problems, have refused to lend unless Madrid pays impossibly high rates for credit. The only relief available has come from the European Central Bank (ECB). But at base, even that is insufficient. The best the ECB can do is buy Spain time for more fundamental fiscal, financial and economic reform.

The first aspect of Spain’s crisis looks, in its essentials, much like the rest of Europe’s periphery. Madrid has long overcommitted the state’s financial resources so that the nation, despite high rates of taxation, has run ever-larger budget deficits. The red ink flowed even in the best of times. But in the wake of the global recession of 2008–2009, shortfalls in revenues and greater demands for government assistance have widened the budget gap to shocking proportions. Last year, the budget gap averaged €109 billion, an impossible 9.4 percent of the country’s gross domestic product (GDP). The run of deficits has accumulated to an immense debt overhang, verging on 80 percent of GDP. Meanwhile, the understandable reaction among lenders has driven up Madrid’s longer-term borrowing costs to near a 6 percent rate, compared with just over 2 percent, for instance, for Germany. With so much debt outstanding, the rising borrowing rate has pushed debt-service costs up over 10 percent of annual government outlays or almost 3 percent of GDP.

In addition to all these strains, Spain now also faces a second banking crisis connected to the collapse of its real-estate markets. This kind of pressure is surely familiar to all Americans. Much like the United States, earlier in this century Spain enjoyed a housing boom. Though the country avoided subprime, its banks still lent freely—too freely—causing an unsustainable surge in real-estate prices that prompted still more aggressive buying and still more reckless lending. The resulting bubble surely would have burst on its own, but the global recession has hurried the process along.

Now Spanish banks face a huge overhang of bad loans, approaching 10 percent of their total lending, the highest level since the country began collecting statistics in 1962. Depositors, aware of the danger, have begun to withdraw their funds, compounding the banks’ problems and imposing on them a desperate need for new capital just to keep their doors open.

The threat to the Spanish economy cannot be overestimated. Spain, under pressure from the global economic slowdown and its fiscal crisis, was in recession even before the banking crisis broke. Unemployment has reached an astronomical 23 percent of the nation’s workforce. Youth unemployment has risen over 53 percent. Against such a backdrop, Spain dare not allow any bank to fail. The collapse of even a middle-sized financial institution could prompt a general flight of deposits, a proverbial run on the banks. Combined with an intense reluctance among international lenders, even a relatively minor failure could create a cascade of bank failures. To avoid such a catastrophe, the government, understandably, has decided to stand behind the nation’s banks, effectively, if not literally, making their debts its own and so adding them to the government’s already severe fiscal imbalance.

Spain needed outside help with its financial problems even before adding the banks’ bad loans. The euro zone’s Stability Mechanism is simply unable to cover all this debt, especially since other nations in the periphery also need help and fewer member nations have financial resources to spare. The only viable source of immediate help is the ECB. Through its president, Mario Draghi, the central bank has offered its immense financial resources, promising to supplement private lending to Madrid by buying enough Spanish bonds in secondary markets to contain the rise in lending rates. But even this massive and welcome relief cannot meet Madrid’s needs.

Full recovery can only come from a restoration of sufficient confidence among investors, international lenders and depositors to bring down borrowing costs to manageable levels. Spain will only do that when it demonstrates that it can 1) narrow its budget gap and put its public finances on a sustainable path; 2) support economic growth to produce enough real wealth to repay its debts; and 3) show that it has implemented sufficient financial reforms to guard its banking sector against future profligate behavior.

On two of these three fronts, the rest of Europe seems ready to force Spain’s hand. The euro zone, led by Germany, has attached severe austerity demands to any financial aid. Madrid’s compliance has already impelled it to cut spending and take other measures to reduce its fundamental budget imbalances. Further, the euro zone has begun procedures to enforce ongoing budget discipline on all its members, including and perhaps especially Spain. The euro zone also has taken a hand in banking reform. Before agreeing to advance any financial capital to Spain’s banks, EU leaders—again under German pressure—have taken steps to implement zone-wide bank regulation and supervision, which at least promises to control the kind of profligacy that led to Spain’s recent real-estate bubble.

On the most difficult front—advancing economic growth, especially the teeth of the enforced budget austerity—Spain has had to act alone. Remarkably, this beleaguered government has managed to use the pressure of the dual crises to push through fundamental reforms that would have seemed impossible a year ago. Following the lead Germany set some ten years ago, as well as guidelines offered by the International Monetary Fund, Madrid has begun to reform labor laws long identified as overwhelmingly rigid and an impediment to both growth and job creation. Unable to move on this front for years, Spain, in just the last few months, has managed to ease hiring and firing rules, decentralize collective bargaining and generally take steps to reduce labor costs while improving the ability of businesses and the economy to respond to changing economic circumstances and opportunities. Madrid has made clear its intention to extend its imitation of Germany further to loosen other labor-market rigidities as well as regulations that to date have interfered with businesses formation, product development, and, by implication, growth and job creation as well.

The jury is still out on whether Spain, or Europe generally, can make this work. Huge street protests could yet derail the needed austerity program, especially since it will take time for the fundamental economic reforms to relieve the unemployment and income strains that have brought out the protesters in the first place. Banking reform is still in the planning stages. Nor are markets willing to take anything on faith. They will impose premium borrowing costs on Spain for the foreseeable future, forcing Madrid to continue to rely on ECB support for some time.

The crisis, in other words, will drag on until today’s threads of reform can weave themselves into something more substantive.

Milton Ezrati is senior economist and market strategist for Lord, Abbett & Co. and an affiliate of the Center for the Study of Human Capital and Economic Growth at the State University of New York at Buffalo. He writes frequently on economics and finance and is just completing a book on demographics and globalization.

Image: Fotograccion