“Over the past months, we experienced a worrisome trend towards re-nationalization and ‘summitization,’” said Martin Schulz, President of the European Parliament and member of the German opposition SPD, to a forum of the European Commission on Wednesday. His complaints went to the heart of democracy at the European level. Government leaders were becoming “more arrogant” and made decisions “behind closed doors, in violation of the community method.” They were attempting “to create a fiscal union outside the control of parliament, bypassing the EU Commission.” Calls for reintroduction of border controls within the Schengen area were “an extremely dangerous development” because “any attack on the freedom of movement is an attack on the foundation of the European Union.” And so, he said, the collapse of the EU was a “realistic scenario.”

Even at the highest levels, the can of worms has now been acknowledged as open—just as the rift that zigzags through the Eurozone has become deeper and wider: according to information the Süddeutsche Zeitung obtained, the ECB and a group of Eurozone countries are trying to make it possible for the permanent bailout fund, the ESM, to bail banks out directly. The countries remained unnamed but, given the nature of the topic, would have to include Spain.

Any such effort would violate the two fundamental principles of the ESM—that a country will get bailed out if, and really only if, it commits to the reforms necessary to make its economy competitive and to reduce its deficit; and that only countries will receive funds, regardless of what they do with them, and not banks. The goal was to alleviate the causes of the debt crisis—high deficits and uncompetitive economies. It was how German parliamentarians had been persuaded to vote for the bailout packages.

Nevertheless, a working group will determine over the next two weeks—lightning speed by EU standards where progress is measured in months and often years—how, not if, banks could receive bailout funds directly from the ESM. Cause for the rush: Spain.

Spanish banks have been ravaged by the implosion of a real-estate bubble that they themselves caused with their reckless lending practices. Now they needed an immediate injection of at least €50 billion, and much more later, as bad loans and collapsing real-estate values on their books would finally have to be dealt with.

By having the ESM bail out banks directly, a debt-sinner government could avoid painful reforms and deficit reduction programs; and it could avoid having to bail out its own banks, highly unpopular when “austerity” is being imposed on the citizens. This just happened in Greece where banks reported €28.2 billion in losses. 13% of GDP! But €25 billion in rescue funds had already been transferred to the government—to bail out the banks, not the Greeks themselves.

Spain could have asked for bailout funds long ago, but it didn’t want to do that because, hampered by a mind-boggling unemployment problem, it didn’t want to subject itself to the painful reforms that had been imposed on Greece, Ireland, and Portugal. It would be much easier if the banks could get bailed out directly.

And it’s not just Spain. “Once Spain sits under the bailout umbrella, the markets will focus on Italy,” said an unnamed representative of one of the unnamed countries. And there aren’t enough means to bail out both. So keeping Spain from getting officially bailed out has now become one of the more bizarre strategies in solving the debt crisis.

Alas, Germany is categorically opposed to direct loans from the ESM to banks. Finance Minister Wolfgang Schäuble declared that he wouldn’t even discuss it. The treaties didn’t allow it, and that would remain so. Bundesbank President Jens Weidmann said that as long as Member States were responsible for oversight and regulation of their banks, they would also be responsible for bailing them out. “Liability and control must remain in balance,” he said. The Netherlands, Austria, and Finland also rejected it.

But Germany no longer controls the ECB. It is now run by Mario Draghi, an Italian, who appears to have a sympathetic ear for the plight of Spain and Italy. And so on Thursday, he pushed Germany to the sidelines once again and made similar noises by calling on politicians to create a new European fund charged with bailing out the banks. Vitor Constancio, Vice President of the BCE, and Portuguese, called for going as far as possible towards a pan-European solution to the crisis.

Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:

Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.