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Financial Crisis: Europe and Spain act in slow motion, should have learned from “keynesian” Bernanke.

Spain's prime minister, José Luis Rodríguez Zapatero

MADRID — A planned merger has stalled between two weak savings banks in Galicia, in northwestern Spain, illustrating the reluctance of the Spanish government to take a firmer hand to its financial problems.  Spain’s prime minister, José Luis Rodríguez Zapatero, has delayed strong action.

The longer consolidation is delayed among the banks, which are saddled with losses on loans to the construction industry, the more expensive it may be to deal with them.  What’s more, regional banks are deteriorating not just in Galicia, but throughout the country.

Investors and analysts say the lack of progress in tackling the banking issue underscores the Spanish government’s shortcomings in addressing its broader problem: crushing fiscal deficits arising from high unemployment and a persistent recession.

Spain risks falling into the same trap as Greece, these investors say, unless it takes more forceful action. It could find itself unable to raise money on the private markets at acceptable interest rates — even though its government debt burden, as a share of the overall economy, is only half what Greece carries.

“Any further wavering could lead to a much more critical situation,” said Xavier Vives, an economics and finance professor at the IESE business school of the University of Navarra. “A year ago, the government didn’t even want to think about reforms. Now, under pressure from financial markets, they are at least talking about reforms. But the government really needs to get going.”

So far, the federal government has delayed significant fiscal tightening. It fears that doing so would cause political harm, particularly in regions where elections are coming soon, while also choking off a long-awaited recovery.

José Luis Rodríguez Zapatero, the center-left prime minister, presented an austerity plan this year based mostly on measures that would not kick in until next year at the earliest. The measures include spending cuts amounting to a modest 2.5 percent of gross domestic product.

But Mr. Zapatero may no longer be able to wait. Just as he has been unable to force the savings banks, Caixanova and Caixa Galicia, to consolidate before the situation deteriorates further, he finds Spain increasingly vulnerable to forces beyond its control.

The planned merger of Caixanova and Caixa Galicia — banks known here as cajas and important to local politicians — is caught up in squabbling over who would dominate the combined institution. Desperate to break the deadlock, a Galician government official warned last week that fighting between power brokers from the cities where the banks are headquartered could lead to “self-destruction.”

In a broader setback, Spain joined Greece and Portugal last week in being downgraded by Standard & Poor’s, the rating agency. While Spain remains well above the junk level S.& P. gave to Greece and ahead of Portugal’s A- rating, its fall from AA+ to AA was a blow.

Among the reasons for its decision, S.& P. highlighted Spain’s private sector indebtedness of 178 percent of G.D.P. and an inflexible labor market that was likely to leave Spain with a jobless rate of 21 percent this year.

To date, Mr. Zapatero’s policies have rested on the hope that the economy would begin to recover soon and that the jobless rate would average no more than 19 percent this year.

Yet the jobless rate has already reached 20 percent, according to government statistics for the first quarter released Friday, almost double the level when Spain’s recession began in 2008.

The bleak outlook makes it difficult to come up with a coherent policy. Mr. Zapatero is now boxed in, experts say, because he failed to adopt changes that challenged existing political interests when he enjoyed greater popularity after his re-election in 2008.

The leading Popular Party opposition has rallied against his economic management, often with the backing of trade unions that once supported the Socialists. While the Popular Party’s own credibility is suffering because it is engulfed in a bribery investigation, it now enjoys an advantage over the Socialist government in polls.

Perhaps the biggest obstacle to overhauling the economy is… READ MORE HERE.