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Insight: Chicago "Love Boat" steered Spain to bailout

By Fiona Ortiz and Annika Breidthardt

MADRID/BERLIN (Reuters) - In Chicago, they know about offers you can't refuse.

So when Angela Merkel asked Spain's prime minister out for a boat ride on the Chicago River, last resting place of more than one unfortunate who got too deep in debt, Mariano Rajoy may have had cause for unease over what the German leader would tell him.

Any sense of foreboding wasn't misplaced.

That Sunday cruise in May aboard the "First Lady" before a NATO summit hosted by U.S. President Barack Obama, sank any hope the chancellor might let his government off the hook for a fix to plug big holes in the accounts of Spanish banks and brought Rajoy, three weeks later, to swallow pride and accept a huge EU bailout which Berlin had quietly been urging on him for months.

Though from Chicago Spanish newspapers offered up headlines like "The Love Boat" after being briefed on Merkel's warm endorsement of her fellow conservative's efforts to cut budget deficits and scrap uncompetitive labor laws, the Spanish prime minister actually stepped ashore fuming in private frustration.

Rajoy "hit a wall", confided a government source in Madrid, one of many officials whose remarks to Reuters build a picture of how, with markets losing patience in a euro zone buffeted by Greek elections, Spain finally asked for and got a 100-billion euro loan with some face-saving elements on Saturday.

Euro zone paymaster Merkel had been sounded on ways to bend EU rules and pump cash back into Spain's sick banks without the Spanish state accepting funds in its own name. Madrid had been exploring a range of inventive options, since Rajoy had feared humiliating comparison with Greece, Ireland and Portugal - and the foreign supervision those previous bailouts imposed on smaller nations whose debts have poisoned the common currency.

But on May 20, after hours huddled over a table on the sunny after-deck of a vessel modeled on the presidential yacht USS Sequoia, the local lawyer from rural Galicia, in the job for just six months and short on diplomatic experience, appears to have realized Merkel's kind words did not add up to a 'yes'.

Several key dates preceded that day in Chicago, home to a U.S. president who is urging European leaders to sort out an economic crisis he fears could cost him re-election in November.

But after long months of bargaining, things picked up speed in the three weeks after the NATO summit, leading to a final few days in which the language of public denial from Madrid turned subtly into a silence that as good as confirmed a deal was done.

In Brussels on March 12, after Spain declared it was cutting itself some slack on an EU budget deficit target, Luxembourg's Jean-Claude Juncker had hammed up to the media by embracing Rajoy's economy minister Luis de Guindos warmly by the throat; behind closed doors, euro zone leaders were less playful, and several pressed Spain to seek help before it was too late.

"They've got to swallow their pride," a German official said at a time when Merkel's finance minister Wolfgang Schaeuble was giving out icy signals, couched in the politest of terms, that he found Spain's new ministers infuriatingly hard to fathom.

Though German leaders persistently denied any pressure from Berlin there appears to have been a difference in perception in Madrid; Spanish sources said that when Schaeuble went out of his way to fly down to Santiago de Compostela on April 30 to make a speech, he used the trip to press de Guindos to seek EU funds.

"ESPANA NO ES UGANDA"

Elected in November after a decade of Socialist rule that ended in recrimination after a real estate bust had destroyed banks and jobs, Rajoy and his fractious, double-headed economic team of Cristobal Montoro at treasury and de Guindos at economy had been some months coming to terms with the issues.

But Chicago narrowed their options. And the discovery in the days that followed of bigger losses at banks forced their hand.

For weeks before Greece's May 6 election pitched the euro into renewed crisis by reviving fears it might crash out, a game of poker had gone on between Madrid and Berlin, between Rajoy insisting Spain could sort out its own banks and EU partners who saw that as a bluff which was stacking up more risk the zone's fourth biggest economy could end up needing so much more aid to restore confidence that it might sink the euro altogether.

German officials fumed in private about "fatal hubris", while in Madrid, though there was understanding for Merkel's need to manage exasperation among German taxpayers, the government, whose own debts were relatively modest, felt justified in pressing for the European Central Bank to do more to solve what it saw as a problem for the banks, not the state.

"They are proud. They don't want help," a German negotiator said anxiously in March. "We've got to solve the problem now."

An awareness Spain was "too big to fail", its bankruptcy too damaging to the rest of Europe for it to be countenanced, also played into Rajoy's gamble that, unlike smaller states forced to accept sovereign rescue deals and accept the onerous foreign tutelage that went with them, he could win direct EU help for Spanish banks without his government signing for the bill.

As he was reported to have texted to his economy minister while de Guindos negotiated the final deal: "Stand fast. We are Europe's fourth power. Spain is not Uganda". Aides won't comment on a message reported under headlines of "Espana no es Uganda". It caused some indignation, not least in Africa. But it did encapsulate a Spanish negotiating tactic familiar in Brussels.

To an extent it has paid off, although persistent market doubts remain this week that Spain accepted enough help.

GERMANS HELP SAVE FACE

Crucially, in the days after Chicago, Merkel began to signal a willingness to help Rajoy save some face - by routing aid more or less directly to Spanish banks via an EU fund set up for the purpose and with fewer strings than a state bailout, albeit that the loan would still add to the national debt.

On Wednesday, May 23, when de Guindos said major lender Bankia, subject of an emergency nationalization, would need at least 9 billion euros ($11.2 billion), Rajoy insisted: "The government has no interest and no intention in accessing any funds from the European Union or any other organization."

Two days later, as Bankia said it really needed 19 billion, that assertion was wearing thin, not least as Spain's autonomous regions were raising alarms about their, separate, fundraising.

After the weekend, as officials stuck to the line that Madrid could bail out its own banks, one senior official told Reuters on May 29 of "another plan" in the works for EU aid now that Madrid's hopes for new ECB lending had all but vanished.

De Guindos flew to Berlin the next day, May 30, where, German sources say, Schaeuble urged him to seek urgent aid, but specifically for the banking sector. The alternative, he made clear, was to wait till Madrid was obliged to come back cap in hand for a humiliating, full-scale EU/IMF bailout, like Greece.

In public and private, German officials were careful to say that Spain was not being bullied and was free to judge its own policy. Pressure, they knew, could backfire and there was some sympathy in Berlin for Rajoy's predicament in being beholden to murky private bank balance sheets and also to big-spending autonomous regions with powers not unlike Germany's own states.

"It is totally up to Spain to decide how to solve its problems," a German source said at the time. "We just warned of the danger that if Spain waits too long, the risk could grow that the country has to apply for a full fledged program."

Officials in Berlin began after the meeting with De Guindos to leak ideas into the German media that Madrid could save face by accepting aid into its national banks' fund, the FROB.

Conscious of the crisis eroding support for his People's Party and perhaps aware of his own unconvincing performance on the European stage, his features impassive behind his beard and glasses, his halting English a handicap in summitry, Rajoy made a keynote speech on June 2 spelling out his vision for Europe.

By declaring his willingness to subject Spain to a common EU fiscal authority, he underlined a commitment to budgetary rigor and to a stable future for the euro, that would help Merkel and Schaeuble justify to German voters why Spain merited help - even if such mechanisms for fiscal union remain pure theory.

"THIS IS IT"

With public holidays in London and New York on Monday, June 4, offering a measure of calm to the markets, Merkel met EU Commission President Jose Manuel Barroso. They spent the evening planning how to time and announce a bailout of Spanish banks.

"This is it," one of those aware of those talks told Reuters. "We're moving to the rescue." Still to be settled were precise terms, including how far the Spanish government would be bound by the loan conditions, and the sequence of events.

"Merkel definitely needs strong conditionality for Spain to sell the rescue to the Bundestag and her party," another said.

Playing for time, Rajoy was still pushing for the loosest of terms, hoping to avoid having to formally request funds from the EU. And his European partners were becoming increasingly anxious to complete a deal before Greeks went back to the polls next Sunday, June 17 - a moment that may trigger a new wave of panic on markets if the winners look like defaulting on Athens' debts.

"You've got to keep the emergency contained," one said.

Wednesday, June 6, was marked by intensive telephoning among leaders and aides in Madrid, Berlin, Brussels, Paris, the euro zone's number two power, and the ECB in Frankfurt.

One of the signatures of the week's negotiations was that euro zone ministers maintained an unusual degree of secrecy. A teleconference on Thursday involving de Guindos, Schaeuble and other euro zone finance ministers passed without journalists being sure it had even happened.

Merkel stepped up Germany's discreet pressure on Spain by declaring the EU stood ready to help Madrid and, after days of denying in public that any rescue was afoot, Spanish officials - significantly, it seemed - stopped taking calls from reporters.

When official sources in the euro zone confirmed to Reuters on Friday morning that Spain would ask formally for credit in a euro zone conference call on Saturday, markets reacted sharply but Rajoy's spokeswoman would say only she knew of no plans for a call and his deputy premier deflected repeated questions at a news conference by noting the auditors' results were not in.

Yet when Soraya Saenz de Santamaria finally conceded that "at least a preliminary figure" would be needed for any bailout, she as good as confirmed that IMF experts who were running the data were about to give a rough target for what banks needed.

The IMF did just that, saying at least 40 billion euros was required, while officials indicated that more would be better.

Spain did not give up negotiating. There was even talk from officials that, after senior euro zone negotiators had spoken by telephone for two hours on Saturday morning to shape the final package, Madrid threatened to walk away from the deal.

It did not, however, and de Guindos agreed to ask for and a accept a loan worth nearly 10 percent of Spain's annual income during a second call with his peers. That still lasted about two hours, some ministers anxiously checking watches as the latest match in the Euro 2012 soccer tournament kicked off at 6 p.m.

It only remained for the Spanish side to face the music of public opinion. It was a haggard economy minister, his first words drowned out by clattering cameras, who told Spaniards that in effect they had finally accepted a German offer made over the past weeks and months in the face of proud Spanish refusal.

Only the next morning did the prime minister appear. He defended what he insisted was not a "rescue" and denied he was cowardly letting de Guindos announce it. And he would not cancel a flight to Poland to see Spain's soccer world champions play, potentially a more agreeable Sunday diversion than that cruise down the Chicago River with Angela Merkel three long weeks ago.

(Additional reporting by Julien Toyer in Madrid, Andreas Rinke and Matthias Sobolewski in Berlin, Paul Carrel in Frankfurt and Luke Baker in Brussels; Writing by Alastair Macdonald)

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