Pity the incoming Spanish prime minister. Whoever wins in Spain’s general elections on March 9 will be spending his term dealing with the economic consequences of the bursting of Spain’s housing market bubble. And, within the constraints of euro membership, he will be doing so without the benefit of an independent interest rate or exchange rate policy at a time when global credit markets are under unusual stress. At the heart of Spain’s forthcoming economic problems will be the bursting of the country’s extraordinary housing bubble of the past decade. Between 2000 and 2006 alone, Spanish home prices increased by around 130%, making the American housing market bubble pale by comparison. As in America, this extraordinary increase in home prices is now showing every sign of unwinding.

It is true that Spain’s favorable demographics, especially its high immigration rate, have provided considerable support to the Spanish housing market. So too have the artificially low real interest rates that Spain has enjoyed by virtue of its euro membership, at a time when Spain’s inflation rate has been almost double the European average. The net result has been a massive boom in the Spanish construction sector that has generated around a third of all Spanish jobs over the past five years.

The extraordinary movement in Spain’s housing market affordability indices provides a good gauge of the magnitude of the country’s housing bubble. Whereas the ratio of Spanish home prices to household income was 4.0 in 2000, by 2006 this ratio had risen to 7.0. That makes Spain, along with Ireland and Great Britain, among the least affordable housing markets in Europe. Most studies now conclude that Spanish home prices are anywhere between 20% and 60% above the level that is justified by Spain’s housing market fundamentals.

In contrast to the American banks, Spain’s banks refrained from the use of subprime mortgage lending. However, the Spanish banks’ exposure to residential construction is considerably higher than that of America’s: Spain’s exposure ranges between 25% and 50% of their balance sheets.

Adding to the Spanish banks’ vulnerability, particularly at a time of turbulent credit markets, is the fact that they have funded a significant part of their mortgage lending operations through issuing securities rather than using their deposit base. The vulnerability of the latter has been underscored by the sizeable discounting of Spanish bank mortgage paper at the European Central Bank as global credit markets have seized up.

The seriousness of Spain’s coming housing bust is underlined by how large that sector looms in the Spanish economy. America’s house construction industry and housing related industries constitute less than 10% of the economy, whereas in Spain that figure approaches about 20%. Equally troubling is Spain’s loss of international competitiveness over the past few years — around 35%, which is now reflected in an external current account deficit of about 9% of GDP. This makes it highly improbable that jobs lost in the construction sector will be offset by job gains of any meaningful extent in the rest of the economy.

Policymakers in America are reacting to the American housing bust by aggressively cutting interest rates and by allowing the dollar to slide. Sadly, being stuck with the euro, Spain does not have those policy tools at its disposal. To make matters worse, Spain is obliged to accept a level of interest rates set by an ECB that has the economic conditions of France and Germany more in mind than those of Spain. It also is obliged to endure the crushing burden of an appreciating euro that only further cramps Spain’s international competitiveness and constrains its export possibilities.

The one thing going for Spain at present is that it enjoys a budget surplus of around 2 % of its GDP. However, one does not want to exaggerate the room for policy maneuver afforded by that budget surplus given the dependency of Spanish tax revenues on the health of the overall economy and on the housing market in particular.

Over the next few years, as unemployment rises and as Spain rapidly moves from being one of Europe’s superstars to one of its sick men, markets will increasingly question Spain’s willingness to adhere to the rigors of euro membership. At the same time, it is more than likely that Spain’s premier will be ruing the fact that he spent so much effort seeking the job.

Mr. Lachman is a resident fellow at the American Enterprise Institute.