The failure of home-appliance maker Fagor has shaken Spain's Mondragón network. Shown, workers outside Mondragón headquarters in November. Christopher Bjork/The Wall Street Journal
MONDRAGÓN, Spain—For decades, the giant network of industrial and retail cooperatives born in this small town was held up as an international model. Whenever one co-op got into trouble, the rest of the Mondragón Corporation would rescue it with cash or take on workers at risk of losing their jobs.
Then the unthinkable happened.
In October, home appliance maker Fagor Electrodomésticos, a global exporter and the U.S. market leader in pressure cookers, shut its factories after the other co-ops denied it a lifeline. That, in turn, has shaken the Mondragón network, the largest of its kind in the world, fraying the bonds among its 109 surviving co-ops and eroding confidence in the weaker ones. Many of its 80,000 employees now fear for their jobs in a country with 26% unemployment.
"This is our Lehman moment," said Juan Antonio Talledo, who lost his job on Fagor's refrigerator assembly line, recalling the U.S. investment bank failure five years ago that nearly brought down the global financial system.
With debts of €850 million ($1.16 billion), Fagor is one of the biggest casualties in Spain's record-setting year of bankruptcies. Even as the economy emerges from its second recession in five years, growth remains too weak to save many deeply indebted Spanish companies.
But Fagor's abrupt closure reverberates beyond Spain. Many scholars in the U.S. and Europe have argued for decades that employee-owned co-ops are a more productive and worker-friendly alternative to traditional shareholder capitalism. The crisis here highlights a weakness: Co-ops have fewer options to raise capital when trying to ride out a recession.
The long Spanish downturn that drained Fagor of resources now threatens core principles of the network it had helped create—democratic management and job security for employee-owners.
George Cheney, a Kent State University professor who has studied Mondragón for 20 years, said the network will survive but faces severe strains. Cooperatives around the world, he added, are watching how it resolves competing demands of employees and lenders, and financial fallout among its members.
The question, he said, is: "How can Mondragón maintain its soul?"
Fagor's 1,800 workers in Spain have lost their jobs and access to savings they had plowed into the co-op. Tajo, a small co-op in the Mondragón network that makes car parts and components for household appliances, says it could face bankruptcy because Fagor bought much of its production. Creditors owed €2.5 billion by supermarket chain Eroski, the network's largest co-op, have told the management to retrench by selling or closing outlets.
"Contagion is inevitable," said Lorenzo Bernaldo de Quirós, head of Freemarket International Consulting in Madrid and a former adviser to Mondragón. "Some co-ops lent money to Fagor. Others were its suppliers. They're all intertwined."
Laid-off workers stage frequent protests outside Mondragón's austere concrete-and-glass headquarters, perched on a hill overlooking the factory town and a lush valley in the Basque region of northern Spain.
Mayor Inazio Azkarragaurizar Larrea calculates that Fagor's closure alone will raise unemployment in the town of 22,000 people to 20%, from the current 15%.
"The town is in a state of psychosis," said Estibaliz Iñurrieta Lauzirika, owner of the Plus Ultra bar, where townspeople fret about the co-ops over evening drinks and talk of little else.
They and their elders had thrived as Fagor, founded in 1955, sold refrigerators, washing machines and televisions to Spain's emerging middle class. Fagor's pioneer entrepreneurs, influenced by socialist thinkers and Christian values, gave financial backing to other factory workers to start their own co-ops, then merged them into a forerunner to Mondragón Corporation in 1984.
Workers in a co-op pool resources and own the business collectively, sharing in profit and loss. Mondragón took the model a step further by pooling individual co-ops' research, training and banking services, and creating a common safety net of employment guarantees and social-security benefits. It grew to be the seventh-largest employer in Spain and reported €14 billion in revenue last year.
Fagor expanded to markets in more than 100 countries, becoming the fifth-largest appliance maker in Europe.
Three decisions exposed Fagor to trouble just before the recession hit Spain in 2008.
The co-op acquired a French appliance company to try to achieve the scale to compete with Whirlpool Corp. WHR +0.22% and Electrolux ELUX-B.SK +0.54% AB. But while those larger rivals moved production to low-wage Asian countries, Fagor kept most of its assembly lines in Spain and France to preserve worker-owners' jobs. It could no longer compete on price, and the acquisition raised its debt burden as sales plummeted at home.
Meanwhile, Fagor sank €6 million into the Driron, a refrigerator-size invention that could dry and iron clothes at the same time. A €1,875 price tag and clunky look made it a colossal flop.
The appliance maker had few options to stay afloat. As with other co-ops, its ownership structure legally barred the sale of new shares to raise capital, and its ability to borrow was exhausted. It turned to its Mondragón partners, who injected €300 million into the co-op after 2008.
Fagor also hit up employees, selling them €80 million in high-yield debt on the promise they could withdraw the investments within a month.
That wasn't enough. At a tense meeting of Mondragón's board in September, Fagor chief executive Sergio Treviño, pleaded for an additional €50 million for an orderly restructuring. The aid plan required unanimous board approval, but chiefs of the two largest co-ops, Eroski and lender Caja Laboral, balked, according to people familiar with the deliberations. At the next meeting they voted to rebuff him, saying the plan would throw good money after bad, these people said.
"I warned that if Fagor fell, a tsunami would wash over them, but they dismissed the idea," Mr. Treviño said in a subsequent interview.
Fagor's demise has upended the lives of 44-year-old forklift operator Igor Unamuno and his wife, Leire Barona, who worked on the refrigerator assembly line. In addition to losing their jobs, he said, they worry about recovering the €55,000 in savings they had invested in Fagor—money now tied up in bankruptcy proceedings.
With an expensive mortgage and two children at home, the couple pins their hopes on Mondragón's pledge to find work at other co-ops for at least 1,000 of Fagor's employees. More than 300 have been relocated, most to temporary positions with fewer rights and benefits.
"The days pass, and you hear about other workers getting called in for a [job] interview," Mr. Unamuno said. "You hunker down. What else can you do?"
—Ilan Brat contributed to this article.
Write to Christopher Bjork at christopher.bjork@wsj.com