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This next story is a side effect of Spain's economic catastrophe. The country's credit rating was downgraded yesterday, by the way, and today's unemployment figures climbed to nearly 25 percent. As the economy has collapsed, more and more people in Spain are calling an illegal settlement outside Madrid home.

And as the Spanish capital has grown, the city limits have moved even closer to that shantytown. Now, with the city desperate to find new revenues, it is eyeing the property for possible development. Lauren Frayer has the story.

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LAUREN FRAYER, BYLINE: In Canada Real, roads are unpaved. Houses are made of corrugated metal or cement. Some lots are just piles of garbage.

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FRAYER: And when the power goes out, local men get together to climb up the utility pole and fix it. Forty years ago, Canada Real was built by peasants who moved to Madrid for jobs. With the economic crisis, the settlement has swelled to as many as 40,000 residents - a mix of North African immigrants, Roma people, and other Spaniards down on their luck. Cristina Pozas has lived here for 11 years.

CRISTINA POZAS: (Through translator) We've lived here for generations. But now the suburbs are encroaching on us, and suddenly we bother them. The city has arrived here, and they want to get rid of Canada Real. They want the money this land could bring them, and they want us to disappear.

FRAYER: After decades of turning a blind eye to this illegal settlement, cash-strapped municipal authorities want the land back. So over the past two years, they've sent bulldozers to demolish dozens of homes here. Abdul Ghailan's house was one of them.

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FRAYER: He kicks at a pile of rubble, all that's left of his home. A broken ceramic tile - a memento from his homeland, Morocco - falls off the side of the pile.

ABDUL GHAILAN: (Through translator) They totally left me in the street. Thanks to help from my neighbors, I rebuilt my house again. But six months later, they came at 4:30 in the morning and demolished the house again, leaving me and my family in the street.

FRAYER: Canada Real is built on a traditional livestock path, a 9-mile-long dry riverbed that's been public land for 700 years. People are allowed to be here, just not to build permanent dwellings. Residents pay income and sales tax, but not on property. Most built their houses themselves, with water tanks but no sewers. There are no schools, nor a health clinic either. People have to walk to other neighborhoods for those services. And they often use friends' or relatives' addresses, says Pozas.

POZAS: (Through translator) When my sons apply for jobs, they give the address of their grandparents. Because if they admit that they live in Canada Real, no one will give them work. And they are very accomplished students. Like them, it happens to so many people.

FRAYER: The stereotype of Canada Real is unfair, says Marta Mendiola with Amnesty International.

MARTA MENDIOLA: The local authorities have tried to criminalize the people living there. They always have represented this area as a drug area, as an arms-dealing area.

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FRAYER: Residents and human rights groups say those problems are exaggerated to win public support for demolitions. It draws attention away from the real problem, they say: lack of affordable housing in Spain. Luis Nogues is a social worker and professor who studies Canada Real. He says the slum provided many of the construction workers during Spain's housing boom.

LUIS NOGUES: (Through translator) But now in the crisis, Canada Real no longer serves a purpose for big business interests in Madrid. And that's the problem. So they're poised to remove it now. The only question is how.

FRAYER: On that recent night without electricity, locals mill around in the unpaved street. Ahmad Bilqayn came from Morocco 20 years ago, for a better life. He says the living conditions here are a rude awakening.

AHMAD BILQAYN: (Through translator) We are here in the European Union. You can't leave people without houses, without anything, out on the street - leaving children out in the street. You can't do that.

FRAYER: Especially in a country with surplus housing. The irony is, many of these residents helped build high-end condos that now sit empty, while they live in squalor. Abdul Ghailan, whose house was demolished, struggles to explain this all to his two kids.

GHAILAN: (Through translator) They say, Papa, it's OK, we can build another house. I tell them our house was built poorly, and that I'll build a better, more beautiful house for them. I say it to calm them down - to stop them from worrying.

FRAYER: But he worries himself. Canada Real is now one of the sites where developers are thinking about building EuroVegas, a casino complex that would bring revenue to the city. If the project goes through, it's unclear what would happen to thousands of people living here.

For NPR News, I'm Lauren Frayer in Madrid.

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