Even Spanish banks resist flawed idea of 'bad bank' bailout

As reported by the NY Times, even Spanish banks are resisting the flawed idea of a 'bad bank' to hold the non-performing assets in the Spanish financial system.

This is the clearest indication yet that even the bankers understand in a modern financial system they do not need to be bailed out.

The implications of not bailing out the banks are significant as it allows the government to use its scarce resources on boosting the real economy.

As investors raise the pressure on Spain to clean up its banking sector, some of the largest and healthiest financial institutions in the country are fretting over the impact that a bailout would have on their own valuations.

In recent days, the conservative government of Prime Minister Mariano Rajoy and the Bank of Spain have been studying whether to allow banks to transfer toxic assets to a state asset management company, along the lines of the government-backed agency that Ireland set up for its troubled banks in late 2009. 

The exact structure and size of such a transfer is being debated, as well as whether it would be guaranteed by Spain, or would need to be bolstered by rescue funds from international lenders, as part of a broader recapitalization of the Spanish banking sector. 

Yet such a rescue plan is being resisted by the largest Spanish commercial banks, Santander and BBVA, whose exposure to the Spanish market is comparatively small thanks to hefty investments overseas, particularly in Latin America. 

On Friday, Emilio Botín, the chairman of Santander, said at a conference in Murcia, in southeastern Spain, that he opposed allowing toxic assets to be parked in a “bad bank.” Such a strategy, he argued, was “not the solution” and would not improve the banking sector’s lending capacity.... 

A bad bank, Mr. Botín said, “would be something that would cost the taxpayer money and will not lead to providing more loans.” 

Instead, he called for “completing the restructuring” of the sector.

Beginning with all banks being required to provide ultra transparency and disclosing on an on-going basis their current asset, liability and off-balance sheet exposures.

With this data, market participants can confirm that all toxic assets are written down to market values and subsequently that the banks clean up their balance sheets.

Many economists, however, consider that keeping afloat the most troubled savings banks, or cajas, will require fresh capital rather than more mergers and cost cutting....

Overall, the consolidation has already cut the number of cajas to 15 from 45 in the past two years. 

Such mergers, however, “don’t remove the holes but simply pass them on from one institution to another,” Xavier Sala-i-Martín, an economics professor at Columbia University in New York, wrote recently on his blog. “The only thing that will work is fresh money, to recapitalize some banks that have no capital left, and since it’s clear that banks cannot raise sufficient private capital, that means there are only two solutions: bankruptcy or public money,” he added....

Not surprisingly, economists do not understand how a modern banking system operates and that deposit insurance and access to central bank funding mean that banks can operate for years with negative book capital levels.

As a result of not understanding how a modern banking system works, economists tend to focus on immediately recapitalizing or closing banks and do not recognize that banks can recapitalize themselves through retention of future earnings.

The I.M.F. also encouraged Spain to consider taking over toxic assets from troubled banks. 

Robert Tornabell, a professor of banking at the Esade business school in Barcelona, estimates that a state agency will need to take over and guarantee at least €130 billion of assets from Spain’s ailing banks. 

By comparison, Ireland’s national asset management agency was set up to take over as much as €90 billion of toxic loans.

A number that has turned out to be far less than the true level of toxic loans in the Irish banking system.

One of the problems with a bad bank is that without ultra transparency no one knows if all the toxic assets have in fact been concentrated in the bad bank.

“The big commercial banks, Santander and BBVA, don’t want to be linked to the creation of a bad bank, and the government is clearly under their influence,” Mr. Tornabell said. “Instead of delaying further, Spain should bail out its banks as soon as possible to avoid further problems, not only for its banks but also for its reputation and overall economy.”

Whether the Spanish government is under the influence of the large commercial banks or not, bailing out its banks will not help its overall economy.  This was tried in Ireland without success.

Forcing the banks to recognize all the losses on the excess in the financial system will help the overall economy.  This was tried in Iceland with success.

Indeed, the Spanish government is struggling on other fronts, notably how to enforce stricter fiscal targets on regional governments that accounted for two-thirds of Spain’s budget deficit slippage last year. 

On Friday, S.&P. downgraded nine regional governments, including Catalonia, whose rating was cut by four notches to BBB- from A, bringing it close to junk status....

This makes it even more imperative that the government realize the banks do not need to be bailed out and instead focuses its resources on the real economy.