Monday, May 7, 2012

Learning nothing from the Irish experience, Spain prepares a bad bank bailout

The Dow Jones reports that Spain's leaders have done a u-turn and are now setting up a bad bank to absorb all the troubled real estate loans from the banking system.  The hope is that this will restore confidence in the banks and get the banks to make loans to stimulate growth in the economy.

Your humble blogger predicts that like Ireland before it, this bad bank will neither restore confidence nor restore loan growth.

It will however use up scarce resources that could have gone directly towards promoting economic growth.  This will not be missed by voters at the next election.

Without the growth and with a far higher debt level, Spain's bonds will become even riskier.  This will be immediately recognized by the credit markets.

Setting up a bad bank is a classic example of a lose/lose solution with only one beneficiary:  bankers.  They get to stay around and collect their next bonuses.

The reason I am predicting that the bad bank will not restore confidence is that, like Ireland, it is not going to be accompanied by a requirement that the banks provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposures.

It is this information that is needed if market participants are ever going to believe that all the bad debt was removed from the banking system and confidence restored.

I am predicting that ultra transparency will not be required because if it were then there would be no need for the bad bank in the first place.  By providing ultra transparency, market participants could see for themselves that the banks set aside enough reserves to absorb the losses on the bad assets.

In summary, no ultra transparency, no confidence.  No confidence, 100% waste of scarce government resources.

Bottom line:  Spain's setting up a bad bank falls under Einstein's definition of insanity - doing the same thing over again (Ireland did this twice already) and expecting a different result.

Spain may pump public funds into its banking system to revive lending and its recessionary economy, Prime Minister Mariano Rajoy said Monday, signalling a policy U-turn. 
The government had pledged to not give money to the banking industry that is struggling in the wake of a collapsed, decade-long, housing boom. 
"If it was necessary to reactivate credit, to save the Spanish financial system, I wouldn't rule out injecting public funds, like all European countries have done," Rajoy said in interview with Onda Cero radio stations. 
It didn't work for these countries so why should it work for Spain?
The weakness of Spain's banks is weighing on the economy that contracted 0.3% in the first and fourth quarters, meeting most economists' definition of a recession. The unemployment rate is at an 18-year high 24.4%, data showed April 27. Banks have sharply reined in credit in the face of rapidly growing bad debt and problems getting finance on international markets. 
Government borrowing costs soared as investors fear the price tag of a banking-sector clean up could break already strained finances.
Setting up a bad bank justifies these fears and does nothing to end the fears as there is always the possibility of more bad loans in the banking system.
Yields on Spanish debt, up five basis points at 5.78% Monday, have risen above 6% this year, a level seen as unsustainable in the long run. 
The government is cutting costs to lower its budget deficit to 5.3% of gross domestic product this year from 8.5% in 2011. 
Perhaps the yield on Spanish debt is increasing as a result of the austerity programs.  With austerity, there is less growth in the Spanish economy.  Less growth leads to higher unemployment and increased difficulty servicing existing debt.
Similar austerity measures by governments across Europe have provoked a popular backlash. 
The two mainstream parties in Greece were given a drubbing in parliamentary elections Sunday. Combined they garnered less than 33% of the vote compared with 77% in the previous election three years ago. Greece, Portugal and Ireland have received bail outs from the International Monetary Fund and European Union....
Perhaps receiving bailouts is a bad idea particularly when in a modern banking system the banks can absorb the losses on the excesses in the financial system and alleviate the need for a bailout or austerity.
An official at Spain's finance ministry said the measures that are expected to be approved by cabinet on Friday will include guidelines to remove impaired real-estate assets from banks' balance sheets. 
The government has already forced Spanish banks to set aside a big chunk of earnings to cover potential losses on loans to real-estate developers and foreclosed properties. 
The segregation of toxic assets is seen as key to completing the clean up and calming investors.
With ultra transparency, the investors could calm themselves.
The ministry official added that the government and central bank are studying a specific clean-up plan for Bankia SA (BKIA.MC) and parent company Banco Financiero y de Ahorros SA, which could include a shake up of their management. 
Daily El Pais said Monday the government also plans an injection of state funds via convertible bonds with a rate of about 8%. 
Bankia's parent, considered one of the weakest banks in the Spanish financial sector, recently carried out a EUR2.75 billion write-down of the group's assets by lowering the value of its real-estate holdings.... 
Spain's central bank estimates the country's banks' total exposure to the country's ailing real estate industry at EUR338 billion, of which it considers some EUR176 billion problematic.
With a 24+% unemployment rate, there will be plenty of analysts who might argue that a whole lot more than 176 billion euros of real estate exposure are problematic.  This is yet another major problem with a bad bank... getting ahead of the curve of identifying bad loans.

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