Wednesday, May 9, 2012

Regardless of how Spain addresses its banking problem, investors are going to want ultra transparency

As more information leaks out over how the Spanish government is addressing the bad asset problem at Bankia, one of Spain's largest banks, it is becoming clear that investors want ultra transparency to confirm the problem has really been fixed.

As reported by Reuters

Spain has owned up to the extent of its banking problem with a $10 billion euro (8 billion pounds) rescue plan for Bankia SA, the country's fourth-biggest lender that is saddled with a huge toxic property portfolio, but investors want more details to be convinced that the financial system is recovering.
Until Bankia and every other banks has to provide ultra transparency and disclose on an on-going basis its current asset, liability and off-balance sheet exposure details, investors will not have the data they need to be convinced that all the bad assets have been dealt with.

Not requiring banks to provide ultra transparency is an explicit admission by the Spanish government that there is something to hide on or off the banks' balance sheets.
The government will unveil its banking reforms on Friday, hiving off property assets from banks' balance sheets as well as pumping cash into Bankia, in a fourth attempt in three years to reassure investors on the health of the sector....
But what is still unknown is exactly how the Bankia rescue, involving 7 to 10 billion euros ($13 billion) of public cash, will work and what will be the mechanics of a system to separate property holdings from banks.
All of which are completely unnecessary if the banks are required to provide ultra transparency.

Since the Spanish government guarantees the deposits and the ECB is willing to provide liquidity, the Spanish banks are designed to continue without a bailout to support the real economy after recognizing the losses on all their bad debts.

Hence, not only is a bailout unnecessary, but it ties up limited governmental resources that would be better used to support economic growth.
Spanish banks have effectively become the country's biggest real estate agents after a devastating property crash in 2008, and investors fear losses could strain the public finances, dragging the country further into the euro zone debt crisis....
The losses only strain the public finances if the Spanish government engages in unnecessary bailouts.
"This is the sort of thing you should do over a weekend, not let out by press leaks on a Monday with vague promises of a resolution on Friday," said one banking analyst. 
For months the new government, elected late last year, had said it would not put more public money into rescuing the banks. The Bankia rescue plan, confirmed by government sources on Monday, marked a change in direction under pressure from the country's major banks, the IMF and ratings agencies.
Talk about market participants with an outsized conflict of interest given the significant stake each has in the Spanish government bailing out the banks.

For the major banks, it assures that the bankers can continue to collect their bonuses.

For the IMF, it ties up scarce government resources and increases the probability that the IMF might be called on to lend funds.

For the rating agencies, it enhances their importance (please note:  with ultra transparency, the rating agencies would have the same information as every other market participant and therefore would be just another commentator).
The government on Tuesday said the Bankia operation was not a state takeover, but a restructuring aimed at guaranteeing the bank's viability. Bankia holds a tenth of the deposits in the Spanish banking system. 
Economy Minister Luis de Guindos said all depositors and borrowers at Bankia could be absolutely sure the bank was solvent. A source at the bank said there had been no sign of people withdrawing their money.
People don't withdraw their money because of the deposit guarantee.  To them, the solvency of the bank is irrelevant. 

Spanish people are not stupid.  The collapse of the real estate bubble is well known.  As is the fact that Bankia has a significant exposure to real estate.  In short, the depositors already know that Bankia is insolvent.

If they cared about Bankia's solvency, the depositors would have already withdrawn their funds.

This point is critical and unfortunately is too complicated for PhD-level economists to understand.  Since the beginning of the financial crisis, they have been pounding the table endlessly on how bank capital is important.  In the real world of depositors, it is not!

For the last several months, I have asked every economist I have talked to how much capital was reported at the end of the last quarter by the bank where they have their checking account.  Not a single one could answer the question.

Clearly, in their personal lives, economists also rely on the fact that their deposits are guaranteed.

The inability to answer the question confirms how meaningless bank book capital levels are.

The definition of a government wasting scarce resources is a government that on the recommendation of economists and market participants with an outsized conflict of interest would provide funds to a bank to raise its meaningless book capital levels.
In the reforms to be announced on Friday, banks will form property units where they will park their real estate assets. Unlike a bad bank, the government aims to make these units work without public money .... "We are sceptical that this will be the silver bullet the market is looking for," said Carlos Berastain of Deutsche Bank...
Why bother with accounting shenanigans when adopting ultra transparency does not require public money either (breaking the link between the banking system and sovereign debt) and addresses the investors need for data to confirm that the problem assets have been addressed.

The government could simply require the banks to provide ultra transparency.

With ultra transparency, market participants would exert discipline on the banks to recognize the losses on all their bad debt.

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