Wednesday, May 9, 2012

To nationalize or not to nationalize, that is the question for Spain's banking system

Amid all the conflicting reports out on what Spain's government is going to do with Bankia, the key question is to nationalize or not to nationalize?

In order to answer this question, you have to ask the question of what is the value of the 1 trillion euros of real estate exposure in the Spanish banking system.

Your humble blogger would venture that it is not worth 1 trillion euros.  In fact, I might go a little further and suggest that it is not currently worth 800 billion euros.

This is not an extreme prediction.  Spain has 24% un-employment.  It had a real estate bubble as big as Ireland's, but prices in Spain have only falled 20+% as oppose to the 60+% in Ireland. In addition, it has several hundred thousand unsold houses.

Frankly, there is nothing to suggest that Spain's house price will not decline by as much as Ireland's house prices have.

If this occurs, 800 billion euros is going to turn out to be too high a valuation.

The reason for walking through this valuation scenario is that the difference between the 1 trillion euro exposure and the actual valuation is what the market is going to perceive the Spanish government to be on the hook for if it nationalizes the banks.

Can the Spanish government afford another 200 billion euros of debt? 400 billion euros?

I know I keep saying this, but Spain's government should definitely not nationalize its banking system or inject capital into it.

As 2 of Greece's largest banks are showing, banks can continue to operate with negative book equity and do not need a bailout.  The book level of equity in these banks reflects the losses they absorbed on their share of the private sector investor Greek sovereign debt restructuring.

The Spanish government should require Bankia to face up to the losses on and off its balance sheet and provide ultra transparency so that market participants can confirm the fact, monitor its future performance and exert market discipline if its risk profile increases significantly.

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