Saturday, June 9, 2012

EU talks about recapitalizing Spain's banks without knowing size of capital shortfall

The EU finance ministers are about to engage in a completely unnecessary and absurd activity.  They are going to talk about how to recapitalize Spain's banks when no-one in the world knows how large the capital shortfall is.

Regular readers know that in a modern banking system with deposit guarantees and access to central bank funding governments recapitalizing banks is totally unnecessary.  Banks are designed to continue operating and supporting the real economy while they rebuild their book capital positions.

However, in an effort to guarantee banker bonuses and absolutely crush confidence in the EU financial system, the EU finance ministers are engaging in a discussion of how to recapitalize Spain's banking system.

There are two potential outcomes of this discussion.

One, they recognize that Spain has a modern banking system and tell it to require the banks to recognize all the losses on their balance sheets, provide ultra transparence to let market participants confirm this fact and rebuild their book capital through retention of future earnings.

This would be an incredibly positive result for Spain and the EU.

Two, the EU finance ministers could agree on say a 100 billion euro bailout and then set out to sell market participants that this is adequate.

The problem with the second outcome is that there is absolutely no one who knows how much capital has to be put into the banks today to offset all the losses on and off their balance sheets.  This fact is well known and trying to convince the public differently simply undermines the credibility of the EU finance ministers and other policymakers.

After all, if 100 billion euros was really the right number, the EU finance ministers and Spain would require that the Spanish banks provide ultra transparency and disclose their current asset, liability and off-balance sheet exposure details to let all market participants confirm the fact.

Without this requirement for providing ultra transparency market participants will continue to assume that the banks have something to hide.  Hence, the complete loss of credibility.

A couple of interesting stories (see here and here) in the Guardian suggest that there is plenty of reason for the market participants to make this assumption.

All this began in 1998, and the bubble burst in 2007. Nine years of speculative madness (10, in Japan). 
Banks have now discovered that their balance sheets were filled with non-performing loans and toxic assets: urban land, unfinished housing developments, unpaid real estate loans to developers, and so on. 
The total assets of Spain's banking system amount to about €3tn. The net amount of toxic assets – unsold real estate valued market to market – is not known for certain. 
 In fact, the problem is so severe that

It has been dubbed the "Costa Catastrophe". Hundreds of thousands of unsold new homes litter Spain's coastal provinces – and now the banks are finally pulling the plug on developers and selling off their stock for whatever they can get. 
All the major Spanish banks have opened real estate websites (each translated into English to appeal to British buyers) to offload the new and repossessed homes on their books, promising discounts of as much as 60% off asking prices. But many experts think that prices in Spain still have further to fall and that asking prices remain a long way from reality.... 
At the height of the boom in 2006, Spain built more than 760,000 homes, five times the level of housebuilding in the UK. Housing starts have since collapsed by 90% and the struggling banks can no longer "extend and pretend" the unpaid interest on the colossal loans advanced to developers. 
The banks know that as they bring the property to market, prices will fall even further, so many offer 95% or even 100% loans at low interest rates so long as the buyer is willing to pay the original, inflated price. It's a gambit few believe will find many takers. 
Official statistics mask the scale of price falls. The Bank of Spain says prices are 25%-30% below their peak, but estate agents say falls of 40%-50% are common in some areas.

This is only the real estate troubles on the banks' balance sheet.  There is also the consumer and business troubles that occur when an economy has 24+% unemployment and is engaged in austerity fiscal policies that are pushing it further into recession/depression.

No comments: