Regular readers know that in a modern banking system with deposit guarantees and access to central bank funding banks are designed not to need government bailouts.
In fact, banks are designed to absorb the losses on the excesses in the financial system today and protect the real economy. Subsequently, banks can rebuild their book capital levels through retention of 100% of pre-banker bonus earnings.
As RBS's Stephen Hester confirmed this with his observation that governments should use their money growing the economy and not bailing out individual banks.
Spain seems trapped on a conveyor belt carrying it toward a furnace - an international rescue of the euro zone's fourth biggest economy.
Bad commercial loans, economic decline and sliding real estate prices are all aggravating problems at Spain's over-extended banks, which lent too much too freely during a credit fuelled property boom that lasted almost a decade.
Madrid's euro zone partners are making available up to 100 billion euros to clean up the banks and, they hope, shield Spain from a debt crisis that has engulfed Greece, Ireland and Portugal and now threatens the single currency project itself....
Signs of the spending spree that began when Spain joined the euro on 1999 are everywhere - empty apartment blocks, unused airports, grandiose cultural centers and highways to nowhere. The house of cards collapsed in 2007-2008 leaving banks with 300 billion euros - equivalent to almost one third of annual economic output - of exposure to the property sector.
The banks, and Spain's indebted regions have been economists' main focus in trying to fix the Spanish problem....If the financial crisis has taught any lesson, it is that economists' do not have any idea what they are doing when it comes to advising on how to end a bank solvency led financial crisis.
It is no surprise that economists are focused on bailing out the banks. It is simply confirmation that they do not understand how the modern banking system is designed (after all, they assume it works in their models).
In theory, the bank bailout agreed earlier this month should banish doubts over whether lenders can handle the fallout from economic recession....Only an economist's theory would suggest that a bailout would banish doubts.
Everyone else knows that the only way to banish doubts is by requiring the banks to provide ultra transparency and disclose on an ongoing basis their current asset, liability and off-balance sheet exposure details. This way market participants can independently assess what is going on.
A detailed independent audit of the banks by four major global accounting firms - due by September - may show companies from other business sectors have also been pushed to the brink of default. Banks are already seeing rising mortgage defaults and bad loans in non-property sectors.
Time is also of the essence.Actually, banks have all the time they need to generate the earnings to rebuild their book capital after recognizing all the losses hiding on and off their balance sheets.
What time is running out on is requiring banks to recognize the losses and providing ultra transparency to show that they did.
One banker who says the audit should find the banking system mostly sound still doubts it will come on time.
"What I'm not sure is whether it will be enough to recover market confidence, that it is not going to make things worse," he said, speaking on condition of anonymity because of the business sensitivity.....Of course the results of the audit will make things worse.
Does anyone think the results will show that the Spanish banking system needs 400 billion euros to rebuild its banks' book capital levels (this is the amount of losses projected by Moody's and other independent analysts)?
Or does everyone expect that the results of the audit will somehow come in at less than the 100 billion euros Spain has been given to bailout the banks?
The report from Oliver, Wyman says that Spanish banks need 62 billion euros in additional capital.
A result that will do absolutely nothing to end the crisis of confidence in the Spanish banking system. But has the potential to further undermine the credibility of the Spanish government as it becomes known that the losses are well in excess of those assumed.
Spain is following in Ireland's footsteps. We saw Ireland fail to require its banks recognize all of their losses and provide ultra transparency to let market participants confirm the fact and the failure to do so does not end well.