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Spain: Chronicle of a Disaster Foretold

MADRID, May 21 2012 (IPS) - The nationalisation of Bankia, the fourth largest Spanish bank, and its parent company BFA, caused an uproar and focussed attention on the failure of the financial reforms passed by the government of Mariano Rajoy last February 3. The insufficiency of these reforms combined with investors’ lack of confidence and the requirements of the European Central Bank (ECB) and the European Union (EU) forced the government on May 11 to decide on a new reform package intended to “definitively” provide solvency and credibility to the national financial system.

The measures adopted require banks to boost provisioning levels and would provide for support using public funds if necessary. They also require the segregation of toxic holdings in real estate firms (surrogates for the “bad banks”). However, even despite the explicit backing of the ECB and EU, there are doubts that the latest steps go far enough.

The nationalisation of BFA-Bankia on May 9 and the new reforms have unleashed a storm of accusations and blame. The ruling Popular Party (PP) and the opposition Socialist Spanish Workers Party (PSOE) accuse each other of using public funds to save the banks, although the reality is that neither is free from blame. No government could simply stand by as a major bank collapsed: the systemic risk involved could spread and bring down the entire system.

The previous socialist government of Jose Luis Rodriguez Zapatero devoted massive amounts of public funds to help troubled banks. And he did this with the support of the PP, then in the opposition. Similarly, the PSOE backed the Rajoy administration’s financial reform in February.

As for BFA-Bankia, the entire government blamed the disastrous lack of vigilance by the Bank of Spain, which had approved its books months earlier. However, oversight was managed and controlled by the PP since 1998. Its last president, Rodrigo Rato, ex-vice president and ex-economic minister in the administrations of Jose Maria Aznar and ex-director-general of the International Monetary Fund (IMF), was forced to resign.

The underlying factor is the failure of the February 3 reform package, given that its main goal, the clean-up of the financial sector, has not been achieved. Not only has it failed to restore the banks to its role as a provider of credit, it has further eroded the confidence of the markets, the EU, and the IMF. The result is that the problems of the financial sector, mainly a matter of real estate holdings, is now the primary and most urgent obstacle to exiting the crisis.

The government’s strategy in February consisted of requiring banks to devote 50 billion euros to clean-up themselves and at the same time to merge “sick” institutions with those that were more solvent. Segregating the most toxic real estate assets in a “bad bank” was rejected because of the unpopularity of such a move. The political cost of using public funds for such a solution would have been extremely high.

But the intervention was too slow, complex, and inefficient. The quantity mentioned was clearly insufficient because the banks’ valuation of bad real estate assets was higher than the market value. This is what happened with Bankia and its parent company.

Nonetheless, the government continued to say that it was satisfied with the reforms. On April 7, the minister of the economy, Luis De Guindos, stated that Spain could lift itself out of the crisis “without foreign assistance” -as if the low-interest liquidity from the ECB wasn’t exactly that.

The economic chiefs “sold” the notion that the drop in the risk premium was due to the effects of the austerity measures, when in reality this change would have been the result of the liquidity provided by the ECB since December in the form of long-term, low-interest credit.

Spanish banks simply devoured these funds. However, the ECB soon recognised the danger that this “all you can eat” liquidity could anaesthetise the banking sector, dampen efforts to clean itself up, and implement reforms in countries accessing it. So the ECB said it was closing the tap. Experts then predicted that when this happened, the countries that had failed to carry out deep restructuring of the financial system would be hit hard. This seems to be what we are now seeing.

Finally it became clear that new reform was needed to ward off imminent disaster, though it was planned in a confused manner as all blamed the “mess inherited” and the Bank of Spain.

On May 11, the council of ministers took its hardest decision yet. Recapitalising the bank with public funds was a hard sell given the growing difficulty of financing the state and regions and the social hardship caused by budget cuts, even it was cast as an emergency intervention.

The reform requires banks to segregate their toxic property assets in real estate companies and boost provisions on losses revealed in audits by an independent entity with international credibility. Provisioning will be required even on non-problematic assets. The government is requiring banks to come up with 28 billion additional euros to cover real estate risk and is offering 15 billion in convertible bonds at 10 percent interest to entities that cannot obtain credit on the market (which is probable) and need help to comply with the new requirements. These measures would cover 45 percent of the 304 billion euros connected to real estate.

The new plan, which has the explicit backing of the EU and the ECB, raises numerous doubts. Details like how these real estate companies will be financed remain to be worked out. And it could well be that the 15 billion euros that the government considers to be the “maximum necessary” will not be enough to cover the new valuations. Moreover, the requirement for provisions against healthy assets will create fragility throughout the financial system, which in many cases will have to reduce dividends. The public supports the idea but stakeholders are selling. It should be borne in mind that banks are already suffering the negative effects on business in its entirety.

The new reform may seem like a big step forward but the proof is in the pudding. Will it be, like the last phase of reforms, insufficient? (END/COPYRIGHT IPS)

* Guillermo Medina, a journalist and writer, is ex-director of the newspaper “YA”, ex-deputy, and ex-president of the Defence
Commission of the Spanish Congress.

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