Banks shrink from counterparty risk as EU financial crisis gathers steam

Both Reuters and the Wall Street Journal had articles (see here and here) on how banks, including Chinese banks, are reducing their exposure to other banks because they cannot assess the risk of the other banks.

Regular readers know that in the absence of ultra transparency where banks disclose on an on-going basis their current asset, liability and off-balance sheet exposure details that the interbank lending market is prone to freezing.

This is further confirmation of that fact.

From Reuters,

Alarmed by Europe's latest debt crisis and its unpredictable outcome, banks are getting increasingly picky about who they do business with for fear of taking on risky exposures to rivals who could be about to be whipsawed by bad debts. 

Greece's slow-motion crash towards default, coupled with the poor health of banks in Spain, have left banks wondering if any of their fellow institutions will end up holding catastrophic losses and will be unable to meet their obligations.

Only the requirement that banks provide ultra transparency fully addresses this issue.  It is only with this data that can assess whether any of their fellow institutions will end up holding catastrophic losses and will be unable to meet their obligations.

All banks then are becoming increasingly cautious about their dealings with counterparties perceived to be in the firing line - making it harder for those firms to do their everyday business, throwing grit into the cogs of the financial system and ultimately crimping prospects for economic recovery. 

"Banks are particularly wary of counterparties at the moment and no compliance officer is going to take on exposure to a counterparty just because historically they have a strong track record," said Christopher Wheeler, an analyst at Mediobanca.

Being wary translates into a freezing of the credit market and a disruption of the real economy.

This disruption to the real economy was completely preventable.  It has been well known since the beginning of the credit crisis, which also saw the interbank lending market freeze because banks could not tell who was solvent and who was not, that the solution was to require ultra transparency.

The fact that policymakers and financial regulators have not made ultra transparency a requirement is an example of the efforts of Wall Street's Opacity Protection Team as well as regulators gambling with financial stability to protect their information monopoly.

In the fast-moving banking sector, failures can happen quickly. Just ask anyone involved with MF Global, which collapsed overnight in October last year after clients and trading partners pulled back amid rumours of a trading loss in the European sovereign debt crisis. 

Three years previously, Lehman Brothers became the largest bankruptcy in U.S. history, after it was brought to its knees by a combination of losses, nervous clients and credit rating downgrades. 

Failures like those can leave massive losses splattered across the financial system, reason enough for compliance officers to rein in risky exposures to their peers. 

For any bank, loss of trust is potentially fatal and can catch it in a pincer movement where it rapidly finds it harder to borrow money, while being asked to put up more costly security in its daily trading. 

There are signs in the market this is already happening. 

"Banks are being very cautious over who they do business with. They are avoiding counterparties they perceive to be risky ... and this attitude will become more extreme if market conditions deteriorate further," said Wheeler.

An added problem is that many of the markets in which investment banks participate are virtually invisible to regulators.

The problem is not that the markets are invisible to regulators.  The problem is that each bank's positions are not visible to their banking fellows.  Without this data, the other banks cannot make an assessment of each bank's riskiness.

From the Wall Street Journal,

Some of China's biggest banks have cut off a handful of their European counterparts from borrowing and derivatives trading as they seek to reduce their exposure to the simmering crisis on the Continent, people familiar with the matter said....

The moves by the Chinese banks, which occurred late last year and early this year, aren't believed to have had a significant impact on the funding or trading positions of their European counterparts, analysts say, given the still-limited role played by the Chinese in global funding markets and derivatives trading.... 

Many analysts view the Chinese banks' pullback from the European counterparties as a sign of improvement in how they manage risks posed by banks they do business with.

At the height of global financial crisis in 2008, some Chinese banks, including Bank of China, got burned because they failed to unwind their exposure to now-defunct Lehman Brothers Holdings Inc. fast enough.

"The Lehman bankruptcy was a wake-up call to many of us," said a senior Chinese banking executive based in Beijing. "Now we monitor the risks posed by our counterparties all the time, and it's the responsibility of our financial institutions and risk-management departments to adjust the amount of credit extended to our counterparties accordingly."

The European financial crisis has intensified in recent weeks because of fears that Greece will withdraw from the euro. European banks have been largely cut off from public funding markets and are reluctant to lend to one another, though most are under no immediate financial pressure because of the huge loan program implemented late last year and early this year by the European Central Bank.

Big Chinese banks started reviewing the credit profiles of their European counterparts in the second half of last year, with Bank of China—the most international of all Chinese banks—being one of the first to cut back on trading with and counterparty exposure to European banks.

Since late last year, the bank has suspended purchasing derivatives including credit-default swaps—or insurance-like financial contracts—from European banks including Société Générale and Crédit Agricole. ....

In addition, Bank of China also stopped trading certain foreign-exchange derivatives with UBS and BNP Paribas. ... 

Even as they have vowed to further liberalize the domestic financial markets, Chinese regulators have fretted that foreign banks could be a new source of risk to the domestic financial system.

"Risks associated with foreign banks shouldn't be overlooked," Shang Fulin, chairman of the China Banking Regulatory Commission, said in February.

Confirmation that transparency reduces relevance of rating firms

A Bloomberg article confirms that the more transparency provided to market participants, the less relevant the rating firms are.

The response to the Moody’s Investors Service downgrade of the biggest Nordic banks was rising bond and share prices. 

The reaction is the latest sign that investors are paying less attention to the views of rating companies and relying more on their own analysis to determine whether to buy or sell.

“We can see for ourselves just how strong the Swedish banks are so we don’t place much weight on what rating agencies tell us,” Nicklas Granath, a partner at Stockholm-based asset manager Norron AB, who helps manage about $200 million, said in an interview. “More and more the market is likely to take the same approach.” 

Even though Sweden doesn't require the banks to provide ultra transparency, it has a history of requiring the banks to recognize the losses hidden on and off their balance sheets.

As European policy makers try to reduce the dominance of rating companies in financial markets, investors are showing greater willingness to ignore Moody’s, Standard & Poor’s and Fitch Ratings.... 

“The Nordic banks are in general very solid and have currently no issues in funding,” said Espen Furnes, an Oslo- based fund manager at Storebrand Asset Management, which oversees $72 billion. “Moody’s is knocking down open doors with this. In these volatile markets the rating agencies are definitely behind the curve and, strangely enough, could be at risk of being considered irrelevant by the market during times when they actually do have something critical to say.”...

Keep in mind that the rating firms' business model is currently built around the idea of access to proprietary information.  Prior to their ratings being changed, banks have a chance to present the facts that they feel merits a higher rating.  Facts that are not always available to all market participants.

In Denmark, banks have started firing Moody’s after winning assurances from some of the country’s biggest investors that the opinions of ratings companies hold limited value.... 

Swedish banks, still among the best-rated in Europe, are now signaling they may rethink their cooperation with the rating company.

Cooperation that results in the rating firms having an informational advantage compared to other market participants.

“It is hard for” rating companies “to keep track and when you come close to them it is quite apparent they have difficulty following everything that is happening elsewhere,” [Swedbank Chief Financial Officer Goran] Bronner said. “The key is more transparency and then the market can decide.”

In particular, ultra transparency under which the banks disclose on an on-going basis their current asset, liability and off-balance sheet exposure details.  With ultra transparency, the market participants have access to all the information they need to independently assess the risk of each bank.

Former Bankia executive gets 14 million euro payoff

The Guardian reports that a former Bankia executive is going to receive a 14 million euro payoff.

While I have nothing against bankers being well paid when their institutions provide ultra transparency and everyone can see the risks taken, ...

A former senior executive at bailed-out Spanish bank Bankia is to receive a €14m (£11.2m) payoff in a move that will cause controversy beyond the country's borders if Europe is asked to help rescue Spain's banks. 

As the government seeks to raise the €19bn needed by Bankia, the news that Aurelio Izquierdo would walk away with such a large payoff raised questions about what Spain's troubled banks have been doing with their money....

News of the payoffs came amid growing uproar over the multimillion euro deals handed out to executives at Spain's cajas, or savings banks, during the boom years when they helped inflate a housing bubble that burst four years ago. 

Many have since been forced out of the banks they ruined, taking millions more euros in payoffs.

Showing that bankers get paid regardless of performance.

The toxic real estate assets they left behind are at the root of growing worries that Spanish banks will need a European-funded bailout on top of the Bankia rescue.... 

Bankia said on Tuesday that bailout money would not be used for the multimillion euro executive payoffs as the sums were already accounted for. In Izquierdo's case, they said, the money was owed by one of the seven cajas that merged to form Bankia, and which remain shareholders, rather than by the new bank. 

Izquierdo was the number two at Bancaja, the second largest of the cajas that were merged two years ago....

Bancaja brought large amounts of toxic real estate to the merger. Bankia's parent company BFA now recognises €40bn of such assets. 

Bancaja operated in eastern Valencia, a coastal region that became a byword for both voracious construction and political corruption. 

With control of individual cajas in the hands of local politicians, their presidents were largely political appointees. 

A study by economists Luis Garicano and Vicente Cuñat in 2009 found a close relationship between political caja bosses and bad loans. These increased by 50% where the president was a politician with no banking experience.... 

Yet another reason for requiring ultra transparency so that market discipline can restrain risk taking.

Regulations adopted since financial crisis inhibit recovery

In his Telegraph column, Jeremy Warner provides a terrific description of the financial regulations adopted since the beginning of the financial crisis.

In this description, he confirms your humble blogger's observation that the regulations are a response to the financial crisis that treat symptoms without looking at the root cause.  Since the regulations only treat symptoms, they often contradict each other and/or inhibit recovery of the real economy.

As if the [corporate debt] refinancing problem wasn't already challenging enough, into it all stumbles the European commissioner for internal markets, Michel Barnier, to prove the old saw that there is no mess quite so bad that official intervention won't make even worse.... 

After a crisis of the magnitude we've just seen, it's perfectly right and proper, and certainly very human, to want to take immediate steps to fix the system, so as to ensure that this kind of nonsense can never happen again. 

However, you cannot count on luck if you want to fix the system and make sure this doesn't happen again.  You actually have to look not at the symptoms, but the root causes.

If policymakers had looked at the root causes of the financial crisis, they would have seen that the bankers  reintroduced opacity into the financial system.

They did this in many ways.

For example, rather than offer ultra transparency that was the sign of a bank that could stand on its own two feet, banks complied with minimalists disclosure requirements and turn themselves into 'black boxes'.

For example, they created structured finance securities that gave Wall Street an informational advantage over the investors as Wall Street had access to reports on the underlying collateral performance well before investors.

There is also something to be said for striking while the iron is hot. Leave things too long, and the political will to act melts away.

Actually, by investigating the cause(s) of the financial crisis, the political will to regulate remains.  This was shown in the aftermath of the Great Depression when the Pecora Commission paved the way for the regulations implemented by the FDR Administration 3+ years after the start of the financial crisis.

Even so, it's not clear that right now, with the crisis self evidently approaching some kind of fresh denouement, is the time to be buttressing the system against the once in a hundred year event of the present maelstrom. Nor in any case can the sort of extreme regulatory overkill we are seeing at the moment ever be seen as appropriate.

As I have been saying since the start of the financial crisis, the right regulation can both resolve the current problems with the financial system and buttress the financial system against the once in a hundred year event.

The right regulation was to adopt ultra transparency and shine a light into every opaque corner of the financial system.

Adopting ultra transparency leads directly to adoption of the Swedish model.  This leads to banks recognizing the losses on all the excess debt in the financial system.  In turn, this removes the burden of servicing this debt from the real economy and the restoration of growth.

Adopting ultra transparency also leads directly to market discipline being applied to the financial system.  With this disclosure, investors can actually assess the risk of banks and structured finance securities.  This leads directly to an ability to value these securities and make investment decisions (buy, hold, sell) based on the prices being shown by Wall Street.

As far as I know, Mr Barnier is well intentioned enough. He wants to protect us all from the calamities of the past. But in attempting to regulate away all future risk, he also threatens to undermine growth and further reduce already wanting European competitiveness. 

To be fair, it's not all Mr Barnier's fault. He's only part of a posse of international regulators riding furiously off in the wrong direction long after the horse has bolted.

A direct result of not investigating the causes of the financial crisis.

If even a fraction of the time spent on trying to protect us against a crisis that's already happened was devoted to finding a way out of it, then we might actually be getting somewhere. As it is, almost every part of the reform agenda is making matters worse, not better.

Please re-read the highlight text as it summarizes both why ultra transparency needs to be adopted and why most of Dodd-Frank (the Consumer Financial Protection Bureau and Volcker Rule being exceptions) should be repealed.

In its analysis of the refinancing challenge, S&P concedes that it might just about be possible for the banking system to cope with the wave of corporate debt maturities, assuming no further deepening of the eurozone crisis. But providing the $13 trillon to $16 trillion of new money to spur growth is going to be a much bigger ask, especially in Europe. 

"Much will depend on the continued ability of banking system regulators to pilot a path through the minefield that lies ahead", S&P observes. 

Well that appears to be that, then. Abandon all hope, for at the moment these very same regulators seem to be blundering their way forward as if entirely unaware of what lies beneath their feet. Ever more onerous capital and liquidity requirements have steepened the refinancing challenge, even with highly supportive central bank funding on hand. 

European banks, still grappling with high leverage and a worsening sovereign debt crisis, are particularly badly affected. Because of the escalating European banking crisis, they face intense pressure to meet new capital and liquidity requirements more quickly. With new equity virtually impossible to raise, this has only further exaggerated the de-leveraging problem. Enforced recapitalisation from governments which are themselves insolvent scarcely helps matters.

The financial regulator driven credit crunch I previously discussed.

In the US, there is at least a highly developed corporate bond market to act as an alternative to bank funding.

The reason is that non-financial corporations have to provide disclosure that provides all market participants with acces to all the useful, relevant information in an appropriate, timely manner.

That's not the case in Europe, where to the contrary, the regulatory agenda seems determined to put as many obstacles in the way of a viable bond market as possible. 

Standard & Poor's calculates that if corporate issuers in Europe were to tap the bond market for 50pc of their new funding requirements (up from 15pc historically), it would imply net new yearly issuance of $210bn to $260bn. In only two years in the last decade has net new European issuance exceeded $100bn. 

You might think this a significant growth opportunity, but Mr Barnier's new solvency directive threatens to snuff that one out too, by requiring that only the most credit worthy and liquid bonds count for capital purposes. 

The new solvency requirements virtually outlaw bundling together corporate loans and issuing them as asset backed securities, or rather, they prevent financial institutions from providing a viable source of demand for such bonds. Instead, finance is pushed by regulation ever more aggressively into sovereign bonds, even though many of them are now less than credit worthy.

As I previously said, most of the regulations that have occurred since the beginning of the financial crisis should be dropped.

Today, bank capital is completely meaningless (by extension, so are bank capital requirements).  Regulators are practicing forbearance and as Spain has shown banks have a virtually unlimited number of ways to practice 'extend and pretend' on zombie borrowers.

 Mr. Warner identifies one of several problems with the new solvency requirements.

A much better approach would be to adopt ultra transparency.  This will end the financial regulators' information monopoly and bring market discipline to the banking system for the first time in almost 80 years.

My bet is that market participants will reward firms that have a strong, liquid balance sheet.

Europe desperately needs growth, but it seems determined to stifle the credit needed to provide it. How stupid can you get?

Despite what the government says, more Spanish banks need to recognize their losses

In his Telegraph column, Alistair Osborne asks how is Spain going to cope with the 270 billion euros of losses analysts predict are in its banking system when Spain is struggling trying to figure out how to deal with Bankia.

Regular readers know that the source of capital for rebuilding bank book capital levels is retention of future earnings.  The IIF estimated that it would take less than 4 years of earnings to rebuild the bank book capital levels after recognizing losses of this order of magnitude.

By way of comparison, the financial crisis has been going for 4+ years already with no apparent end in sight.

The answer to Mr. Osborne's question is that Spain is going to deal with all the losses in its banking system by adopting the Swedish model with ultra transparency.

As a result, the losses are going to be recognized today.  The burden of excess debt is going to be removed from the real economy as debtors are going to have their loans written down to levels they can afford.

Over the next several years, Spain's banks will rebuild their capital levels through retention of their earnings and by issuing bonuses in stock.  At the same time, market participants will assess the banks using the information disclosed under ultra transparency and exert discipline on the banks so that they do not take excessive risks.

How long can Mariano Rajoy keep this up? You know, the old matador routine. Swooshing his cape and declaring: “There will be no rescue of the Spanish banks.”...

If the Spanish government adopts the Swedish model with ultra transparency, the answer is forever! 

You’d hardly expect Spain’s PM to say anything else. But no-one believes him, judging by yesterday’s trampling in the bond markets.... 

The reasons? For starters, Madrid’s botched bail-out of Bankia, that paella of seven cajas, or savings banks. In just a fortnight, Bankia has gone from requiring €4.5bn (£3.6bn) of emergency funding to €23.5bn. Go figure, as they say. 

In addition, there is the simple fact that the PM is being advised by former and current bankers.  As everyone knows, 100% of the advice offered by these individuals is self-serving.

The question the PM must ask is there any overlap between what is best for Spain and this self-serving advice.  When it comes to the government bailing out the banks by injecting funds, the answer is there is no overlap between what is best for Spain and the bankers' self-interest.

Then, there’s all Rajoy’s mixed messages, in one breath ruling out a foreign bail-out for Spain’s banks, the next backing a eurozone rescue fund for lenders that bypasses national governments. “Lots of people are in favour of that, and I certainly am,” was his take on that. 

And this is before you consider the big picture. That, on Centre of European Policy Studies figures, Spain’s banks face potential write-offs of €270bn, once they finally 'fess up to the true horrors of a property bust. That’s roughly a quarter of Spanish GDP.

In that context, the leaks over Spain’s preferred fix for Bankia were especially telling. Until now, the state-backed FROB (Fund for Orderly Bank Restructuring) had been raising money in the debt markets and transferring it to any troubled bank. 

But there are two problems now. First, that the FROB only has €5.4bn, including €1bn already committed. Second, as Rajoy admits: “With a risk premium at 500 [basis] points, it is very difficult to raise finances.” 

So, Madrid is considering injecting newly-issued bonds directly into Bankia’s parent, Banco Financiero y de Ahorros. Bankia could then use them as collateral to borrow from the ECB. 

Rajoy may see it differently but that looks uncannily like a foreign rescue by the backdoor. What choice has he got, though? 

Whatever he says, Rajoy knows Spain can’t afford to bail out its banks – not amid a double-dip recession and with the jobless rate near 25pc.

Fortunately, Spain's banks can afford to rebuild their own capital levels without the government stepping in.  They can do this by simply retaining future earnings.

Keep in mind that it does not matter whether the banks need 4 years or 10 years to rebuild their capital.  In a modern financial system with deposit guarantees and access to central bank funding, banks can continue to operate and support the real economy while they are rebuilding their capital levels. 

Did Bankia's depositors buying bonds require Spain to bailout bank?

Bloomberg carried an interesting article in which it presents the argument that Spain was on the hook for bailing out Bankia because its depositors were significant investors in its bonds.

This argument reflect one true and one fase assumption:

• True:  Spain has a moral obligation to protect investors; and

• False:  Maintaining positive book capital levels is necessary to prevent bank runs.

Spain has a moral obligation to protect investors that results from its information monopoly.  

If banks were required to provide ultra transparency and disclose on an ongoing basis their current asset, liability and off balance sheet exposure details, market participants would not be dependent on the government's assessment of the bank's solvency.  There would be no moral obligation as investors could use this disclosure and independently assess the solvency of the bank's for themselves.

However, since investors, unlike regulators, do not have access to ultra transparency, they are dependent on the the regulators to accurately assess this information and to report their findings.  This dependency creates the moral obligation.

Bank book capital is an accounting construct.  In a modern financial system with deposit guarantees and access to central bank funding, it can be positive or negative without effecting the bank's ability to operate and provide loans to the real economy.

As a result, there is no reason for governments to bailout the banks today.  The banks can simply rebuild their book capital levels through retention of future earnings.

Spain’s hands are tied with the rescue of Bankia (BKIA) because alternatives to injecting cash or government debt, such as forcing bond investors to bear the cost, risk hurting ordinary depositors.

Actually, the alternative of requiring the bank to recognize all of the losses hidden on and off its balance sheet today and provide ultra transparency does not risk hurting ordinary depositors.

Ordinary depositors are protected by deposit guarantees.  These guarantees are strengthened by the government not investing.  These guarantees are strengthened by the losses being recognized as the losses do not become a burden that crushes the real economy.

Bankia is among Spanish lenders that sold 22.4 billion euros ($28.2 billion) of preferred stock to individual investors through retail branches, according to data compiled by CNMV, the financial markets supervisor. 

In a so-called bail in, these investors would be wiped out before holders of more senior bonds, which tend to be banks and institutions.... 

“The sale of preferred stock to depositors means that almost the only option for the government now is injecting capital,” said Arturo Bris, a professor of finance at IMD business school in Laussanne, Switzerland. “A writedown of preferred shares placed with depositors would cause a social problem. It’s not really a feasible alternative.”...

The option of letting the bank rebuild its book capital level through retention of future earnings is still feasible.  It would avoid the social problem.

A taxpayer-funded bailout of Bankia would foist losses on a wider portion of society than making individual bondholders, many of them depositors, lose money....

A taxpayer-funded bailout would place the burden of the excess debt squarely on the real economy.  Everywhere this has been tried the result has been a long term economic decline.  As a result, this is not a viable option.

Fernando Herrero, the secretary general of ADICAE, a Madrid-based association of clients of financial institutions, estimated that about 1 million Spanish households bought banks’ preferred shares, some of which have been converted to common equity or subordinated convertible bonds.

“The instruments were marketed as very liquid and as safe as a deposit,” said Herrero, who described issuing the risky securities to individual investors as an “original sin.”

The bank was able to get away with this marketing because of the government's information monopoly.

If the bank had to provide ultra transparency, investors could have assessed the riskiness of the bank for themselves.  Since investors could not assess the risk of the bank, they had to trust what the government said about the bank.

Iceland shows that debt forgiveness under Swedish model leads to best recovery

Bloomberg ran an excellent article on Iceland confirming that adopting the Swedish model for handling a bank solvency led financial crisis results in recovery (as oppose to the Japanese model which results in prolonged economic decline).

Regular readers know that under the Swedish model banks absorb the losses on the excesses in the financial system today.  These excesses are the total of all the debt that excedes the borrower's capacity to repay.

By writing off all of this debt today, the banks protect the real economy.

Icelanders who pelted parliament with rocks in 2009 demanding their leaders and bankers answer for the country’s economic and financial collapse are reaping the benefits of their anger. 

Since the end of 2008, the island’s banks have forgiven loans equivalent to 13 percent of gross domestic product, easing the debt burdens of more than a quarter of the population, according to a report published this month by the Icelandic Financial Services Association. 

“You could safely say that Iceland holds the world record in household debt relief,” said Lars Christensen, chief emerging markets economist at Danske Bank A/S in Copenhagen. 

“Iceland followed the textbook example of what is required in a crisis. Any economist would agree with that.”

While your humble blogger agrees that Iceland is doing what is required in a crisis, I see very little evidence that 'any' economist would agree beyond Patrick Honohan and Joseph Stiglitz.

The island’s steps to resurrect itself since 2008, when its banks defaulted on $85 billion, are proving effective. 

Iceland’s economy will this year outgrow the euro area and the developed world on average, the Organization for Economic Cooperation and Development estimates. It costs about the same to insure against an Icelandic default as it does to guard against a credit event in Belgium. 

Most polls now show Icelanders don’t want to join the European Union, where the debt crisis is in its third year. 

Remember, the EU chose the Japanese model with its focus on protecting bank book capital levels.  As a result, the bad debt is still in the banking system and the real economy is spiraling down under the weight of the excess debt.

The island’s households were helped by an agreement between the government and the banks, which are still partly controlled by the state, to forgive debt exceeding 110 percent of home values. On top of that, a Supreme Court ruling in June 2010 found loans indexed to foreign currencies were illegal, meaning households no longer need to cover krona losses.

“The lesson to be learned from Iceland’s crisis is that if other countries think it’s necessary to write down debts, they should look at how successful the 110 percent agreement was here,” said Thorolfur Matthiasson, an economics professor at the University of Iceland in Reykjavik, in an interview. “It’s the broadest agreement that’s been undertaken.”  

Without the relief, homeowners would have buckled under the weight of their loans after the ratio of debt to incomes surged to 240 percent in 2008, Matthiasson said....

Please re-read the highlighted text as it confirms why the real economy must be protected from the excesses in the financial system.

Iceland’s approach to dealing with the meltdown has put the needs of its population ahead of the markets at every turn.

Once it became clear back in October 2008 that the island’s banks were beyond saving, the government stepped in, ring-fenced the domestic accounts, and left international creditors in the lurch. The central bank imposed capital controls to halt the ensuing sell-off of the krona and new state-controlled banks were created from the remnants of the lenders that failed. 

Activists say the banks should go even further in their debt relief. Andrea J. Olafsdottir, chairman of the Icelandic Homes Coalition, said she doubts the numbers provided by the banks are reliable. 

“There are indications that some of the financial institutions in question haven’t lost a penny with the measures that they’ve undertaken,” she said. 

According to Kristjan Kristjansson, a spokesman for Landsbankinn hf, the amount written off by the banks is probably larger than the 196.4 billion kronur ($1.6 billion) that the Financial Services Association estimates, since that figure only includes debt relief required by the courts or the government....

This demonstrates one of the reasons that banks must be required to provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details.  With this disclosure, market participants could confirm that loans had been written down.

According to Christensen at Danske Bank, “the bottom line is that if households are insolvent, then the banks just have to go along with it, regardless of the interests of the banks.”

The real bottom line is the banks have to go along with absorbing the losses on the excesses in the financial system regardless of the interests of the bankers.

Following the lead of the US, UK and EU, Spain jeopardizes financial system and real economy by lying

In a must read Bloomberg article, the problems with pursuing the Japanese model for handling a bank solvency led financial crisis are laid bare.  At the top of the list is lying about the true condition of the banking system.

Spanish banks are masking their full exposure to soured property loans while they continue to prop up insolvent “zombie” developers, leading to credit-rating downgrades and plummeting share prices. 

Spain is trying to clean up its banks, requiring lenders to set aside more for possible losses on loans deemed performing to developers likeMetrovacesa SA (MVC), which hasn’t completed a project in more than a year and has none under way. 

While that represents about 30 billion euros ($38 billion) of increased provisions, it’s not enough because many of the loans said to be performing aren’t, said Mikel Echavarren, chairman of Irea, a Madrid-based finance company specializing in real estate. 

“Spain has engaged in a policy of delay and pray,” Echavarren said in an interview. “The problem hasn’t been quantified by anyone because there is huge pressure not to tell the truth.”

Please re-read the highlighted text as it confirms why banks must be required to provide ultra transparence and disclose their current asset, liability and off-balance sheet exposure details.

Without requiring ultra transparency, banks, their financial regulators and their host governments will lie about the condition of the banks by allowing them to engage in 'extend and pretend' practices....

There is a significant cost to the real economy from this practice.

Many Spanish banks are avoiding property sales so they don’t have to make “mark to market” valuations. Instead, they’re giving developers new loans to pay debt coming due to prevent defaults, said Ruben Manso, an economist at Mansolivar & IAX and a former Bank of Spain inspector. 

“The larger banks have been selling bits and pieces and can absorb the losses,” Manso said. “Smaller savings banks are acting in bad faith in their refusal to allow transactions and saying they can’t mark to market because there isn’t one.”...

In an environment of regulatory forbearance, banks have a number of ways of avoiding recognition of the losses on and off their balance sheets.

“The Irish property market had to collapse like the Spanish one because the economy was collapsing,” Kelly said. “Spain is looking like a re-run.” 

More than half of Spain’s 67,000 developers can be categorized as “zombies,” according R.R. de Acuna & Asociados, a real-estate consulting firm. They have combined debt of 180 billion euros that will lead to 104 billion euros of losses that hasn’t been fully provisioned for, Acuna estimates. 

“They aren’t officially bankrupt because they have been refinanced time and time again,” Fernando Rodriguez de Acuna Martinez, a partner at the company, said by telephone. “Their assets are worth much less than their liabilities, they struggle to repay loans and they haven’t revaluated them to reflect today’s prices.”

Confirming why all the strategies that failed in Ireland will also fail in Spain.

The Bank of Spain allows loans that are refinanced before turning delinquent and interest-only loans to be considered “normal” or “performing” on banks’ books, according to Manso. 

“You won’t find that data anywhere,” Manso said. “There has been a lot of cheating going on where banks have lent developers new money, classed as new lending, so they can pay off their original loans.” That’s masking delinquency, he said.

This is an example of what banks can do when there is regulatory forbearance and banks are not required to provide ultra transparency.

Refinancing the current and future zombie developers will cost 30 billion euros over the next two years, according to Acuna. The depreciation of those developer assets from 2012 onwards will generate a further 20 billion euros of losses in that time, he said. 

The Bank of Spain doesn’t publish data on the amount of restructured developer loans or interest-only paying loans that are classed as normal. The bank closely monitors refinancing to ensure that arrears aren’t being hidden, said a spokeswoman for the Bank of Spain who declined to be identified.

Please re-read the highlighted text as this is a partial estimate of the cost to the real economy from not forcing the banks to recognize their losses.

[Echavarren] forecasts that the larger Spanish banks with income from international operations will be able to pay for domestic real-estate losses within two years. The rest can’t take such a hit and will have to be nationalized, he said.

Confirming again that the government should not bailout the banks but should instead allow the banks to rebuild their book equity through retention of future earnings.

“We cannot continue to jeopardize the whole financial system by not telling the truth,” Echavarren said.

Investors have lost confidence in Spain

According to a Telegraph report, Nicholas Spiro, at Spiro Sovereign Strategy observed

The Spanish crisis has reached a tipping point. Investors have lost confidence in Spain. 

The botched bail-out of Bankia was the trigger for this morning's abrupt sell-off - a sell-off that threatens to turn into a rout unless bold and decisive measures are swiftly taken by eurozone policymakers to shore up the bloc's endangered sovereigns and their banks. 

Spain has become the focal point for market anxiety about the pernicious links between distressed sovereigns and their banks. 

Although Spain's banking woes are much less severe than Ireland's, the same negative feedback loop that felled Ireland in 2010 is undermining confidence in Spain. 

What is most concerning, and what necessitates speedy action on the part of the eurozone, is that the Rajoy government is stuck in a rut. It is in a 'damned if it does and damned if it doesn't situation'.

Regular readers know that adoption of the Swedish model with ultra transparency is the only solution that successfully addresses all of the concerns expressed by Mr. Spiro.

It separates sovereigns from their banks as future retained earnings become the source for rebuilding the banks' book equity levels.

It ends the undermining of confidence in Spain by ending the need for Spain's governments to make statements about how bad the situation with its banks is and risk having these statements being shown as false within days.  With ultra transparency, the market participants assess exactly what is going on with the banks for themselves.

By unnecessarily bailing out its banks, Spain runs out of money

As reported in the Telegraph by Ambrose Evans-Pritchard, Spain has run out of money as it does not have the financial capacity to bail out is banks.

The direct result of the decision to unnecessarily put capital into its banks is that Spain, like Ireland and Greece, will have to turn to the EU, ECB and IMF for funding.

Your humble blogger has consistently maintained that this decision is only beneficial for bankers.  It is truly detrimental to Spain's real economy and its citizens.

That policymakers endorse bailing out banker bonuses and hurting their citizens is not surprising.  Policymakers engage bankers and former bankers to provide advice.


By definition, bankers are great salesmen whose every utterance is 100% reflects and is focused on advancing their self-interest.  


Whether the bankers' self-interest is also in Spain or any other country's best interest is a separate question that policymakers have to answer for themselves before accepting the bankers' advice.

Since the beginning of this financial crisis, there has always been an alternative to advancing the bankers' self-interest and saving bankers' bonuses.

The alternative has been the adoption of the Swedish model with ultra transparency.  Under this policy, banks would be required to recognize all the losses hidden on and off their balance sheets.

Premier Mariano Rajoy and his inner circle have allegedly accepted that Spain will have to call on Europe's EFSF bail-out fund to rescue the banking system, even though this means subjecting his country to foreign suzerainty. 

Since it is in the bankers' interest that this occurs, you have to wonder who told the press.

Mr Rajoy denies the story, not surprisingly since it would be a devastating climb-down, and not all options are yet exhausted.

"There will not be any (outside) rescue for the Spanish banking system," he said.

Which is absolutely true if the Spanish government adopts the Swedish model with ultra transparency.

Fine, so where is the €23.5bn for the Bankia rescue going to come from? The state's Fund for Orderly Bank Restructuring (FROB) is down to €5.3bn, and there are many other candidates for that soup kitchen. 

Spain must somehow rustle up €20bn or more on the debt markets. This will push the budget deficit back into the danger zone, though Madrid will no doubt try to keep it off books – or seek backdoor funds from the ECB to cap borrowing costs. Nobody will be fooled....

Actually, under the Swedish model with ultra transparency, the source of the 23.5 billion euros is retention of future bank earnings.

The IIF provided a study which shows that future bank earnings would be sufficient to rebuild the Spanish banks' book capital levels after absorbing over 200 billion euros of losses in under 4 years.

This all has a very Irish feel to me, without Irish speed and transparency. Spanish taxpayers are swallowing the losses of the banking elites, sparing creditors their haircuts.

As shown by Ireland, exactly the wrong strategy.

Barclays Capital says Spain's housing crash is only half way through. Home prices will have to fall at least 20pc more to clear the 1m overhang of excess properties. If so, the banking costs for the Spanish state are going to be huge. 

The Centre for European Policy Studies in Brussels puts likely write-offs at €270bn. We could see Spain's public debt surge into triple digits in short order.

Only if Spain unnecessarily recapitalizes the banks.

A Spanish economist sent me an email over the weekend after the Bankia details came out saying: 

"It looks like game over for the sovereign and the financial sector at the same time. Unless we get a Deus ex Machina, we'll be discussing much more seriously the benefits of a return to the peseta in no time."

The Swedish model with ultra transparency solves this problem.