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Spain, Bad Banks, Assets, Losses and Lies

I thought it might be a good moment to take a broad look at Spain’s financial troubles and outlook.  For those of you who tire of details, the executive summary is that is that it is bad and without a doubt going to get  considerably worse over the next 6 – 18 months despite Spanish government and EU claims to the contrary.

Here’s why.

On Friday (31st Aug) the Spanish Government passed what it said would be Spain’s definitive banking reform. This is actually the third such ‘definitive’ reform. The previous two were more blather than action. All the talk in this reform centres around the creation of a so called ‘bad bank’. Which, it is being claimed, will sort Spain’s ailing banking system once and for all. This despite the fact that Spain already has a bad bank, a really bad one, Bankia. I say this only half in jest. I’ll come back to Bankia.

First let’s deal with what a  bad bank actually is and does.

Bad Bank

A ‘bad bank’ isn’t a bank. It’s an ‘Asset Management’ company. A company is created, which buys all the rotten, failed, toxic, non-performing loans which Spain’s banks and it’s Caja’s have on their books. The company then ‘manages’ these assets. There, all better now?

Of course you might have a couple of questions. Like, who set’s up this company? With whose money? What does ‘manage’ mean? And if the company can make a profit from ‘managing’ the assets it buys from the banks, then why couldn’t the banks ‘manage’ them?

So how is it going to work, exactly? Well according to Spains Minister for the Economy,Minister Luis de Guindos, speaking at a news conference  last Friday,

The aim is for private investors to take a majority stake in the bad bank .

He went on,

“The asset-management company should be viable and not generate losses and in the end not have any impact on the taxpayer,…”

Gosh, why didn’t we think of this before?  Private investors are going to pay for the whole thing, and then it will make oodles of money and cost the taxpayer nothing.  Oh really?

Before we go on with this fiction lets just stop to mention how the company makes money. The ONLY way it makes any money is if it pays a realistic market price for the assets it buys them. At the moment those ‘assets’/loans and repossessed properties are being held by the banks at mark-to-model,not mark-to-market values. Which mean if the new company/bad bank buys them at a market price then the banks will take a considerable loss. The amount of the loss will be the difference between what the bank originally loaned out/expected to get back during the bubble years and what it now selling that loan for in a deep recession. The size of that difference will be the loss taken by the banks, which will be the size of their next bail out. There is no way around the fact that the assets being sold have lost value. Setting up an ‘Asset Management company’ doesn’t magically get rid of that loss. The only question is who takes it.

Now, the company, if it is a real company set up to make a profit,  will only buy the bad assets if it thinks that it can get them for a price that is in line with their actual worth today AND has a prospect of making money with them going forward. You don’t make a profit just by acquiring ‘assets’. You have to make money with them. So how will it make a profit?. First, even from really rotten assets – in this case securities backed by mortgages and loans to developers and builders – there will be some income from the fraction of the loans still being repaid. Second the company will attempt to sell the securities and loans to third parties who think they will be able to squeeze more repayments  from the loans or who think they  can sell the underlying land, property for a profit no one else has seen.

The obvious question is why doesn’t the  bank write off the loss but then keep the marked down assets and make the residual profit themselves? The answer is time.  Time is money. Spain’s banks, its Cajas in particular, have neither. It will take time to eventually see a profit from rotten loans. Spain’s banks need to be seen to be clear of debts soon.

The whole rational for a bad bank is to transfer the loss making ‘assets’ out of the banks because they need to borrow and do banking right now, while the Asset Management Company, does not. . The Asset Management company buys everyone time. The official plan is for the Bad Bank to,

…try to sell the assets over 10 to 15 years.

Who will remember in 10 15 years?  The toxic loans will be safely hidden away, out of the politically sensitive banks and in company that will be less familiar and, even more importantly, rarely, if ever, reported upon.

How many people have heard of the ‘Asset Management companies which the Chinese government set up the last time it had to bail out all of its major banks? Anyone? We’ve all heard of the banks. They made massive losses on bad loans at the end of the 90’s. They would have all died except that  bad banks were set up, one for each of them – to manage those bad assets.  They too were going to cost the tax payer nothing and make money. None of them have made money from the rotten assets they bought from the banks. In fact after 10 years when they were supposed to pay back money loaned to them, they coudn’t. They were bankrupt and were only saved, themselves, by the government footing another bill in order to extend their loans for another ten years. Even today those companies have only recovered 20% of the value of what they bought. To add insult to injury, the FT reported last year, that those companies are now thought to be making stupid and toxic loans to businesses that can’t get loans from any of China’s other fine banks.

Bad Banks don’t make money. They just get the cost and embarrassment of a crisis off the front pages. The sorry saga of China’s bad banks will prove to be, I think, the blue-print for how Spain’s will unfold. The Spanish Government, however, all our governments in fact, would tell you I’m wrong and that bad banks are like a good fairies. They sprinkle fairy dust on disasters and turn them to gold. So, back to the fiction.

The Spanish government’s ‘aim’ is for private investors to take a majority stake. Well they are only going to if they see a profit. So how will they get a profit from assets that the bank can’t profit from? The key, of course, is the price the asset management company pays for the assets. The bad bank can only work if it pays a low price. A low price, however, would leave the banks with a large loss. Those banks would then not have bad assets on their books but would have a huge hole in their finances. Who will pay?

According to the Spanish government, as reported by Reuters,

Private investors in rescued banks will bear some of the cost of the clean-up. Holders of complex instruments known as preference shares will take a major hit, as the prices for those securities have fallen steeply.

Which sound like the Spanish government making ‘the bond holders’ and the financial world pay its share of the losses. Actually not quite. The government says it will make some junior bond holders and well as share holders take losses.   I think the junior bond holders will challenge this and I wouldn’t be surprised to see Madrid trying to back out. The EU and IMF will try to force them to hold the line.  

More importantly, much more importantly, however, are these ‘Preference shares’, described as ‘complex instruments’. Describing them as such makes you think they must be the sort of thing major financial institutions hold. And they should be. But sadly they are not – not in Spain. The Preference shares were  offered to professional investors who largely refused to buy them. The government decided if the professional market wouldn’t buy them, then they would just have to be flogged to the ever trusting voters. The shares the professionals wouldn’t touch were sold to ordinary Spanish savers by ‘local banks’ as the article coyly puts it. Which ‘local banks’? Well Bankia for one. Bankia and the other Cajas, whose ‘rescue’ depended on the sale of these oh-so-safe shares, sold €22 billion of them to their own depositors and other small investors.  

As recently as this May an article in Bloomberg – which I recommewnd you take a look at so you can verify that I am not making this stuff up – quoted  Arturo Bris, a professor of finance at IMD business school in Laussanne, Switzerland, who said,

“A writedown of preferred shares placed with depositors would cause a social problem. It’s not really a feasible alternative.”

The article went on to note,

A spokeswoman for the Spanish economy ministry had no immediate comment. A Bankia spokesman, who declined to be identified, wouldn’t comment.

They knew then the unfeasable, unthinkable was probably what they were going to do all along. The government’s plan means that the up-coming losses in Spain’s banks are going to be heaped upon ordinary Spaniards, NOT their wealthier ruling class. As The Wall Street Journal reported,

The potential move would affect around 120,000 retail customers who poured their savings into these instruments. The products were sold by local banks as a low-risk, higher-yielding alternative to regular deposits, but have since plunged in value as Spain’s economic crisis has worsened.

So if the  government makes the bank sell their assets at a market price – very little – then ordinary Spaniards who were sold preference shares as a ‘low-risk’ way to protect their savings – those savings will be lost. And then those same ordinary people will be forced to pay for whatever further part of the bank losses gets covered by another cash injection/bail-out.

Of course the government could avoid some of the political fallout from all this by insisting/agreeing that the Asset Management Company pay the banks way over the market price for the assets, nearer to what the banks should have got if the bubble had never popped. The banks would then lose very little on the deal. The loss wouldn’t go away, it would be rolled off the banks and on to the asset management company.  The new company would have bought assets far above what they were really worth.

This second option would save the massive anger that will surely come when all those people who were sold preference shares see their nest egg for the future taken from them , but would make the Asset management company non-viable from the start. So it helps with one political nightmare but creates another. Because no private investors will buy in to that.  Unless… the government sets up the company in a sly way so that the private investors are guaranteed to be first in line for whatever profits are made. In other words cheat the profit structure.

That is what I think will happen. The banks will be paid inflated prices. Not high enough to protect the small, Preference  share holders. They are little people. They will get shit on.  But the senior bond holders – the ones who have friends in government – who often ARE in government  – the banks, the wealthy and the powerful – the big investors – the price set will be high enough to protect them. This will leave  the bulk of the losses to be rolled in to the new company. Of course the government is still spending tax payer money. But it will be ‘hidden’.  People understand a bank bail out enough to make them angry. So replace a feel-bad story with a fiction that hides the truth. In this new fiction there are no bank bail outs or are at least smaller. Instead there is the creation of a ‘bad bank’ which will make money and cost nothing.  In place of a bail out we now have a wise investment. Oh joy!

By the time it is clear that private investors are not going to take the lead – and /or that to encourage them the eventual profits will go to them while the government will get very little, and that the investment was not at all wise and was never going to make a profit –  by the time anyone hears any of this,  those responsible will be retired and immune from prosecution.

In short, bad banks are rarely a real solution. They roll losses out of the public eye and in to the future. The loss is still as real as ever and it is still the tax payer who will foot the bill.

OK that is bad banks in general. Next question is what might actually be in this Bad Bank? Normally we would have trouble knowing. We are forced to buy the stuff but not allowed to know what it is because it’s ‘commercially confidential’ don’t you know.

In this case, however, we might be able to get a glimpse of the ugly truth, thanks to Bankia. 

So that people don’t lose the will to live reading all this, I will break here and continue in a second part.


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20 Responses to Spain, Bad Banks, Assets, Losses and Lies

  1. Jim M. September 4, 2012 at 2:38 pm #

    Hmmm … Bad Bank, public ownership of private debt, Asset Management Companies…

    What could possibly go wrong?



    • Golem XIV September 4, 2012 at 3:40 pm #

      Nama is probably THE best example of the abusive use of a Bad Bank.

      And namawinelake is tops.

      Thanks for the links.

  2. Pat Flannery September 4, 2012 at 2:44 pm #

    Golem: you are of course right that the purpose of creating “bad banks” is simply to disguise the full extent of bank losses. Witness Ireland’s NAMA, which is simply a “bad bank”, programmed to slowly suck up taxpayer money by dying an unnatural slow death over many years rather than dying a natural sudden death.

    It is like “outsourcing” death. Don’t you wish we could all do that?

    But what I don’t understand about the Spanish “preference shares” scam you describe is how it affects Spanish pensions. You say:

    “Preference share were what were sold to ordinary Spanish savers by local banks” and
    “… when all those people who were sold preference shares see their pension taken from them …”

    I assume that Spanish banks hoodwinked their ordinary unsophisticated Spanish bank customers into buying these “preference shares” using fast-talking sales people in the bank’s lobbies. We know that such thievery went on during the boom in most western countries.

    I am just curious to know how these thieving over-the-counter “preference shares” instruments got into the Spanish pension funds.

    • Golem XIV September 4, 2012 at 3:09 pm #

      Sorry – not being clear here – I’ll change that. All I meant is that people would have purchased the shares on the advice that it was a super safe investment. So many would have bought them as part of their nest egg for the future.

      Taht’s all I meant to say.

      Sorry to mislead.

      • Pat Flannery September 4, 2012 at 4:28 pm #

        Duh! It was clear enough. I just read too much into it. The fast-tongued salesmen probably sold them as great “pension” assets.

  3. John Souter September 4, 2012 at 4:55 pm #

    El Toros version of the American Savings & Loan scam. The mythology of finance cultured by corruption.

  4. Phil T. September 4, 2012 at 6:59 pm #

    Dear Golem et al ~

    In 2008/09 timeframe Dr. Roubini was staunchly advocating for the establishment of “Bad Bank(s)” in order to resolve the mega-problem of toxic assets in the USA.

    Officially, there were never any Bad Banks created (to my knowledge).

    I surmise that to some degree, The Blackstone Group/BlackRock in coordination with the FED in the USA seem to have provided the function of “Bad Bank” as you describe it above.

    If my guess is accurate, then why wouldn’t Spain and the rest of the Sovereigns replicate that solution (as debauched as it might be) ?

    • John Souter September 5, 2012 at 7:54 am #

      Phil T – the 1% can’t have that, it would make money wealth worthless if all sovereign nations did it.

      The price must be paid in order to afford it substance and appear to give it legitimacy.

      • Phil T. September 5, 2012 at 10:21 pm #

        Greetings Your Honor ~ are you assigning an air of decency (relatively speaking) to this elite layer of life? Do they really think like that in this day??

        The timing of this (Golem’s) post is spectacular for many reasons, including its coincidence with the recent PR splash from the NY Fed that the Maiden Lane LLC’s (I,II,III) loans have been repaid in full and significant profits have been realized from MBS Assets sales – a boon to US taxpayers !

        As I am sure you know/ have read, there was great demand for these “Assets” (some how the toxicity evaporated from them in the womb of the Maidens…) and various institutions were eager to take them on, etc. etc… If one takes it all on the surface, the Maiden Lane formations and accompanying innovative facilities was a brilliant stroke of financial genius that the general public should be thanking their leadership for !!!

        In my simplistic view it seems that what is happening in the EuroZone is a Europeanized replay of events in the USA from a few years ago … with different players at the helm of similar but more numerous institutions with different names under different regulatory frameworks where the too big to fail entities are not only Banks but Sovereigns as well…

        The end result will be the same as in the USA – a boon for the taxpayers of Europa !

        I do not understand what you mean by ” it would make money wealth worthless if all sovereign nations did it…”

        Are we really talking about ALL Sovereigns at this juncture of a select few?

        Are you referring to the fundamental differences between the $ and the € and whether the € survives in its current form? In my ignorance, I guess I am assuming that all of the facilities that have been created on both sides of the Atlantic to backstop the € and the EZ up until now, as well as those currently proposed, will form the special purpose vehicle(s) for the offloading of impaired assets (i.e. …ESM, EFSF, HFSF (Greece)…) and the ongoing management mechanism(s) of those “Assets.”

        I realize that by the time I replied to your post the Golem has been very productive and added 3-more posts – so if you wish to reply in whatever the current thread might be , I shall look for you there as well …

        Best wishes to all …

  5. Golem XIV September 4, 2012 at 7:05 pm #

    Interesting thoughts.

    I suppose in theory there is nothing to stop them doing something similar. It wouldn’t alter the costs though. Blackrock would only invest in stuff and at a purchase price they thought they could make a proft from. Unless they were getting Fed money by a backdoor.

    Perhaps the Europeans haven’t gone the ‘Blackstone’ because Europeans are, I think, a little more anti private investment companies than the Americans are.

  6. bill40 September 4, 2012 at 9:52 pm #

    “How many people have heard of the ‘Asset Management companies which the Chinese government set up the last time it had to bail out all of its major banks? Anyone?””

    Ah, that’d be then I suppose. As a state the Chinese automatically suppose they can afford anything and everyone believes them. China also assumes that other governments can too, its’ achilles heel.

    All the costs of big finance are shouldered by the state. If I tried to explain otherwise no-one would belive me and rightly so. Am I becoming blinkered in my thinking living in China?

    I think not.

    • Golem XIV September 4, 2012 at 9:58 pm #

      Hello Bill40.

      I hope life finds you and yours well and happy. Always good to hear from you.

      Always good to get your thoughts and perspective from inside China. It is a danger commenting for those of us who are so far outside.

  7. thomas fowler September 5, 2012 at 9:24 am #

    As a Spaniard still living in Spain and being able to speak some English (not many of us left now that they´ve all emigrated) I think that I´m in a good position to add some more details:
    a) Like we say here, in Spain we have bad banks and now we have a “worse” bank.
    b) The staff at the banks have sold these “preference shares” without wanting to know what they were selling (some of the people buying them are iilterate, signing with their fingerprints). This is extensible to most of the people involved in this ponzi scheme: homeowners convinced themselves that house prices would always increase, banks thought they would always be able to increase their businness, etc. If it´s too good to be true, then it´s not true: no one is really inocent.
    c) If you apply the numbers to your anglosaxon social-economic model, you end up having a bloody revolution. Here we distrust any institution, it´s in our genes. That´s why we are not that angry, because we expect what´s going on and try to enjoy the most out of it, while we can. That is why we have “25%” unemployment, etc but still no blood on the streets…in any event, there is only so far the banksters can opress us, so don´t touch our jamón ibérico!

    • Golem XIV September 5, 2012 at 9:58 am #

      Hello Thomas Fowler,

      Welcome. There are quite a few readers from Spain who come to the blog but few who comment. So thank you. It is tremendously valuable to hear anything from those who live in the countries we read about. I try not to get things wrong but I am sure I do. Having someone who can verify or correct what we are thinking is great.

      Please do comment again any time you can.

      As for a revolution on the streets of anglo-saxon land …well I think you give us too much credit. We are slow to rile and too many of us have what I calll Headmaster syndrome – a childhood inculcated fear of authority.

      Still, I agree with you. There is only so far people can be oppressed before enough of them withdraw consent and then things get ugly.

  8. Pat Flannery September 5, 2012 at 9:37 am #


    Do you think the ECB may be encouraging the use of “bad banks” in order to get around the German Constitution problem? Would the setting up of “bad banks” in Spain create a workable pipeline from Frankfurt to Madrid? Could this be Draghi’s ‘whatever it takes’ solution?

    If the “big bazooka” bond purchase that he wants to announce were 3 year short-term “investment” bonds in various “bad banks”, would he be within current law?

    Remember ‘whatever it takes’ includes lying. We know they would have to be rolled over in 3 years. He has to come up with something – and quick.

    • Golem XIV September 5, 2012 at 10:10 am #

      Morning Pat,

      That’s a really interesting idea. Hadn’t thought of it. But now you’ve sown the idea…

      On the face of it I think you could be on to something. To bail out the banks the ECB must require collateral. They have loosened their requirements so far already there isn’t much more they can accept. Virtually all the assets, even pretty bad ones, are already encombered. And that is a major problem for all the crooks concerned.

      The ECB can’t bail out sovereigns direct.

      But it is clear there is a conscious move to give the ECB more power and power separate from and outside of the democratic powers of nations and the EU itself.

      Seems clear to me they are legislating powers to the ECB in order to create a financial union by default. A financial union will force a political one without having to wait for any pesky ‘yes’ votes.

      I think it is quite possible that an empowered ECB would abrogate new powers to itself one of which they would justify in terms such as … “to issue new debt for the purpose of supporting systemically essential transnational financial structures.”

      Some such nonsense would allow them, as you say, to get around natinal parliament obstructions and to directly support a network of bad banks.

      Could be done. The IMF could also support it with its own bonds.

      Yep. Makes a hideous sense.

  9. Pat Flannery September 5, 2012 at 11:01 am #

    Golem: you opened up the door by drawing attention to the Spanish “bad banks”.

    NAMA is probably the best case study. I have no doubt it was an EU, not an Irish, creation from the start. The Irish Government, this one, the previous one or any future one, is merely the handmaiden of its EU masters.

    Everywhere you look here in Ireland you see NAMA-owned properties. If it is abandoned, half finished, empty, ugly, you can be sure it is owned by NAMA. We no longer talk about bank-owned properties. The banks are in the clear. Their balance sheets are now free of toxic assets. They have been “recapitalized”!

    No wonder we Irish call NAMA “nama from heaven”. At least we still have our sense of humour.

    So, if it works in Ireland, why not in Spain, Italy, Greece, everywhere? It seems that under current law there is no definition of what the ECB can “invest” in, so long as its stated purpose is to “stabilize” bond markets in the interest of the Euro. That is the ECB remit.

    Short-term securities derived from “bad bank” assets, no matter how toxic, are therefore legitimate. They can call the bonds by any name they wish and roll them over as often as they like. So long as they are derivatives, as we have all learned, you don’t have to worry about how many times you encumber the underlying asset. You create a new “asset” with each new derivative.

    And they can disguise the “bad bank” by any fancy name the spin artists come up with. NAMA was pretty good. Ahead of its time maybe. It certainly has taken the spotlight off the Irish banks – and off the Irish Government. Nama from heaven – that it is.

  10. paul@Bank Repossessions Spain September 6, 2012 at 8:44 pm #

    The banks are only going to sell properties to Banco Malo if they can get better prices/terms than selling themselves direct. That means that to then move the properties on to the consumer Banco Malo has to sell at a loss immediately. Not particularly pallatable for the Spanish taxpayer but then it’s ok because the politicians have made a promise that the bank will break even in 10 to 15 years. Well outside any current administration or even the next election. So now the government gets to control the property market. Golem, I agree. The assets have lost value they are what they are. Let the free market deal with that not “the taxpayer” who can afford to hide them away for 15 years and hope.


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