Banks and savings banks : a triple responsibility
If we want to have a complete picture of the situation, we are still missing an important piece to the puzzle in order to understand a mass psychology that drove several generations to put themselves into debt just to access a home. The role of the banks in the example in this puzzle that clearly demonstrates the dynamics of unbridled capitalism with its unlimited ambition and clearly suicidal tendencies.
This crisis would not have been possible without the negligence of banks and savings banks. We must, therefore, understand the key components in order to explain predatory nature of the banking sector that has devoured even its own children and whose behaviour continues because the State has not allowed it to fall.
When Spain joined the European Union and stabilized its currency, interest rates were growing at a progressive rate. With Spain's integration into the European Zone, interest rates reached their historical lows. From 1995 until 2003, interest rates went down from 11 to 3,5%. As the business of financial institutions is based on the lending of money at a certain rate, if the price of money went down, then financial institutions would need to increase their volume of business in order to maintain the same rate of return. If banks and savings banks wanted, therefore, to continue showing millionaire results in their annual returns, then they had to give out ever more non-discretionary mortgages. They could do this by extending the repayment terms on loans to thirty, forty, fifty years or more. From 1997 to 2007, the average loan amount when from 50,786 to 149,007 euros and the average mortgage term rose from 19 to 28 years.
With the dogma that the housing prices would never fall now set in stone, financial institutions designed a perverse system of incentives which rewarded traders who managed to bring to market the greatest number of mortgages. Between 1998 and 2007, the number of formalized mortgages rose annually to 822,000, more than 8 million mortgages in total.
Within an international context of abundant liquidity, financial entities started to open up new branches in every corner and expand throughout the entire territory. They used mortgages as a kind of strategy to attract clients and tap into new markets in zones and regions never entered before. In this way, they entered into a competitive spiral, whereby each bank entity lowered its minumum criteria for granting mortgages, fearful that another entity might easily takes its place and corner the market.
Ruinous management of credit portfolios by financial entities led us to the precipice of disaster. Their (ir) responsibility functions of three levels.
In the first place, they have a direct responsibility towards the families, as financial institutions made a mockery of the few existing credit control mechansims and rushed them towards a reckless policy of credit.
Red carpets
With all cogs in now in place in the financial industry, the machinary went to work to try to sell as many mortgages as possible. All were red carpets when it came to recruiting the star product. Marketing departments inundated the market with every type of mortgage products for every type of profile: the "young mortgage", the "easy mortgage", the "free mortgage", the "open mortgage", the "tranquil mortgage", "the "global mortgage", the "mortgage without fees", the "wild mortgage", the "super mortgage", the "revolutionary mortgage", are some of the names that the creatives came up to baptize mortgage loans with. Banks and savings banks competed in an endless race to attract customers through increasingly aggressive and deceptive advertising. Viral internet campaigns, mail-outs, television spots, email spam and street omnipresence thanks to a vast network of bank branches encouraged you to buy. Everywhere with the same stimulus and encouragements: that the monthy fees would always be affordable, the bank would lend a hand should you ever run into any difficulties, if you should ever lose your job you could always sell the flat and return the loan, etc. It is not surprising that many people ended up succumbing to temptation.
How to circumvent control mechanisms: cross-guarantees and co-owners
Bad banking practices proliferated during the height of the housing bubble. Financial insitutions abused people's trust and took advantage of their prevailing in financial matters by placing them in complex products and involving them in high risk financial transactions.
In this way, banks and savings banks spread the so called "crossed guarantors", a prop for disguising Spanish subprime mortgages (high risk mortgages). This operation consisted of grouping people with few resources to endorse amongst themselves. These guarantors acted as collateral and in this way banks formally covered any risk in the event of non-payment. That is to say, that the holder of the loan simultaneously assured the loan of other people who in turn would also guarantee the first holder's mortgage, so that in the end everybody had endorsed each other. Therefore, people were successful in getting a mortgage loan who, under normal circumstances, would have never been successful in securing one. Guarantors were not just family members or friends but sometimes strangers. This system required that all "crossed guarantors" operations were finalized within a short interval in order to elude the risk control system put in place by the Bank of Spain. Opacity, rashness, non-synchronous information and deception where common denominators within these types of operations.
The crossed-guarantors scam: the case of the immigrant's central mortage
In November 2010, the National Coordinator of Ecuadorians in Spain (CO-NADEE), an association that brings together Ecuadorian immigrants living in Madrid, presented with the support of PAH Madrid a denouncement of a scam whose aim was getting rich from subprime mortgages which had crossed-guarantors. The main accused, Enrique Caño, specialized in offering mortages to people of Ecuadorian origin and within economicaly precarious situations, from which he charged a commission for each mortgage that he set up. According to those affected by the scan, Caño demanded that each buyer before signing his or her mortgage had to sign the mortgage, as if they were also co-owners, of another who would then co-sign another's and so on down the line. To avoid any risk control mechanisms by the Bank of Spain, he demanded that each had quickly to sign his or her mortgage as well as of the other client, even though they didn't know each other. Therefore, even people with high risk profiles together formed an acceptable operation, even though each mortage would never had been granted if they had been considered separately.
But there was even more. According to the argument by prosection lawyer, Rafael Mayoral, Caño could not have acted alone and these operations were carried out with the full knowledge of the implicated financial institutions: CAM, Caja Madrid (now Bankia) and Caja España, who were fully aware of these mortgages. The allegation, therefore was also against these institutional branches.
In spite of this, in December, 2011, the judge decided that there was insufficient evidence of illegal activity to convict Enrique Caño of any wrongdoing. Meanwhile, the courts continue processing eviction orders for families affected by the scam.
Another equally or even more perverse mechanism, was that of the co-owner. The difference between crossed-guarantors is that in this situation people are not simply endorsing each other's mortgages, but are becoming co-owners of the loans and are obliged to answer to the total sum of the mortage applied to the houses. Many of those involved where not aware of the conditions when they signed these types of mortages in front of a notary. Many others only realized this during the foreclosure process.
This interconnected plot involving guarantors and co-owners only works if everybody implicated in the process fulfills their obligations. The problem occurs when one of the links in the chain breaks. Like a falling house of cards, the insolvency of one drags the other down in a domino effect. Within this archetypal pyramid scheme, banks and savings banks found ways to circumvent rules imposed by the regulator. And this did this in a widescale manner. It was, therefore, a scam in the making or, even better, a scam both regulated and protected by the law.
Appraisals: artificial inflation of prices
Another bad banking practice consisted of inflating property appraisals to comply with a recommendation from the Bank of Spain that loans should not be granted above 80% of the purchase price. In this way, financial institutions granted mortgages which, on paper, did not exceed the limit but which in practice amounted to 100% of the purchase price. They went so far as to offer mortages at 120% of the appraisal value, with the belief that the property would be revalued above the awarded amount.
Recently, the newspaper Diagonal echoed a story that never made it's way into the mainstream press. Bankia, the merger led by Caja Madrid, divested itself of shares of an agency who carried out surveys of real estate assets that acted as guarantees of loans. Aside from the reasons, Bankia might have had for selling the shares, this news clearly indicates how poorly the mortgage market functions. When banks hired a company to carry out an appraisal prior to granting a mortgage, there is hardly any appraiser who would determine a price that was contrary to the client's, that is to say the bank's interests. To do so would risk losing a client. We find ourselves, therefore, confronted with a vicious relationship and conflict of interest that questions the supposed objectivity of the appraisal process. If banks were also the owners of the same agencies that appraised homes and sat on boards of directors of these companies, then they could also exercise control, directly influencing both the management and design of their operations. They therefore became for judge and jury. It is therefore not that strange that during the housing bubble appraisers set prices in favor of banks and savings banks nor that, now that these same financial institutions are interested in undervaluing assets to avoid granting daciones en pago, appraise under the market price.
To big to fail:
The socialization of losses.
Ruinous management that our children will be left to pay
Nevertheless, the responsibility of financial institutions operates at an even more structural level. If a good part of the Spanish population were so deep in debt that for each Euro saved there was 1,5 Euros of debt then where did the money to continue financing the housing bubble come from? From the savings deposited by German and French citizens in their nation's banks. For years, the Spanish banking system received money coming from international capital markets. German and French banks lent money to Spanish banks and savings banks who in turn financed businesses and individuals. The mana of money throughout the country took on the form of an immense cement lava flow. The banks' self-revaluation of real estate assets accentuated this flow of capital which in turn fed the housing bubble. However the onset of the crisis and collapse in real estate prices marked a 180 degree change. We went to sleep competing with economic champions of some of the world's most advanced economies and woke up to a doomsday scenario. Billions of euros vanished overnight. The capital flow that had flooded our economy not only ceased but went in the opposite direction.
With almost two thirds of loans granted concentrated in the residential and construction sectors, how was it possible within our financial system to pay back the money used to purchase assets no longer worth what they originally cost? The answer is already known; by socializing losses. A good part of public subsidies and contributions from the Fund for Orderly Bank Restructuring (FROB) were used to repay loans and fill up holes in bank balance sheets. This was money that the State did not have and had to borrow outside of Spain. This is a debt that we pay with our taxes. Money that our children and grandchildren will continue paying in return for nothing. A real escape that is bleeding public budgets. We have consumed resources from the future in order to buy land and houses now devalued by the crisis. We have an economy leveraged with growing debts and assets worth increasingly less. This is our bet for the future and our future legacy. We have ended up paying dearly for our bet on easy money. The irresponsibility of a few has resulted in austerity for many.
With a dry tap there's no possibility for new model
There's still more. The irresponsibility of the banks has also compromised our economic future, squandering the resources of entire generations and shaping economic recovery. The high level of debt within both the private and financial sectors restricts the capacity to react to an economy within a crisis such as this. With external funding sources depleted and a population heavily in debt, we find ourselves constrained in a straitjacket with little room for maneuvering. Without the ability to finance, we cannot invest. Without investment, the lever that could catapult us towards another model is blocked.
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