Vidas Hipotecadas

El rescate de Bankia y la reforma financiera

The Bankia bailout and financial reform

In March 2012, the government, faced with the unfeasibility of the financial institution and of its inability to repay public loans given out by FROB on time, announced the nationalization of Bankia. During that same week, on the 11th of March, the Council of Ministers approved new financial reforms, the second in less than three months, that tried to dispel any lack of trust in the Spanish financial system and to provide greater transparency towards balance sheets containing overvalued assets. In this regard, several considerations:

In the first place, financial reform shows that the Achilles heel within the system are not the foreclosed homes of bankrupt families, as some politicians and experts would led us believe, but the risk of loans awarded to developers and builders. Therefore, reform focuses on forcing banks to increase provisions (a mattress that acts as a type of security to protect against losses in the event that credit becomes an uncollectible debt) to deal with problematic credit but even the healthy ones (currently making payments) granted to real estate companies to finance the purchase of land, premises and housing developments as well as covering the depreciation of real estate assets within existing portfolios, which acts as a guarantee of outstanding claims. These provisions amount to EUR 137,000 million, or 45% of the 310,000 million attributed to the construction sector (excluding sector-related credit granted to public administrations).

Secondly, the reform provides for the creation of "bad banks". This forces financial institutions to transfer all property accumulating on balance sheets to management firms who then administer and sell these real estate assets. This property is transfered at book value less provisions carried out on the assets (estimated depreciation on the asset). In this way, banks do a little tidying up by removing toxic assets and losses from their balance sheets. The government has already assured that it will inject the necessary capital into these financial institutions that, once the reform is applied, will require further recapitalisation in order to be viable. Public aid which will be channeled in the form of loans by Orderly Bank Restructuring Fund (FROB). In the case that institutions are unable to pay back these loans on time (within five years), such as what happened with Bankia, these borrowed funds (known as Cocos) turn into State shares. This would imply nationalizing the institution.

FROB funds: public assistance or not?
The government assures us that these injections of capital should not be considered public aid, but loans that will be paid back at 10% interest, more than the 6% that the State is required to pay in order to be financed through the issuance of public debt. This is a smart move, however misleading. Firstly because getting funding and allocating resources to plug the hole of the banks, even in the form of loans, prevents channeling resources to other sectors of the economy. This is what economists refer to as "opportunity cost". If we allocate scarce resources for certain things, then we can't use them for others.

Secondly, such as was already shown with Bankia, the probability that a bank would not be able to pay back the borrowed money on time is relatively high. In this case, funds would be converted to shares, but at what price? How is it that most of the 4,465 million euros injected into Bankia have only served to control 47% of a company that is leaking like a sieve? It is, therefore a convert transfer and another scam in the making. There is no doubt that the value of these shares will depreciate over time. And if they have not go down until now, it paradoxically because the "market" anticipates that the institution will be bailed out by public funds taken from taxpayers. They still continue calling it a "free market" when it's just a game of poker played with marked cards. To the extent that shares were to drop in value and materialize as losses, the consequences of these reductions would come in the form of more cuts within public budgets. In addition, the State would continue shouldering the 6% interest corresponding to the issuance of public debt that they were obliged to come up with to finance much of the EUR 4,000 million lent out to Bankia. This is exactly the same type of logic that they would apply to the rest of the other institutions and aids.

Thirdly, as in the case where banks must put aside provisions to cover potential defaults on problematic credits, institutions who borrow funds by the State are also potential defaulters. The State, therefore should also have a mattress and provisions in the event of a non payment of credit. If the government continues to be obsessed with a zero deficit policy yet at the same time refuses to increase revenue by making those that have more pay more, then the only other option will be to continue with social cuts in order to balance the budget.

Bad banks versus good banks
As has been already mentioned, financial reform obliges financial instititions to dispose itself of its real estate assets. For this reason, management companies were created who then bought these assets which they would sell after. The minister, De Guidos, assured that these assets were bought at a reasonable price.

What the Minister of Economy and Finance has not clarified was who would be financing these bad banks nor where would the money come from to purchase these assets. Once again, the taxpayers are the chosen ones. Who can ensure us that all the plots of land, incomplete promotions and ghost housing developments that the banks get rid of are then purchased at a reasonable price. Is it enough to discount the provision allocated on the book price of the assets to adjust to the current market value? How much is an unbuilt potato field bought at exorbitant prices really worth?

Mr. De Guindos has also made reference to the intention that these management companies are wholely owned by private capital. This would create a kind of public-private consortium. In this case, who would end up with the good assets and who would keep the bad ones? Who would end up with the homes in good condition and who the bad? Wouldn't this just open new door to another scenario in which losses are socialized and profits privatized?

There is, however, another way to manage the current situation. As has been mentioned before, the serious lack of social housing accounts for much of the housing and even financial crisis that we currently find ourselves in. Why don't we demand that the bad banks become good ones and at the same time convert the homes currently held by these institutions into social homes for rent? Why not take the opportunity to recover and protect public land? Obviously land and housing prices would have to be adjusted to a more realistic price and to the current property value. This is not an easy task, but it is a necessary and exciting challenge. It is without a doubt that we are at a critical moment in time. But it is certain that we are facing a historic opportunity that will not present itself again any time soon. We cannot let it pass us by.

And if we exit the Euro?

Lately there has been speculation that Spain could leave the single currently. Even though this is an unlikely scenario, it's worth taking a look at it.

Let's start with the following premise: Spain announces its exit from the single currency and conversion of its balances at a set rate into the new currency "peseta".

What would happen with all the mortgages in this case?

There are at least two possible hypotheses:
The first scenario is the following: Citizens would perceive their income in the new national currency but maintain their mortgages in the euro. This would be a situation similar to citizens in other countries who also have mortages in other currencies, such as the yen. From that moment the exchange rate of the new national currently 'peseta' would fluctuate with the 'euro'. In this case it is more than likely that on the day after switching to the new currency, the national currency would devalue against the euro. This would imply that our debt would increase by an amount inversely proportional to the devaluation of our currency. This situation, although technically possible, in unlikely from a political standpoint since people would not be in support of and would revolt against it.

In a more probable situation, mortgage balances would be converted into the national currency at a determined exchange rate. In this case, citizens would switch to owing "pesetas" and would therefore not be affected by fluctuating exchange rates. In this situation, that main problem would be that of the financial institutions in paying back the euros they borrowed from their international creditors. Under this hypothesis, financial institutions would go bankrupts and the State would be forced bail them out and then nationalize them. In this way, private debt would be converted to public debt overnight. This would result in many scenarios with unpredictable outcomes. On one hand, international markets would exert extreme pressure and we would be immediately subjected to a new wave of savage cuts. However, with strong opposition and social protest on the streets, it would be possible to put enough pressure on the government for them to declare the debt illegitimate. We could refuse to pay it and renegotiate the debt, just like Argentina or, more recently, Iceland, with more interesting results.