By Don Quijones, Spain & Mexico, editor at WOLF STREET.

One thing that the world is not in short supply of these days is bad banks. They are everywhere, it seems. But there are bad banks, and there are Bad Banks. This article is about the latter, the officially dubbed “Bad Banks” launched by governments and central banks to conceal the rising tide of triple-F toxic junk (derivatives, securitized debt, non-performing loans…) that threatens to engulf the world’s financial system.

As Bad Banks go, few are as bad as Spain’s SAREB, the public-private company responsible for managing assets transferred from the four nationalized financial institutions BFA-Bankia, Catalunya Banc, NGC Banco-Banco Gallego, and Banco de Valencia.

In theory, SAREB was never meant to exist: “There will be no Bad Bank in Spain, and we will establish procedures that will not be burdensome for taxpayers.” Those were the famous words of Spanish PM Mariano Rajoy during the first few months of 2012. The promise was made on numerous occasions, and not just by Rajoy but also by his Minister of Economy (and former Lehman advisor) Luis de Guindos.

But in politics, promises are not made to last; they are there to be broken. By December of that same year, Sareb was born and Spanish taxpayers were left holding the tab for the biggest bank bailout in Spanish history.

Fast forward to today. Sareb is hemorrhaging. In 2014 the firm’s total losses were €585 million, more than double the amount registered in 2013, its first full year of operations (€260.53 million). It’s a stark contrast from the rosy picture painted by KPMG, the firm hired by the government to draw up Sareb’s original business plan. According to KPMG, investor returns, based on “conservative estimates,” would be in the order of around 15%!

Enough investors needed to be brought on board “to ensure that the participation of the FROB (the government’s Fund for Orderly Bank Restructuring) remained below 50%. That way, Sareb’s debt would not count as official public debt,” one source told Spanish financial news website El Confidencial. “To do that we had to reel them [investors] in with promises of really high returns,” said another.

Putting the “Bad” into Banking

Bad Banks have been around for decades. Arguably the first ever incarnation of a Bad Bank was Grant Street National, created in 1988 to house the souring assets of New York Mellon Bank. Since then, countries as far and wide as Sweden, China, Mexico and Ireland have experimented with the model, with varying degrees of success or failure – mainly failure!

According to Spanish economist Juan Ramón Rallo, bad banks are by nature a bad idea (unless, of course, you’re a senior banker working for an insolvent bank, or an investor with sizable holdings of slowly putrefying bank shares or bonds, in which case they’re a stroke of genius):

A bad bank is a mechanism for redistributing the wealth of a country from its taxpayers to the shareholders, executives, workers and creditors of financial institutions… The logic is disarmingly simple: if the only party willing to buy the [toxic] assets at the prices [offered by the banks] is the State, the chances are that the assets are not worth what the State is paying for them.

This may go some way to explaining why so few foreign investors – only two Europeans banks (Barclays, Deutsche Bank) and a smattering of insurance firms (Axa, Generali, Zurich and Santa Lucia) – could be persuaded to take a stake in Sareb when it was launched in 2012, despite the Spanish government’s frantic lobbying efforts. After all, if the assets are heavily overpriced, how would Sareb’s investors make money?

The rest the private-sector shareholders are home-grown entities, mainly banks and insurance firms. According to some reports, their 52% participation in Spain’s bad bank owes much less to the fanciful expectations raised by KPMG than to serious arm-twisting by the Rajoy government and the Bank of Spain.

A Good “Bad Bank” and a Bad “Bad Bank”

Sweden’s experience from the early nineties offers a rare positive (or at least not so negative) example of bad banking. Unlike in Spain, Swedish banks that were nationalized or merged with other banks after the country’s 1992 financial crisis were forced to overhaul their management. There were also serious strings attached to government assistance (what a novel idea!). Bank shareholders were not covered by the blanket guarantee, and in order to receive the government loans, banks would have to open up their entire books for inspection.

Such clarity and transparency are ominously absent in Sareb’s case. Even after over two years of operations the organization still lacks fully established, broadly accepted accounting standards. According to the Spanish daily El Periodico, this is one of the reasons for the sudden deterioration in losses last year. The organization’s regulator, the Bank of Spain, decided to apply different rules halfway through the financial year, forcing the bank to undertake “extraordinary restructuring” measures in order to cover hundreds of millions of euros of unpaid unsecured debt.

What’s more, in Spain the brunt of the financial pain has been borne by taxpayers, whereas in Sweden it was the nationalized banks’ shareholders that took the biggest hit. Indeed, many economists have argued that if you factor in the country’s continued stake in the nationalized bank, now called Nordea, Swedish taxpayers ultimately broke even. In Spain, by contrast, taxpayers are unlikely to break anywhere close to even. They (myself included) will be on the hook for 48% of Sareb’s toxic assets for well over a decade. Given the magnitude of the recent housing collapse and its anemic recovery, few of those assets are likely to turn a tidy profit any time soon.

Nonetheless, Sareb’s new president Jaime Echegoyen remains upbeat. “Initial forecasts were perhaps excessive, but we will continue to strive to provide positive returns to investors, as long as the economy continues to improve.”

But what if things get worse? What if Spain’s tentative economic remission reverses? Sareb has already burnt through €1.2 billion of capital and there’s only €350 million left in the kitty. Not much of a buffer for a bank with some of the ugliest assets in the western world!

If further capital is needed – something Echegoyen dismisses for now – taxpayers could end up having to cover 48% of the new capital injection. Worse still, as El Confidencial points out, if Sareb runs out of capital it may not be able to keep servicing its huge debt – €45 billion at last count. It just so happens that the guarantor on that debt is … the Spanish state.

It’s an old plot with a familiar twist. One way or another, the taxpayers will be left holding a bag of worthless assets… until, of course, they can’t. Or unless the Bad Bank in question is an Austrian entity by the name of Hypo Alpe-Adria [read… Austria Pulls Ripcoard on Bailouts].

Meanwhile, Europe’s Bad Banks continue to proliferate, to make room for the ever-rising tide of toxic financial waste. As I type these last words, a new Bad Bank is sprouting up in Andorra, to help hide BPA’s dodgy assets. And pressure continues to mount on Renzi’s government to create Italy’s first ever Bad Bank, to help conceal the €333 billion of non-performing loans festering on its banks’ books. The New York Times says it’s a “good idea.” Sure, but for whom? Not the taxpayer. That much we know. By Don Quijones, Raging Bull-Shit.

European banking mayhem spreads to Madrid and shady tax haven Andorra. Read… Rich Man’s Bank Hit by Bank Run, Collapse, “Bail-In”

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