Consumer rights v. broke banks: guess who just lost.
By Don Quijones, Spain & Mexico, editor at WOLF STREET.
After eight years of chronic crisis mismanagement, moral hazard and perverse incentives have infected just about every part of the financial system. Earlier this week, the U.S. Congress published the findings of a three-year investigation into why the Department of Justice chose not to punish HSBC and its executives for their violations of US anti-money laundering laws and related offenses – because doing so would have had “serious adverse consequences” for the financial system – the “Too Big To Jail” phenomenon, a perfect, all-purpose, real-world Get-Out-of-Jail-Free card [read… Congress: “Too Big to Jail: Inside the Obama Justice Department’s Decision Not to Hold Wall Street Accountable”].
But now there’s “Too Broke to Fine.”
Today over a dozen Spanish banks were given a life-line by the EU’s advocate general, Paolo Mengozzi, that could be worth billions of euros in savings for the banks. For millions of Spanish mortgage holders, it could mean billions of euros in lost compensation.
A Legal, Abusive Practice
Just over seven years ago, when conditions were beginning to sour for Spain’s banking system, 40 out of 42 Spanish banks decided to insert “floor clauses” in their mortgage contracts. These effectively set a minimum interest rate — typically between 3% and 4.5% — for all their variable-rate mortgages (which are very common in Spain), even if the Euribor dropped far below that figure.
This, in and of itself, was not illegal. The problem is that most banks failed to properly inform their customers that the mortgage contract included such a clause. Those that did, often told their customers that the clause was an extreme precautionary measure and would almost cerainly never be activated. After all, they argued, what are the chances of the euribor ever dropping below 3.5% for any length of time?
At the time (early 2009), Europe’s benchmark rate was hovering around the 5% mark. Within a year it had crashed below 1% and is now languishing deep below zero. As a result, most Spanish banks were able to enjoy all the benefits of virtually free money while avoiding one of the biggest drawbacks: having to offer customers dirt-cheap interest rates on their variable-rate mortgages. For millions of Spanish homeowners, the banks’ sleight of hand cost them an average of €2,000 per year in additional interest payments, during one of the worst economic crises in living memory. Many ended up losing their homes.
While legal, the bank’s behavior was eventually deemed “abusive” and “non-transparent” by Spain’s Supreme Court. In May, 2013, the court ruled that three financial institutions named in a class-action suit would have to reimburse all their customers the money they’d surreptitiously overcharged them, but only from that moment on. The court argued that the law couldn’t be applied retroactively to 2009, when the banks began introducing the clauses, since it would potentially cripple their finances.
Too Broke to Fine
A more recent ruling that applies to the whole sector adopted the same reasoning: banks need only reimburse customers the money they lost from May 2013.
Not everybody agrees. The European Commission argues that the refunds should extend all the way back to the first mortgage payments, the rationale being that if a clause is declared void, “it is so from its origin.”
It makes perfect sense — until you factor in the fact that if most Spanish banks were forced to refund all the money they had thus extracted from their customers, they would be even less solvent than they are today, raising the prospect of more bail-ins and/or bail outs, which would in turn mean more contagion risk in Europe’s fracturing financial system and more public debt on Spain’s burgeoning balance sheets.
All of which is out of the question – with Italy’s banks teetering on the brink of collapse. Hence, today’s decision by the EU’s advocate general that Spain’s national courts can be trusted to strike the right balance between consumer rights and the broad needs of the financial system. Like Spain’s Supreme Court, the advocate general placed “macroeconomic considerations” (legalese for “what is best for the banks”) before the microeconomic needs of consumers.
While the EU Advocate’s ruling is not binding, in most cases it presages the ruling of the Court of Justice of the European Union (CJEU), which is expected to take place later this year. If the CJEU adopts the same decision as the advocate general, it will set yet another worrying precedent in Europe’s financial sector: not only will the employees and executives of banks be immune from prosecution for the crimes they commit; the banks themselves could soon be immune from any financial consequences of their actions. Put simply, they will be Too Broke to Fine.
Not only will taxpayers have to bail out the banks whenever they run into trouble, stiffed bank customers will also soon have to accept that they have no lawful right to compensation if doing so could run afoul of “macroeconomic considerations.” And with the banks as weak as they are, just about any punitive fine could be construed as posing a risk to the macroeconomic environment. Which advances the theme: the more protection banks are given, the more likely they are to commit further misdeeds down the road, at a hefty cost for everyone else. By Don Quijones, Raging Bull-Shit.
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