Liars, Damned Liars, and Spanish Banks

By Don Quijones. Raging Bull-Shit.

“Spain’s banks are back on track.” That was the upbeat message announced to great fanfare at the last meeting of the Spanish Banking Association (AEB for its Spanish acronym), Spain’s biggest financial sector lobbying group, held in Madrid earlier this week.

The most visible sign of improved health was in the sector’s profits. In 2013 the AEB’s member banks notched up 7.2 billion euros in profits between them — a significant step up from the previous year’s delusory 2.8 billion-euro loss. During a presentation titled “End of an Era: A New Chapter,” Miguel Martín, the AEB’s outgoing president, attributed the dramatic turnaround to the sector’s “reduced need for allowances and provisions” following its “exceptional restructuring” in 2012.

According to Martín, Spain’s banking reform has led to a “stronger, more viable, more efficient and more competitive” financial sector – good news not just for the banks, but for everyone. As Spain takes yet another giant step towards full recovery, its creditors and investors can rest assured that they’re backing the right horse, and Spanish businesses and families might finally begin getting the credit they need to get back on their feet.

Well, at least that’s the official story. On the QT and off the record, it’s a bare-faced lie, a cynical deception masking a much bleaker reality — one consisting of the following four features:

1) A Deepening Credit Drought. Despite the quite literally countless billions of euros that have been ploughed into Spain’s financial sector, businesses are still not getting the credit they need. In fact, during 2013 total bank credit in Spain plunged more than 7 percent. What’s more, it’s a trend that continues to deepen, leaving in its wake a vast trail of defunct not-quite-too-big-to-fail businesses.

2) Total Dependence on Life-Support. To date, Spanish banks have received a total “official” bailout of more than 100 billion euros in transfers, guarantees, and credit lines – more than double the 40-or so billion-euro figure that is usually cited by authorities. Roughly two-thirds of that money has come from public accounts while the other third comes from Spain’s Deposit Guarantee Fund – that is, money that is ostensibly meant to protect customer deposits, not the banks that “hold” them.

According to more extreme estimates, the total bailout figure could be well in excess of 200 billion euros (roughly 20 percent of GDP). To cut a long story short, the banks have received anywhere between 100 and 220 billion euros in capital injections, asset swaps and government guarantees over the last few years. And thanks to the wonders of financial engineering, they can now declare a supposed 7 billion-euro profit without making a single mention of ever returning the tens of billions of euros they “borrowed” from the public coffers in 2013.

3) Bad Bank, Really Bad Bank. Much of the so-called “cleansing” of Spain’s financial sector has involved lifting radioactive debt off the accounts of all of Spain’s banks – including the “good” ones – and burying it under the floorboards of Spain’s “bad bank”, the publicly owned Fund for Orderly Bank Restructuring (FROB). To begin with, taxpayers were sold the idea that they were going to make money from the “bad bank”. It turned out to be another lie and two years on, the FROB is bleeding money like a stuck piggy bank (37 billion euros at last count).

Indeed, as Mike “Mish” Shedlock recently reported on his blog, so grave is the situation that the Spanish government is even considering setting up a new “bad bank” for the sake of burying the overflowing toxic debt in its current “bad bank”. Just to show they still have a sense of humour, the name they would give to the new bad bank is Project Midas’ N+1 — a fitting moniker given that the basic idea behind it is to turn shit into gold. As Mish notes, any investors in Midas (presumably, Spanish taxpayers) will end up with “sheeet”, while the banks, via capital injections from suckers buying into the proposal (once again, Spanish taxpayers), will make out like Midas.

4) Shady Dealings, Clandestine Operations. Perhaps most worrisome of all, the true extent of the latest bailout would have gone completely undetected had it not been for the investigative work of Spanish daily El Paíswhich reported on Thursday that:

A [barely reported] November decree that transformed some of the banks’ deferred tax assets (DTAs) into state-guaranteed tax credits means that the sector may save as much as €40 billion — €10 billion more than the original government estimate…

… DTAs are used to reduce future income tax expenses, often in connection with bank losses or provisions. Generic provisions reduce a lender’s profits, but they are not tax deductible until the losses materialize. If the profit was not large enough for the bank to save itself that tax, then the DTAs were lost. But under the new rules, the state backs them with public debt.

When the International Monetary Fund found out about the government’s plans at the tail end of 2013, it recommended that it apply strict conditions forcing banks to increase their capital ratios through other means — a recommendation that the Rajoy government blithely ignored, preferring instead to offer the state guarantee with no strings attached.

In other words, Spain’s government has gifted the financial sector another 40 billion euros of potential funds – a figure almost five times larger than the banks’ supposed 2013 profits and almost enough to fund one year’s worth of public healthcare and education – in return for diddly squat!

Gimmickry and Trickery

According to the Ministry of Finance, the DTAs are nothing more than a balance sheet operation (read: accounting gimmick). As such, the banks may gain billions of euros, but at nobody’s actual expense — a tall story, you’d have to admit, especially coming from a government that has broken just about every pledge it’s made. For instance, three years ago it promised voters it would never bail out a single bank. A year later it solicited the biggest financial bailout in Spanish history. It also repeatedly told taxpayers that they would make a killing from — rather than be killed by — their forced investment in the country’s bad bank.

What’s more, this is not the first time that the Spanish government and central bank have colluded with the nation’s banks to mask the true state of their balance sheets. Indeed, the main reason why it took so long for the financial strains to show up in Spain was an accounting technique deftly titled “dynamic provisioning” – a euphemism for an old balance-sheet trick called cookie-jar accounting.

To wit, from a 2012 Bloomberg article:

By “dynamic provisioning”, they meant that Spain’s banks had set aside rainy-day loan-loss reserves on their books during boom years. The purpose, they said, was to build up a buffer in good times for use in bad times.

This isn’t the way accounting standards usually work. Normally the rules say companies can record losses, or provisions, only when bad loans are specifically identified. Spanish regulators said they were trying to be countercyclical, so that any declines in lending and the broader economy would be less severe.

What’s now obvious is that Spain’s banks weren’t reporting all of their losses when they should have, dynamically or otherwise. One of the catalysts for [the 2012] bailout request was the decision… by the Bankia group, Spain’s third-largest lender, to restate its 2011 results to show a 3.3 billion-euro ($4.2 billion) loss rather than a 40.9 million-euro profit. Looking back, we probably should have known Spain’s banks would end up this way, and that their reported financial results bore no relation to reality.

Despite the fact that Spanish banks’ use of dynamic provisioning violated international accounting standards to which Spain was a signatory, the EU turned a blind eye to the practice. When asked by Bloomberg why the EU refused to act, Charlie McCreevy, the EU’s commissioner for financial services from 2004 to 2010, gave the following mind-boggling response:

I’m old enough to remember when I was a young student that in my country that I know best, banks weren’t allowed to publish their results in detail. Why? Because we felt if everybody saw the reserves, etc., it would create maybe a run on the banks.

And there you have it — a perfect one-paragraph summation of how our governments view the financial system. They pour trillions of euros, dollars, pounds and yen of new debt that will never be paid into holes on bank balance sheets that will never be filled and then trust that those same banks will do whatever they can to mask the true reality of their financial health.

It is a con trick of breathtaking audacity and staggering proportions, but it’s working — for the banks, that is. As for the rest of us, we are given little choice but to keep paying the piper as the macabre tune he merrily plays leads us closer and closer to the brink of financial catastrophe. By Don Quijones, Raging Bull-Shit


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