Anyone remember Too Big To Fail?
Ever since the financial crisis of 2008, there have been cries for large banks to be broken up. The idea is that no bank should be so large that it cannot be allowed to fail because if it did it would pose a threat to the domestic or international financial system.
So far no banks have actually been broken up, apart from some that failed in 2008 - Lehman and ABN AMRO, for example. But governments and regulators around the world have been looking at ways of limiting bank size (taxing liabilities, for example), ensuring that failed banks can be resolved quickly and safely, and promoting competition in the banking sector to reduce bank power by giving customers more choice.
Except in Spain. The Bank of Spain has taken the OPPOSITE view. Over the last four years it has promoted, encouraged and facilitated the merger of the regional savings banks - the cajas - into much larger conglomerates. Its stated aim is to reduce the number of cajas from 45 to 10. That is by any standards a significant consolidation in the regional banking marketplace.
The reason is the awful exposure of the cajas to Spain's property bubble and their serious lack of capital. When it burst in 2008, many of the cajas lost huge amounts of money, leaving them seriously distressed or actually insolvent. The Bank of Spain's chosen rescue strategy for these cajas is to merge them with other banks. If the banks they chose were themselves in good shape, this wouldn't be a bad strategy. But that isn't what they are doing. Like Frankenstein, they are artificially giving life to dead bodies. And like Frankenstein, in doing this they are creating monsters.
Bankia was such a creation. In December 2010 seven cajas merged to create the monster that is Bankia. All of the seven were in financial trouble and would probably have gone bankrupt due to bad property loans if the merger had not gone ahead. But the merger alone was not sufficient to create a viable bank. The Spanish government, via its bailout fund FROB, contributed 4.5bn euros of capital to the new creation in the form of (non-voting) preference shares. Without that capital Bankia would not have been able to commence trading. It was propped up by its sovereign from the start.
In July 2011 Bankia was floated. Foreign investors wouldn't touch it, so the shares were mainly sold to Spanish companies and individuals.
It now appears that some of the cajas that merged to form Bankia were, shall we say, somewhat less than accurate in declaring the extent of their bad loans. Not surprisingly, the investors are furious. Private investors are currently pooling funds with the intention of pursuing civil action, and Spanish prosecutors are investigating whether the IPO was fraudulent.
Meanwhile, of course, Bankia has gone bust. But it is a LARGE bank - the fourth largest in Spain in terms of assets. Its operations are too extensive and too critical to the Spanish economy for it to be allowed to fail.
You see, the trouble with monsters - as anyone who has read Frankenstein would know - is that they can't be controlled by their creators. Bankia now needs bailing out, because it is Too Big To Fail. But Bankia is also too big to be bailed out by the Spanish sovereign alone. The Spanish government has had to seek help from the EU.
Nor was Bankia the only monster the Bank of Spain tried to create. It also tried to merge the solvent Cajastur (which had already absorbed the collapsed Caja Castilla La Mancha) and two smaller cajas with the desperately troubled Caja de Ahorros del Mediterraneo CAM), itself a sprawling conglomerate of twenty-seven smaller banks that it had gradually absorbed over the previous twenty years. CAM was a non-profit-making organisation with extensive ties to the regional government of Valencia: the chairman of the board was personally appointed by the then President of Valencia, who was subsequently prosecuted for bribery, fraud and corruption.
In March 2011 the attempted merger failed when the extent of CAM's bad loans became clear. The merged entity would have required capital from FROB of 2.78bn Euros, twice the original estimate. There is no doubt that had the merger proceeded the new entity would have suffered the same fate as Bankia - failure and nationalisation, putting the Spanish banking system at risk. Wisely, the management of Cajastur decided not to proceed. CAM was nationalised in July 2011 - effectively transferring the liability for its bad debts to the Spanish government - and sold to Banco Sabadell for 1 Euro. The chairman of the board was forced to resign; the Director General, together with five other directors, was dismissed and is now facing prosecution for suspected accounting fraud.
There are other caja merger disaster stories too. Caja Unnim was created in 2010 from the merger of three cajas: it went bust in 2011, was nationalised and then sold to BBVA for 1 Euro. Catalunya Caixa, Spain's fourth largest savings bank, was created in July 2010 from the merger of Caixa Catalunya, Caixa Tarragona and Caixa Manresa: it was partially nationalised in 2011, as was Nova Galicia Caixa, created in 2010 from the merger of Caixa Galicia and Novacaixa.
The end result of this disastrous merger activity is that, according to the IMF, MORE THAN HALF of the large and medium-sized banks in Spain are now partially or wholly dependent on state support. Only the three largest banks are both fully independent and well-capitalised. All the rest are either already nationalised, about to be partially nationalised (Bankia) or are likely to require partial nationalisation as economic conditions worsen. How this can be regarded as an improvement on the previous network of smaller regional banks is beyond me. Smaller banks can be, and in my view should be, allowed to fail. But instead of allowing the smaller cajas to fail, Spain has created monsters - and now the monsters are draining the Spanish sovereign of its lifeblood.
Unlike Frankenstein's monster, though, these monsters do not seek independence. On the contrary, they have developed a symbiotic relationship with regional and national government which ensures their survival. The Spanish sovereign has become dependent on its banks for funding, just as its banks have become dependent on their sovereign for capital. George Soros described the relationship of banks and sovereigns in the Eurozone as being like "conjoined twins": nowhere is this more apparent than in Spain. To my mind this is the primary reason for Spain's insistence that even quite small banks must be bailed out or merged, not allowed to fail. If the banks fail, the sovereign bleeds to death.
So the challenge for the EU and the IMF is how to separate the banks from the sovereign without causing terminal damage to both. At present no-one has any sensible proposals for doing this, although this post from INET has some interesting ideas. The EU seems unable to think beyond the next bailout, and the IMF actually wants MORE public backstopping of banks (though without public control of banks - moral hazard, much?). But find a way, we must, even if that means painful surgery. The end of Frankenstein carries an awful warning: the death of Frankenstein leads inevitably to the death of his creation. Spain rightly fears the failure of its banks: but far more should banks fear failure of the Spanish sovereign, because if that fails they must fail too - and the rest of Europe with them.