Eurozone: Spain considers creating toxic bank

8th December 2011

The bad bank proposal is only one of a number of measures being considered by the new Prime Minister elect Mariano Rajoy. He may also seek to try and get Spain's banks to start lending again, by backing them with government capital as the Spanish economy continues to flag. Spain is afflicted by some of the highest levels of unemployment in Europe at 22.8 per cent of the working population.

But it not clear how much room Spain has for any sort of dramatic action.

The latest news on the economic front is not good and would appear to restrict the Prime Minister's wiggle room even further. Earlier this week, Business Week reported that Spanish industrial production fell 4 percent from a year earlier in October, the most since November 2009, after a revised 1.4 percent drop the previous month, according to Spain's National Statistics Institute.

The Wall Street Journal reports that "Prime Minister-elect Mariano Rajoy has said he wants to speed up the process of dealing with €176 billion ($236 billion) of impaired real-estate assets from Spain's housing bust.

The newspaper also quotes Tano Santos, a finance professor at Columbia University, New York, who says: "It makes sense to give restructuring a push by cleaning up balance sheets; it signals things are moving along. That has been one of the most damaging things in the Spanish crisis: the lack of movement."

Such a move is not, of course, without risks. It is estimated that a big intervention of this sort could cost Spain euro 100m. That could technically finish off the already weak government finances. However some experts believe that Spain now has to find a way to fix its banks or face long term stagnation.  

As part of such a move, the Spanish Government might buy the toxic debt from its banks at a big discount but having done so, and in a classic catch 22 scenario, it would also have to back those banks with new capital because of the losses which would occur as a result of the asset write down.

Spain would have to raise money for the programme either from the markets – which does not seem likely at the moment – or it might attempt to call on the European Financial Stability Mechanism – another source of help that has been called into question in recent weeks.

However more surprisingly, it is not just Spain but Germany that is to force some kind of action on its banks.

Here is Zeros Hedge's Tyler Durden on the issue.

He notes that German newspaper Handelsblatt has broken the news that Germany will "bailout" the German banking sector by stuffing it to the gills with cash.

Durden is in sparkling form as usual, writing that: "Germany is about to proceed with an implicit nationalization of its banking sector, which means that while we thought yesterday that the German AAA-rating is the safest of all in the Eurozone, following this development we will certainly reevaluate."

The Spanish and German moves arguably follow what the UK and US did in the first phase of the crisis, although the US forced just about every bank to take government cash at one stage. The UK put money into the ailing RBS and Lloyds Banking Group and continues to own a massive share of both.

Additionally, the UK owns a bad bank though many in the country remain unaware of the fact. When Northern Rock was sold to Richard Branson that was only the ‘good bank" part of the failed former building society. The country even made a loss on that transaction.

The UK still retains bad bank UK Asset Resolution run by chief executive Richard Banks. It consists of the combined toxic assets – usually badly performing mortgage loans, of Northern Rock and Bradford & Bingley and owes just under £50 billion worth of debt to the Government which it is paying back very slowly at around the odd billion pounds a year.

These actions have cost Britain dearly in terms of its deficit and the likely effect of cuts on its economy. However it has allowed this country to retain the status of relatively safe haven for the moment.

It is very difficult to see how Spain can follow such a course on its own. Then again, even Germany, complete with a stubbornly growing economy, may have more problems than we think. A huge amount rests on the Angela Merkel/Nicolas Sarkozy proposals, but even then, as these reports show, there may be a few more chapters to the banking crisis.


More from Mindful Money:

The aims and failures of the eurozone

Triple ‘A’ Rating: Does this make Britain a safe haven?

How Eurozone uncertainty effects UK employment

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