Photo: Wikimedia Commons
The latest European bailout, of Spain, has already failed.Why?
- It wasn’t big enough. (Spain’s banks need hundreds of billions of euros, not a hundred)
- The bailout money will be senior to Spanish government debt (smart for those bailing the country out, but not inclined to set worried Spanish bondholders at ease).
- It rewards stupidity and punishes responsible behaviour (moral hazard).
- It doesn’t address the underlying problems.
The same can be said for the bailouts of Greece, Ireland, and other European countries.
And the same can be said for the bank bailouts in the U.S.
In fact, the U.S. started this string of bad bank bailouts–making a mistake that the country is still suffering from. And now Europe is following our lead.
The most annoying thing about this is that bank bailouts can work–and they can be done without costing taxpayers hundreds of billions of dollars or rewarding executives and investors for making bad decisions. They just have to be done the right way.
What’s the right way?
- Seize the bank
- Fire management
- Write down the value of the bad loans to the amount they are actually worth
- Zero out the bank’s equity (shareholders lose everything)
- Apportion the losses to the bank’s subordinated debtholders (they lose something)
- Inject new capital in the form of senior debt and new equity
- Refloat the bank (by selling all or part of it).
In a restructuring like this, the bank doesn’t stop operating–so the economy isn’t screwed.
Meanwhile, the idiots who loaned the bank money and bought the bank’s stock take the losses they deserve. And the bank is then immediately rendered rock-solid again, ready to make new loans to companies and countries that deserve it. (And, hopefully, the remaining loan officers are chastened by their prior stupidity and are more prudent next time.)
It doesn’t matter how big the bank is–you can do this with any size bank.
And, if necessary, you can do it with lots of banks at the same time. You just need an entity–like the US government or ECB–that has the power to seize and restructure banks before they actually go bankrupt and that can write the massive checks necessary to recapitalize the banks.
That’s the right way to bail out banks.
And that’s the only way to do it without rewarding stupid, reckless lending and failing to address the root of the problem.
The root of the problem for Spanish banks, as it was for US and Irish banks, is stupid real-estate loans.
And the Spain bailout, as currently described, will not force the banks to write down the value of those stupid loans. Rather, it will just give the banks enough money to “extend and pretend” and ignore or deny the fact that the loans have gone bad. But the banks will know the loans have gone bad. So they’ll hoard their cash and not make new loans for fear that the old, bad loans will kill them in the end.
The Spanish bailout artists did do one thing that is smart for themselves–make their money “senior” to existing Spanish debt and Spanish bank debt. That means they’ll get paid first if Spanish banks end up cratering regardless.
But the problem is that this seniority is not lost on those lending money to the Spanish government, and the yields on Spanish government bonds are soaring as a result.
And that’s creating the impression that the bailout has failed… before its details have even been finalised.
That’s a travesty.
Spain’s banks are broke.
They’re broke because they made lots of stupid loans.
When anyone in the real world makes a stupid loan, they lose their money.
The idiots who loaned money to Spanish banks to make stupid loans deserve to lose their money.
The idiots at the Spanish banks who made the stupid loans deserve to lose their jobs.
And the rest of Spain should not have to suffer the consequences.
So, perhaps, Spain and Europe could consider bailing out Spain the right way–by following all of the steps above.
This “tough love,” after all, is perfectly fair. And it will finally fix the root of the problem.