If you’re at all curious about the controversy surrounding the health of the Spanish banking system, definitely read this post from John Hempton. It’s too long and detailed to summarize, but the basic idea is that he tries to get a grip oin whether Spanish banks are lying (or at least being unrealistic) about their loan losses, by lookign at their US subsidiaries. His answer: Yes, something is definitely amiss.
Whether the Spanish banks are hiding their losses is a major debate going on in the blogosphere and has been detailed at length in the Financial Times. The stakes are very high – this is a debate about the stability of the Eurozone and possibly of Europe itself.
I have a lot of American readers whose interest in finance stops at the American border. I need to outline what is going on.
Spain had a monstrous building boom – a building boom on (at least) Californian standards based very much on coastal development. The building boom has slowed considerably. The building boom attracted relatively unskilled labour – as building booms are apt to do – and about 40 per cent of all migrants to EU settled in Spain. Wikipedia (I wish I could read the original Spanish source) state that the foreign population in Spain has gone from about half a per cent of the population in 1981 to over 11 per cent recently. This change in racial mix has resulted in only minor tensions (with the possible exception of the large terrorist attack in Madrid).
The financial crisis has hit Spain hard. Unemployment is about 20 per cent – though this overstates the GDP contraction. A lot of the new immigrants are now unemployed.
20 per cent unemployment would normally result in large bank losses – indeed you would expect bank insolvencies. However this has not happened. The two giant Spanish banks (Santander and BBVA) appear amongst the most profitable in the world and have substantial market capitalisation. Strangely Spain looks solvent despite its apparent economic catastrophe. Part of the explanation might be that the economic problems in Spain fall mainly on the newer immigrants and the unskilled end of the labour market – and that these people are not the loan customers of the bank. In this formulation the Spanish recession is about the same depth as the American recession – and the 20 per cent unemployment rate is just an artefact of the migrant economy.
Either way both big banks are depleting loan reserves (at least compared to delinquency and non-performing loans). But both banks are reporting low losses and low loan arrears.
The banks however could be lying.
The stakes are enormous. The bears (led by Spanish resident Economics Professor Ed Hugh and the financial research house Variant Perception) argue that the Spanish regulators and banks are conspiring to hide Spain’s insolvency – and when Spain turns out like Argentina either the European central bank (that is the old German central bank) will bail out Spain at great cost to the Central Europeans or the European monetary experiment – and possibly the whole European political experiment will be challenged as Spain fails economically and socially. It’s alright to bail out Latvia after its economic disaster. Latvia is small. Spain however is large and important in a European context. Ed Hugh would argue that it is best to deal with the problem now – because delayed it will get much worse.
Do not for a minute think that the stakes here are overstated. Full blown economic collapses (eg Latvia, Iceland, Argentina) usually lead to riots and governments falling. Where ethnic tensions run high those riots often have a racial element (rioting crowds find scapegoats). Europe can paper over the Bronze Solider riots in Estonia (which pre-date the crisis). They can paper over riots in Iceland and Latvia because the economies are small. But an economic disaster in Spain would pose major difficulties – difficulties I think European Union would survive – but which would stress the system to its core.
To be this bad though the banks would need to be hiding their losses on a grand scale. Most banks in crises hide a few losses (and spread them over time). However the bears are truly apocalyptic. The Variant Perception report is an absolute classic of hyper-bearishness. If it really is that bad then either central European taxpayers are going to be stuck with a huge bill or the core political union in Europe is vulnerable.
Less worried folk have pointed to inconsistencies in both Ed Hugh and Variant Perception’s data analysis. An ordinary level bank failure could be dealt with by Central European taxpayers with only minor stress – however if you believe Variant Perception we are not looking at an ordinary level collapse – its way bigger than that. Ibex Salad – a blog with the unlikely topics of the Spanish Stock Market, Spanish Economy and the olive oil business is the counterpoint to Ed Hugh and Variant Perception.
The data is mostly ambiguous – as the bears would argue – the data is largely faked anyway – finding inconsistencies in the data is to be expected. They would argue that common sense – and the overbuild visible when you open your eyes – indicates that there is a serious problem here.
I really do not know. I am not close enough to the ground in Spain to know – and – frankly – analysing (supposedly) faked data in a language I can’t read from a desk in Australia is unusually difficult. But there seem to be four variants.
(a). The Spanish banks are telling the truth – and this is a storm in a teacup,
(b). The Spanish banks are doing a normal amount of bank over-optimism in the face of a crisis – and whilst the banks are really stretched (but not telling us) the banks are ultimately solvent – and the European experiment is fine,
(c). The Spanish banks are in fact diabolical – and the losses are maybe 15-20 per cent of a year of Spanish GDP – in which case a bailout by (effectively) German taxpayers is possible or
(d). Variant Perception is in fact unreasonably bullish – and Spain will collapse economically and socially and we will be thankful if all we get back is someone like the Generalissimo. The modern European experiment will be deemed to fail because a single European Union with a single currency can’t hold together in a crisis because Germany won’t or can’t bail out Spain, Italy and Greece in a crisis.