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Finland Trying to Dictate Terms of Spanish Bank Bailout: “No Funds to Bad Banks”

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The Finland effort to dictate terms to the Spanish bank bailout may well turn out to be noise, but it is yet another indicator that despite the general optimism about a rescue, there are a lot of details to be nailed down. In addition, as we have pointed out, some of the pieces that do seem to be in place, such as having the bailout money be an obligation of Spain, are contrary to the objective of reducing Spain’s borrowing costs.

As Bloomberg reports:

Finland doesn’t want any of Spain’s bailout to prop up unhealthy lenders and expects some troubled banks to be split up as the northernmost euro member outlines the conditions it understands are attached to the rescue deal agreed on June 9.

“The unhealthy banks should be brought down or some banks should be possible to chop up” so that the healthy parts continue and the rest ends in a so-called bad bank, Finnish Prime MinisterJyrki Katainensaid in an interview in Norway today. “There must be a possibility to restructure the banking sector because it doesn’t make sense to recapitalize banks which are not capable of running.”

This may sound appealing on the surface, but it isn’t anywhere near that cut and dried. Earth to Finland, when you set up a good bank/bad bank structure, you ALSO need to fund the bad bank. This was a huge bone of contention in the US savings and loan crisis. Congress was very unhappy at having little choice but to fund the Resolution Trust Corporation, which required working capital (mainly funding of the assets of the bad bank) of $50 billion. One of the results was that Congress pressured the RTC to wind up sooner rather than later, and some analysts have argued that forcing the RTC to sell off some of its assets faster resulted in worse prices for the taxpayer.

In addition, the good bank/bad bank structure that generally gets the highest marks, the program in Sweden in the early 1990s, gave the asset manager the authority to extend more credit. In other words, when the asset manager determined loans in the “bad bank” were actually good loans, they could keep the borrower alive.

The second issue with a good bank/bad bank structure is that how long you have to fund the bad bank depends on how long it takes to liquidate the loans. The S&L crisis took place against the backdrop of a nasty but short recession. The overall strength of the underlying economy encouraged various investors to swoop in. By contrast, there are now a lot more banks sitting on dud assets (as in there is a ton more supply) and the prospects for the Spanish economy are far from robust. This indicates that any bad bank would probably need to be funded for quite a long time.

Note I’m not saying a good bank/bad bank structure might not be better than the alternatives, but the Finnish PM appears to be pumping for it to sound responsible and minimize disbursements to Spain. An IMF study of 124 banking crises concluded that recognizing losses early led to lower total rescue costs. But the reason the authorities keep entering into rolling “prop up the bank” exercises is that the cost of resolving sick banks typically looks too scary and large to present to taxpayers, so the banks are put on what turns out to be more expensive, protracted intensive care treatment. In other words, doing a bank rescue right is more costly, not less, in the short run, which is why political leaders have preferred to zombify rather than clean up their banking systems.

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28 comments

  1. kjr63

    They did this good/bad bank structure in Finland in the 90′s. The result was a huge cost for tax payers and even more centralised banking system. Tax payers’ assets in the bad bank were practically looted in the end. Politicians sold them to private sector in a real firesale prices.

    Naturally political elites thought this was a great “success.”

  2. Conscience of a conservative

    When banks get into trouble, debts must be restructured with creditors taking a hit and the bank recapitalized by debt holders and equity holders wiped out. That’s capitalism, and anything else just leads to zombie banks who are too weak to lend money and fullfill their mission. Saddling tax-payers with the losses just encourages mis-allocations of capital.

    1. Synopticist

      The whole game since the bailouts begun has been about avoiding any bondholder haircuts.
      That’s why it hasn’t worked, and won’t.

      The real question is, who are these bondholders?
      It’s pretty opaque. They don’t want you to know.

      1. F. Beard

        The real question is, who are these bondholders? Synopticist

        Yes, but expect them to hide behind pensioners.

        1. Conscience of a conservative

          THE BOND HOLDERS include other banks, and sovereign wealth funds. One reason why the United States back-dropped Fannie and Freddie and protected bond holders was not to tick off The Chinese & The Russians.

          1. duffolonious

            Huh? Stockholders in Fannie/Freddie got scrooched. I had relatives with money in there – it was considered a conservative investment. Lost it all they did…

            Unless the Chinese/Russians had special deal that I’m not aware of – but I recall the Russians and Chinese being miffed about this (interviews on NPR with Russian officials and they didn’t sound happy – but they gave very diplomatic responses in the run up like “we won’t be buying as much Freddie/Fannie”), so I don’t think they were bailed out.

          2. YesMaybe

            duffolonius:

            I don’t know the details of fanny and freddy, but you shouldn’t confuse shareholders with bondholders.

            A bondholder is someone to whom the institution owes money. Bondholders are not part-owners of the company, but rather creditors.

            A shareholder is someone who owns part of the company, but the company doesn’t owe them money. As a result, if a company has zero or negative equity, the shares held are worthless (can’t have negative value because it’s limited liability). The equity is what’s left over when you subtract liabilities (such as debts to bondholders) from the assets.

            What this means is that the shareholders get wiped out before any haircut to bondholders, because the bondholders are owed the money whereas the shareholders own a portion of what’s left (if anything) after the debts are paid.

            Preferred shares are basically like bonds, not like shares (which are called ‘common shares’).

            What often happens when a company is broke is that the shareholders are wiped out and some of the creditors’ holdings (preferred stocks, bonds, etc.) are converted into common shares.

    2. Jumpjet

      Agreed. The banks that created this mess should have been made to lose everything, or had it stripped from them. And they should have been given the finger for good measure.

  3. Valissa

    Rally fizzles as Spain bank bailout details unclear http://www.reuters.com/article/2012/06/11/us-markets-global-idUSBRE8520GN20120611
    Stocks and the euro fell on Monday as investors worried about details of a $125 billion deal to shore up Spain’s banks, prompting traders to cash in hefty gains triggered by the widely expected deal. … “This is a classic case of the market rallying on the expectations and then selling off on the reality,”

    One might even suspect there some collusion going on… but I’m sure that’s just crazy conspiracy talk.

  4. andy

    Yves, do you actually see any reason NOT to model this and future bailouts on the swedish program of the 90′s?

  5. MyLessThanPrimeBeef

    Controversially, Jared Diamond thinks civilizations are products of geography.

    Are banking crises too?

    1. skippy

      “Controversially, Jared Diamond thinks civilizations are products of geography”… MLTPB

      Skip here… Geography that has advantages over others. A good cold snap seems key, as it kills off / stunts bacteria and viruses and promotes hording (making it through the winter thingy).

      “Are banking crises too?”… MLTPB

      Skip here… When hording is leveraged by derivatives, in an attempt to create risk free electrons of price, by orders of magnitude, upon a cob of corn. Well… the silo is basically dry. The image of the massive silo (financial markets) is just a deception, numbers just beget more numbers thingy.

      Skippy… I am not human… with out enough numbers… singing in my head…

        1. skippy

          Just to be clear, I mean societal hording. Hording of that which enables us to live, with out killing every thing for short term profit (individual vanity thingy).

    2. TK421

      It’s interesting that cold countries like Sweden and the Netherlands are the most socially enlightened, though why that is I have no idea. Iceland has handled its banking crisis better than any country, it seems to me.

  6. M.G. in Progress

    I think it’s time to start consider the model of “good banks” again…forget about pouring money into bad banks…

    We should also stop to create money out of thin air and that’s happenning saving the banking system as it is…

    1. Harold

      All money is created out of thin air. Where do you think it came from? Where were all those euros before 1999?

      If the problem is that there isn’t enough money, then the eurozone should create as much of it as it needs.

  7. Joe

    I think it’s time to stop messing around. The Euro (as we know it today) is cactus. It’s not going to be nice, but it’s not the end of the world either.

    1. Mattski

      On the contrary–to the extent that the rape of nature is slowed at all by decreasing production it could buy an otherwise doomed earth another .25 seconds of galactic time.

  8. David

    People should get control of their governments and say no. Until that happens I don’t see much chance of clarity or reasonableness, just more bullshit.

  9. Fiver

    In 2012 I’m not at all sure I’d trust even a Swedish good/bad bank solution. It is pretty much a guaranteed flenzing of the taxpayers’ backside and generous padding of the private sector.

    I found these 2 Bloomberg reports on the Irish “bad bank” and its performance of interest. Roughly 1 month apart. Apparently in Ireland the money can be used to complete frozen projects. What I don’t get is why those projects aren’t over in “good bank” territory and owners told to raise the money privately rather than using taxpayers money to make some people whole, and others very rich – seeing how eager the Irish “Bad” is to invest in such a promising development…

    http://www.bloomberg.com/news/2012-04-12/ireland-s-bad-bank-transforms-debtors-into-landlords-mortgages.html

    http://www.bloomberg.com/news/2012-05-23/irish-bad-bank-to-invest-2-billion-euros-pay-down-debt.html

  10. kaj

    Finland can’t afford to be tough: Spaniards and then others will stop buying Nokia phones, Finland’s biggest company.

    The best solution is for Germany to opt out of the Eurozone, so that the other economies can adjust their own currencies and escape from the collossal stagnation that internal devaluation has imposed upon them. Nearly simultaneous departures from the Euro will stem the extreme devaluation of the weaker nations’ currencies and check inflation, saving a large part of the population. Yes, this massive dislocation will perhaps cause a near Depression, but I believe that adjustment and the rebound would be much faster.

    The Chinese will will naturally suffer a huge loss, well deserved, for having bought a massive portfolio of Euro-bonds and their incredible export machine which has immiserized Europe and caused an immense increase in greenhouse gas emissions. The Chinese economy will then be directed inwardly, albeit at a much lower level, causing unemployment and pressures on the Communist party.

    Germany could set the Neue Deutch Mark(NDM) at 2.35 to the USD similar to the Swiss experiment with the committment to stop all currency trafficking, both, cash and futures, murdering the criminale, ie, the U.S. banks, and promising to look at the the peg every so often, without being specific. All foreign currency transaction could be made via the central bank and the state banks. The world needs to move to fixed exchange rates,with periodic adjustments. The floating rate experiment has been a great fiasco which has led to nothing but gambling away the future of mankind.

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