Eurozone Screws Spain’s Citizens

Yves here. Delusional Economics discussed earlier how hapless Spanish depositors, who’d been sold bank equity products as deposit equivalents, were at risk of being crammed down en masse. That move appears to be proceeding as planned. NC readers confirmed his earlier take, that this abuse of unsophisticated savers was likely to have serious social and political repercussions.

By Delusional Economics, who is horrified at the state of economic commentary in Australia and is determined to cleanse the daily flow of vested interests propaganda to produce a balanced counterpoint. Cross posted from MacroBusiness.

A draft Memorandum of understanding for the Spanish bank bailout became available overnight (available below). Much of the document makes sense in terms of assessing, monitoring and implementing corrective action on the banks. Specifically there is mention of using Special Purpose Vehicles to remove non-performing assets from banks balance sheets:

Segregation of impaired assets: Asset Management Company

21. Problematic assets of aided banks should be quickly removed from the banks’ balance sheets. This applies, in particular, for loans related to Real Estate Development (RED) and foreclosed assets. In principle, it will also apply to other assets if and when there are signs of strong deterioration in their quality. The principle underpinning the separation of impaired assets is that they will be transferred to an external AMC. Transfers will take place at the real (long-term) economic value (REV) of the assets. The REV will be established on the basis of a thorough asset quality review process, drawing on the individual valuations used in the Stress Test. The respective losses must be crystallized in the banks at the moment of the separation. The Spanish authorities, in consultation with the European Commission, the ECB and the IMF, will prepare a comprehensive blueprint and legislative framework for the establishment and functioning of this asset separation scheme by end-August 2012. The Spanish authorities will adopt the necessary legislation in the autumn with a view to assuring that the AMC will be fully operational by November 2012.

There are, however, some very important sections of the document which need highlighting.

Back in April I wrote a post in which I mentioned that Spanish banks were getting “creative” in order to maintain their capital ratios against the backdrop of the failing Spanish economy. One things that stuck out was this:

The key in a banking crisis is to keep the confidence of depositors. But while many countries relied on capital injections and government guarantees, Spanish banks have added a unique twist of effectively turning some depositors into equity holders. That puts customers on the front line.

Some banks started by persuading depositors to switch from low, interest-bearing accounts into preference shares, which paid a fixed, higher interest rate. The benefit for the banks was that these securities counted as core capital under banking rules. UBS says Spanish banks issued €32 billion ($42.7 billion) of such instruments from 2007 to 2010.

But as the crisis deepened, these instruments became illiquid, trading at deep discounts. At the same time, they ceased to count as core capital under new rules known as Basel III. So banks have encouraged investors to convert preference shares into either common stock or mandatory convertible notes, which pay a high initial yield before later converting into stock.

And here is what I said about it:

Liability to asset conversion. Very clever, and fair enough unless you are an existing shareholder. I just hope those depositors understand the risks of what they have just done.

As it turns out these depositors had no idea what they were in for. From today’s MoU:

The restructuring plans of viable banks requiring public support will detail the actions to minimise the cost on taxpayers. Banks receiving State aid will contribute to the cost of restructuring as much as possible with their own resources. Actions include the sale of participations and non-core assets, run off of non-core activities, bans on dividend payments, bans on the discretionary remuneration of hybrid capital instruments and bans on non-organic growth. Banks and their shareholders will take losses before State aid measures are granted and ensure loss absorption of equity and hybrid capital instruments to the full extent possible.

So it would appear that under the guidelines of the MoU many Spanish citizens are about to take a huge bath. But that may not be the only issue for them. Lower down in the document is this:

VI. Public finances, macroeconomic imbalances and financial sector reform

29. There is a close relationship between macroeconomic imbalances, public finances and financial sector soundness. Hence, progress made with respect to the implementation of the commitments under the Excessive Deficit Procedure, and with regard to structural reforms, with a view to correcting any macroeconomic imbalances as identified within the framework of the European semester, will be regularly and closely monitored in parallel with the formal review process as envisioned in this MoU.

30. According to the revised EDP recommendation, Spain is committed to correct the present excessive deficit situation by 2014. In particular, Spain should ensure the attainment of intermediate headline deficit targets of [x]% of GDP for 2012, [x]% of GDP for 2013 and [x]% of GDP for 2014. Spanish authorities should present by end-July a multi-annual budgetary plan for 2013-14, which fully specifies the structural measures that are necessary to achieve the correction of the excessive deficit. Provisions of the Budgetary Stability Law regarding transparency and control of budget execution should be fully implemented. Spain is also requested to establish an independent fiscal institution to provide analysis, advice and monitor fiscal policy.

31. Regarding structural reforms, the Spanish authorities are committed to implement the country-specific recommendations in the context of the European Semester. These reforms aim at correcting macroeconomic imbalances, as identified in the in-depth review under the Macroeconomic Imbalance Procedure (MIP). In particular, these recommendations invite Spain to:

1) introduce a taxation system consistent with the fiscal consolidation efforts and more supportive to growth,

2) ensure less tax-induced bias towards indebtedness and home- ownership,

3) implement the labour market reforms,

4) take additional measures to increase the effectiveness of active labour market policies,

5) take additional measures to open up professional services, reduce delays in obtaining business licences, and eliminate barriers to doing business,

6) complete the electricity and gas interconnections with neighbouring countries, and address the electricity tariff deficit in a comprehensive way.

VII. Programme Modalities

32. Spain would require an EFSF loan, covering estimated capital requirements with an additional safety margin, estimated as summing up to EUR 100 billion in total. The programme duration is 18 months. FROB, acting as agent of the Spanish government, will channel the funds to the financial institutions concerned. Modalities of the programme will be determined in the FFA. The funds will be disbursed in several tranches ahead of the planned recapitalisation dates, pursuant to the roadmap included in Section IV. These disbursements can be made either in cash or in the form of standard EFSF notes.

VIII. Programme monitoring

33. The European Commission, in liaison with the ECB and EBA, will verify at regular intervals that the policy conditions attached to the financial assistance are fulfilled, through missions and regular reporting by the Spanish authorities, on a quarterly basis. Monitoring of the FROB activities in the context of the programme will take place regularly. The Spanish authorities will request technical assistance from the IMF to support the implementation and monitoring of the financial assistance with regular reporting.

So as far as I can tell this MoU is very much a framework for a standard European bailout package. The funding is through a sovereign entity, the FROB. Also, as the Guardian reports, the funding is contingent on Spain implementing its existing fiscal obligations under European treaties including additional recommended action. In addition there appears to be a Troika of sorts, including the ECB and the IMF.

The EU summit statement stipulated that it was “imperative to break the vicious circle between banks and sovereigns” but I can see little in this particular document to suggest that this is happening. As we know there has been a vague promise of transferring liability over to the ESM which would supposedly disconnect the Spanish sovereign from the funding pipeline but this is dependent on an agreement and implementation of an ECB controlled banking supervisor. In fact at this stage it isn’t even certain the ESM will come about because it is yet to be ratified by national governments and the German Constitutional Court is yet to pass judgement.

That being the case, this MoU looks like a terrible outcome for the Spanish public. Not only are many billions of Euros of their assets about to be bailed into banks, but it appears that they will still be holding the can after the fact.

Draft Spain MoU

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  1. Paul Walker

    No wonder the concept of stewardship has become a laughing stock with leadership of this caliber.

  2. Never

    Leran to differentiate between shareholders and ‘savers’ then post ideological rubbish.

    1. Yves Smith Post author

      I gather you have a reading comprehension problem. Savers were told the preference shares were just like deposits. Nothing like ideology getting in the way of basic cognitive skills.

      1. Maju

        I understand that you are right and that commercials have misled many small savers into accepting this kind of capital schemes as apparent deposit-like offers.

        They did the same in the past with the hedge funds and such, right? In understand that it’s the same story with a different twist in the details.

        Of course there’s always the doubt of how much responsibility belongs to the small investor or misled saver who should read the small type before investing their life savings. And one can imagine that they somehow knew that the deals were (allegedly) too good to be mere deposits.

        But AFAIK the banks generally misled the savers, as they did with the hedge funds in the past.

        The bulk of the problem however is not with private small savers (also but not the core) but with the transference of the banks problems to the state (and therefore to all the Spanish society). That IMO should not be done: Bankia and the others should be allowed to collapse into bankruptcy and the state should only intervene to manage the bankruptcy, to make the collapse as orderly as possible, guaranteing small accounts and such.

        Another problem, and not just in Spain, is that no banker is going to jail, not even to court. This strongly suggest that the scam will repeat itself again and again… Capitalism imploding into an Albanian pyramid scheme.

        1. carol

          “Another problem, and not just in Spain, is that no banker is going to jail, not even to court. ”

          This is not ‘another’ problem, but THE problem.

          And not just in Spain, but everywhere.

          Just some examples from UK:

          Regulators are helping the banksters with lobbying:
          “The FSA discussed how a proposed financial transaction tax would make high-frequency trading “prohibitively expensive”, and assessed whether it were possible to form a coalition to block European restrictions on short-selling.”
          and other examples:

          Or the Bank of England making plan B’s for financial meltdown:

          “One of the governors (of the Bank of England) at that meeting proposed that as a mechanism to cope with crisis, the Bank should buy half a dozen or a dozen bicycles in order that members of the Bank could move swiftly and anonymously around the City.”

          With regulators like that, who needs a judicial system?

          1. Jim Haygood

            “One of the governors (of the Bank of England) at that meeting proposed that as a mechanism to cope with crisis, the Bank should buy half a dozen or a dozen bicycles in order that members of the Bank could move swiftly and anonymously around the City.”

            With all due respect, how can this possibly work when the gents in question are cycling down Threadneedle Street in pinstriped suits and bowler hats?

            Perhaps they can be issued Guy Fawkes masks, so that at least their individual identities will remain confidential.

        2. Ruben

          “The bulk of the problem […]. That IMO should not be done: Bankia and the others should be allowed to collapse into bankruptcy and the state should only intervene to manage the bankruptcy, to make the collapse as orderly as possible, guaranteing small accounts and such.”

          The Spanish gov’t might not have had this option because it would cost it money, money it didn’t have.

          1. Maju

            The option of letting them fall is never (or almost never) discussed, exactly the same that putting the bankers behind bars is never debated at TV or Parliament either (and when it comes out the mercenary journalists or MPs rush to dismiss the possibility). Of course letting banks fall it’s economically and socially problematic, more so when we are talking of semi-public savings banks, but the interest of the public, “the taxpayer” as some say, should come first.

            That is what happened in Iceland and, while it’s always fraught with some difficulties, debt is always a bad solution.

            Actually getting indebted is never a solution but a problem. A problem that you may gladly get into when you expect to be able to pay back and reap some profits but a problem that you should never get into when you know that you won’t be able to pay back and that you are getting the loan not for your own profit (that of the state) but for someone else’s.

            This is only done because state debt is becoming the dumpster of the private loses, just as happened in Ireland. That’s because states belong to everyone and therefore no one.

            Would I draft a constitution myself I’d include a provision that every significant debt (say above 1% GDP) must be approved in referendum. That would force politicians to manage the res publica less abusively (and if debt is acquired, citizens would know that they have actually voted it and is not any imposition). I think this kind of stuff works in some counties of Virginia and possibly in some other “classical republics” like Swiss cantons but in most states the will of the people is circunvented all the time – with predictable consequences.

  3. TimoT

    Nothing is ever good enough for some American “economists”, when it comes to Eurozone. When the bailout package is lenient, you complain about moral hazard. When it is hard, you complain about “little” guys (who are shareholders) getting screwed. Hypocrites!

    1. salvo

      what a nonsense. There is nothing hypocritical in pointing out that people have been cheated en masse into converting their savings into higher risk shares and are now forced to pay for it.

      1. TimoT

        “Some banks started by persuading depositors to switch from low, interest-bearing accounts into preference shares, which paid a fixed, higher interest rate….

        So banks have encouraged investors to convert preference shares into either common stock or mandatory convertible notes, which pay a high initial yield before later converting into stock. ”

        You do notice the words PERSUADING AND ENCOURAGED, don’t you?! Nothing FORCED them to change those accounts to shares, they made their own bed and well, tough luck. That is called CAPITALISM in case you did not know that…

        1. salvo

          yeah … cheating necessarily implies some sort of persuasion, doesn’t it. Indees, that’s ‘capitalism’ in case you haven’t taken notice

        2. Kunst

          When two parties make an agreement, if one of them is greatly more knowledgeable and essentially tricks the less knowledgeable into the agreement, that is not an honest transaction. One way to measure it: would the banks have taken the side they “encouraged” their relatively ignorant counterparties to take? How about “buying” Manhattan island for $24 of beads and trinkets when the “seller” doesn’t have the same understanding of the transaction? A lot of these deals are so one-sided that they amount to deception and trickery, and can in no way be construed as fair. No one absolves a drug addict of his responsibility, but that doesn’t mean the pusher who offered a discount on his first hit is blameless. There are many situations where “he/she agreed” is meaningless because of massive disparities in knowledge and/or power. For example, sex between master and slave is ALWAYS rape.

  4. Maju

    The deal is in general awful but since the Spanish regime (and the EU’s regime as well) decided to plunder the res publica in order to save their theiving networks, instead of declaring the affected banks insolvent and then intervening them only to manage the bankruptcy and not to “rescue” them, there’s no good solution. And therefore I feel even more inclined than yesterday for the immediate partition of Spain (let’s say: Majorca to Germany, Madrid to Puerto Rico and the Basque Country for ourselves).

    But besides this matter of the national impossibility of Spain, there’s one thing that irks me more than anything else in all you say:

    “Spain is committed to correct the present excessive deficit situation by 2014”.

    And Germany? And France?

    No kidding here: by the latest figures I read Germany and France had quite worse deficit figures than Spain (and I do not forget that they were also the first ones to break the agreements on these matters, never being fined).

    What they are doing here is to transform a banking mismanagement probably into a public debt one by transferring the mad debt incurred by the banks, banks ruled by the same camarilla that rules Spain as a whole, to the res publica. That’s simply not acceptable: I should never be made to pay their mismanagement.

    But it’s even worse because the word “mismanagement” sounds to incompetence, human error but not intentional plundering and robbery. What happened in fact was a criminal Ponzi scheme (rather well related by Yves in the first part of the article).

    As in the Greek or Irish cases (among others) not just the criminals are at large but the state attorneys are not even investigating the matter (a private demand has been accepted however) and a parliamentary investigation committee is being sabotaged by the ruling majority (who, as I said, are the ones who arranged all this criminal scam since the very days of Jose María Aznar, the dear friend of George W. Bush and Tony Blair).

    Yves says that this level of scam is peculiar of Spain. However I very much doubt it, considering how deeply embedded were the Spanish ruling camarilla and the proto-Tea Party behind Bush – and that the three states have got brutal real state speculation pyramid schemes, etc.

    The main difference is that Spain, as member of the Eurozone, has not been able to buy some time by means of “quantitative easing”, as they call now to old good money printing schemes.

  5. TimoT

    This memorandum contains all the crucial elements. Burden sharing against moral hazard, enhanced supervision AND independent supervisors, coming outside from Spain and a lot of independent auditors (EU, IMF and even private companies) going through everything.

    This Spanish banking crisis will be the most scrutinized crisis ever.

    1. Maju

      You must be kidding: no parliamentary investigation committee, neither in the Spanish Congress nor in the European Parliament. Trial opened ONLY because of private demand (which will be probably dismissed in due time), the state attorneys and the ombudsman… are not researching the matter or doing it only for formal purposes.

      Eurobureaucrats insisting in VAT raises and labor rights’ demolition is not “scrutiny” but mockery!

  6. Eric

    eurozone did not screw Spanish investors, their banks and politicians did.
    investors shouldn’t be saved by taxpayers just because they were scammed into worthless shares.
    this is a matter for criminal prosecution of the politicians that run Bankia, not bail outs.

    1. Maju

      Absolutely, Eric. It should be a criminal and political case but the fact that it’s being transformed into public debt reveals that most of this bottomless crisis is only about transferring banksters’ loses (after due waste and mismanagement) to the public in form of debt that banksters will squeeze once and again… until a revolution effectively happens.

      Let’s not fool ourselves: it’s all about squeezing European citizens to the last drop.

  7. TimoT

    So where is your bailout plan, Americans? If you think you can do better then better show us! US government just reloaded the bad banks and hoped for best! Yeah, that is some “plan”…

    1. salvo

      stopping your offensive nationalistic language and you may be taken seriously. btw I bet you are German, arent’t you?

  8. aeolius

    As sad as it may be, in fact in a democracy we are responsible for what we do. In Spain, as in Greece and here with the sub-prime loans the common folks were offered a free lunch and it turned out to be the poisoned apple. Greed is just a deadly sin as lust.
    It is not a see-saw that if the greedy rich are wrong that the prolitariat is then automatically virtuous.
    The Spanish are no more vertuous then the Tea Party folks. Both choosing to believe that you can get something for nothing.
    One does not need a deep moral understanding. It is as simple as the three little pigs.
    Economics is an ecological science. We are at the point now where the hares are all eaten and the fox populaytion is
    I am abashed to say that I now consider our country lucky that Obama and Timmy saved the banks instead of the mortagees. That he could not do more may have been do to the Congress.

    1. Maju

      I do not accept that citizens are responsible for what governments do… unless there was a referendum first.

      Otherwise governments are responsible and only them.

      “The Spanish are”…

      Don’t generalize (i.e. the Spanish, the Germans, the Greeks, the Europeans…) “The Spanish” what? The Spanish government?, the Spanish Tea Party (oops, it’s People’s Party)?, the Spanish bankers?, the Spanish petit bourgeoise investors?, the Spanish working class? The Spanish what?

      1. Jose Guilherme

        There was no referendum on the euro, either.

        They had one in France. Polls indicated a majority was against the single currency.

        Until, that is, a last minute live TV appearance by Mitterand and Kohl, shamelessly playing the fear card by warning electors that voting No might mean a return to the old days of Franco- german rivalry – meaning war.

        The undecideds heard the message. They got scared and the Yes vote ultimately prevailed.

        And now here we are, in the middle of a crisis that the European system is simply not able to manage.

  9. MarcoPolo

    We were momentarily encouraged when a month ago Rajoy acknowledged that Spanish bank insolvency  was too large for the Spanish govt. to backstop. Then that knucklehead Schäuble reminded us who we were dealing with. And even again at the first reports from the 20 something summit until Merkel appeared to have attended a different summit.  Nothing has changed. 

    Note to Mario & Mariano:
    The jig is up. Abre los ojos. If you make this deal you’ll be remembered as worse than the Hapsburgs. 

  10. Jose Guilherme

    The sad thing about all this is that Spain, if she really wanted it, could likely refuse to implement austerity by simply regaining its monetary sovereignty under the euro to issue currency to finance her deficit.

    According to a paper by Marc Lavoie (page 24)

    a euro government under pressure from bond markets could under present rules regain a measure of monetary sovereignty by “directing its domestic publicly-owned commercial banks to acquire new bond issues at the price of its choice”.

    From a different (right-wing) perspective, Sinn et alia in Germany have come to similar conclusions on the technical rules of the Target 2 intraeuropean payments system. There are giant loopholes that, if used, could provide a way out for countries such as Spain without requiring exit from the euro.

    Unfortunately, the Spanish government is either totally ignorant of this loophole (which, if true, would prove criminal negligence on its part) or more likely just lacks the political courage to take advantage of this possibility to break austerity policies that will cause hard to repare, long term damage to the Spanish economy.

    The EMU eurocrats have their purposes facilitated by the total psychological surrender of periphery elites to an insane, austerian, a-critical europhile mindset.

  11. BOP rules

    Manipulating bank depositors into equity positions is a sort of hostage-taking. One defensible rescue policy amounts to “we don’t give a crap, SWAT will come in and blow em all away with mercury loads.” That’s what we have here. If all the hostage-taking bankers wind up decorating the walls, this approach can be effective over time. In practice, few hostages get killed. But in this case, loss of investment would have to be augmented with something much more fearful for the bank’s real owners and controllers. The bankers who sold customers this product will have to be seen swinging slowly in the wind. Spain, unlike the USA, has an independent judiciary. They also have some competent bombers. This might just work out.

    1. Lyle

      It should be noted that Charles Keating of Lincoln Savings did this. I appears that in general a lot of folks are willing to trust a salestype. Did the documents include the disclaimer that it was not a bank deposit? If so folks who don’t read what is put before them deserve what they get. Bankers will always try to cheat their customers after all they are part of an industry whose only goal is Win and who cares what happens to the other party that is their problem.

  12. briansays

    the take away lesson is
    for the financial services industry fraud is a totally acceptable business practice for which there are no legal consequences if you fall for it

    sounds like an Iceland redo

    the government supposedly yours since you elected them will do little or nothing to stop this

    eventually depositors up against the wall will take matters into their hands and it should come as no surprise with violence particularly those with say a terminal medical condition who feel they have nothing left to loose

    and the media will all ask why

    July 18 is Bastille Day

  13. BondsOfSteel

    Misery loves company. I’m sure the equity holders would feel a bit better if the bondholder also took haircuts. I didn’t see any mention of defaults or haircuts for them.

    It seems the depositors and bondholders are the ones being saved.

    1. F. Beard

      Yes, bondholders appear to be the sacrosanct class. Because of historic ties to Royalty, perhaps continuing to this day?

      And yes the depositors too lest they get desperate and angry and upset the apple cart.

      What a mess usury for stolen purchasing power causes!

  14. The Dork of Cork

    And the seniors escape once again……

    Just create a bit of controversy with the sub debt ….and slip away quietly.

  15. Hans Maier

    “Banks and their shareholders will take losses before State aid measures are granted and ensure loss absorption of equity and hybrid capital instruments to the full extent possible.”

    But isn’t it a key principle of every investment: it can get sour? No matter if bonds, shares or whatever. You can win, and you can lose.

    I think it is rather logical that before other nation’s taxpayers are requested to keep zombie banks alive (which shouldn’t happen at all, they should be dismantled immediately), 1st the shareholders and employees must pay their share.

    I mean, during the good times they didn’t socialize the dividends and interests they got, why now socialize the losses?

  16. Up the Ante

    Abandon Hope, all ye who enter the world of finance

    “.. for the Spanish public. Not only are many billions of Euros of their assets about to be bailed into banks, but it appears that they will still be holding the can after the fact. ”

    The garbage barge Towmaster and his toxic ‘load’, lol

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