The Article called it a “watershed deal masterminded by EU regulators to avoid a damaging collapse.”
Reality is quite a bit different as two more Spanish banks are in serious trouble.
First, let’s finish some details about Banco Popular from the Telegraph article.
Santander will tap its shareholders for €7bn in a rights issue to raise the capital needed to shore-up Popular’s finances in a dramatic private sector rescue of Spain’s sixth-largest lender. It will inflict losses of approximately €3.3bn on bond investors and shareholders but crucially will avoid a taxpayer bailout.
The last-ditch Popular rescue is significant because it marks the first big test of the Single Resolution Board (SRB), the Brussels body that was established two and a half years ago to deal with banking meltdowns in a way that shields taxpayers.
There has been growing concern about loss-making Popular amid fears it would collapse under €37bn of bad property loans it has made. Customers have been withdrawing deposits in a run that has seen billions of euros pulled in recent weeks.
With Popular’s position looking increasingly precarious, the European Central Bank decided overnight that the lender was “failing or likely to fail” and called in the SRB, which orchestrated the forced sale to Santander.
Liberbank and Unicaja Hit by Contagion
Liberbank’s share price fell 41 percent to €0.68 (60p) last week, as Santander rescued Popular by buying its rival for a nominal €1.
Meanwhile, the initial public offering (IPO) of Andalusia lender Unicaja, due this summer, could also be hit.
The Sunday Times reported that Liberbank, which was formed in 2011 by the merger of three failed savings banks, had seen the value of its riskiest bonds collapse by 60 percent in recent days.
Eurointelligence has some interesting comments via email.
There is No Contagion… Oh, Wait!
Despite the fact that the European single resolution board indeed acted swiftly and decisively, the Financial Times relays concerns that “the congratulatory backslapping that greeted” the resolution of Popular may not be justified. In particular, there are questions over the slowness of the reaction of the single supervisory mechanism. Moreover, the celebratory observations that there had been no contagion may also have been premature. Since the market opened on Wednesday with the news of the resolution of Popular, the stock of Liberbank, one of Spain’s small former cajas, has lost 48% of its value including 20% and 19% drops on Thursday and Friday, erasing the gains of an entire year.
The situation has moved Spain’s securities regulator CNMV to consider a ban on short-selling of bank stocks, according to Cinco Días. Speaking of short positions, another story by Cinco Días goes over the various mechanisms for going short (equity derivatives, put warrants, and old-fashioned selling of borrowed stock). Those that have borrowed stock “over the counter” to sell and whose contract does not specify cash settlement by differences but rather delivery of the borrowed stock will actually lose out, because the stock has been delisted and so they cannot buy it back at €0 to settle the contract.
Manuel Conthe wonders in his Expansión blog whether the existence of the resolution mechanism actually encourages bank runs. This for two reasons: the risk of an eventual bail-in of uninsured deposits motivated large depositors including public institutions to withdraw their deposits; and the possibility that a resolution would lead to a firesale, as it happened, may have motivated potential buyers to hold off in Popular’s failed attempt to sell itself.
As we had noted from the FT, Popular drew emergency liquidity assistance from the Bank of Spain last Monday and Tuesday, in the amounts of €2bn and €1.6bn respectively. To appreciate the extent to which Popular was scraping the barrel of its liquidity, consider that according to El País the Bank of Spain had valued the collateral presented by Popular on Tuesday at 10% of face value.
This brings us back to the question of whether the supervisor acted in a timely manner. We think not. The fact that Popular got to the point of resolution with no liquidity left meant that any plan the SRB may have had for a resolution other than by sale of the whole bank could not be executed without public liquidity assistance, which would have triggered a bail-in of 8% of Popular’s balance sheet. We estimate that this would have been under €13bn, compared to the €8bn of equity and subordinated liabilities that were in fact wiped out. If the SSM had shut down Popular earlier, the SRB would have had maybe €1.6bn (on Monday night) or €3.6bn (on Friday night) to play with, allowing maybe a good-bank/bad-bank split (bridge institution and asset separation in the language of the BRRD). As it was, there was no choice but a firesale. And if Santander had walked away from it, Spain’s FROB would have had a problem.
- The ECB accepted collateral at the last minute that was worth 10 cents on the dollar.
- Regulators did not see this coming until the last moment when the bank asked for assistance.
- Delays in recognizing the problem made matters worse for investors who did not manage to get away.
- Investors are now worried about two other Spanish banks.
Investors ought to be worried about all of Spain’s banks, and of course Italy’s banks too.
Leverage, Debt, Structural Problems Not Addressed
Leverage is excessive, structural problems have not been fixed and the ECB has repeatedly kept its bond purchases alive.
Bloomberg reported in March ” It will take until at least the end of next year, and possibly into 2019, before the ECB starts to remove stimulus in earnest and raise interest rates.”
Will there be anything bond assets left to buy in 2019?
Meanwhile, despite the fact that leverage, excessive debt, demographics, the Euro itself, and productivity differences between European countries are the problems, the only solution the ECB has is to encourage more lending in hopes of fueling inflation.
Economic Challenge to Keynesians
Of all the widely believed but patently false economic beliefs is the absurd notion that falling consumer prices are bad for the economy and something must be done about them.
I have commented on this many times and have been vindicated not only by sound economic theory but also by actual historical examples.
And my Challenge to Keynesians “Prove Rising Prices Provide an Overall Economic Benefit” has gone unanswered.
There is no answer because history and logic both show that concerns over consumer price deflation are seriously misplaced.
Deflation May Boost Output!
The BIS did a study and found routine deflation was not any problem at all.
“Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive,” stated the BIS study.
It’s asset bubble deflation that is damaging.
And in central banks’ seriously misguided attempts to fight routine consumer price deflation, central bankers create very destructive asset bubbles that eventually collapse.
When those bubbles burst and they will, it will trigger debt deflation, which is what central banks ought to fear.
For a discussion of the BIS study, please see Historical Perspective on CPI Deflations: How Damaging are They?
Economically illiterate writers bemoan deflation, as do most economists and central banks. The final irony in this ridiculous mix is central bank policies stimulate massive wealth inequality fueled by soaring stock prices.
It’s madness. Another deflationary asset bust is coming.
Mike “Mish” Shedlock