For a Good Bad Bank

The outbreak of the mortgage crisis in the United States has just reached its fifth anniversary. Since then the financial, economic, and social disease has gone through different phases in spiral fashion, ranging from employment to the banking crisis, to the debts of the states. In an unstoppable metastasis, the problems have spread across countries (Ireland, Greece, and Portugal) to affect the core of the European Union, with countries such as Italy and Spain wanting an exit that becomes increasingly urgent and difficult. Thus, after many misgivings, the Spanish government has decided to create the so-called bad bank, a name whose single utterance raises concern. The bad bank is a formula tested in other countries with opposite, and even sometimes downright undesirable, results.

Such was the case for Ireland, where the government decided to guarantee all banks, whatever their solvency. Today, the Irish state is caught in a pernicious circle in which it subjects its citizens to brutal austerity policies, falls into an economic recession, is unable to trace its tremendous unemployment figures, and continues to be subject to payment obligations that seem impossible to meet. The Celtic Tiger,* who only five years ago boasted of its growth, is now only a poor scalded cat, unable to survive without receiving aid from international agencies that impose harsh provisions. Nobody today denies that the case of Ireland is an example of what to avoid. Now Spain is about to face its own banking crisis with the creation of a bad bank that is both fickle and feared.

In reality, and for some time, the major macroeconomic decisions taken at the Moncloa Palace are a convoluted result from months of negotiations. They still maintain a laudable and necessary position that they will not accept solutions or support that can make the remedy somewhat worse than the disease. Thus, in the memorandum of understanding that Spain formally adopted on Aug. 24, in exchange for up to 100 billion euros for the recapitalization of banks, it provides the creation of an asset management company, the bad bank — although with a less pejorative name — in order to “restore and strengthen the solidity of Spanish banks, while minimizing the cost to taxpayers of restructuring.”

Subjected to a harsh thinning regiment, in which millions of people are losing not only their property and savings (preferred options), but its mode of economic and social life, Spanish public opinion remains extremely reluctant to revive banks and insolvent savings with public funds. Obviously, taking from basic social services (health, education) without forming policies to mediate the re-launching economic activity, which should reverse job creation, led to this opinion.

In this complex scenario, the creation of a bad bank appears to be a necessary solution to clean the balance sheets and allow banks to rededicate themselves to revitalizing their business credit. The prices at which the toxic assets are valued and the disappearance of insolvent entities leaving safe deposits are crucial points where this new operation can have a positive impact.

*Editor’s Note: The Celtic Tiger refers to Ireland’s economy between 1995-2007, a period of great economic growth for the country.