Bad Bank in Spain - so far just window dressing.

On October 3rd, the Spanish government announced the implementation of a Bad Bank in December, to relieve domestic banks of their toxic real estate assets.

The model was successfully applied in Sweden and Norway in aftermath of the 1992 banking crises, which followed during a period of collapse in real estate markets. The implementation of a Bad Bank allowed for the restoration of the balance sheets of banks, with two distinct benefits:

1. Removing the risk of a systematic collapse should one of them fail, and;

2. Allowed the countries' banks to lend out to deserving companies and individuals again.

Though the concept of a Bad Bank as has historic evidence that it can be an effective initiative for restoring credit market liquidity and reducing risk, there are some significant differences that imply the Spanish initiative is nothing more than window-dressing:

• In Norway and Sweden in the 1990s, shareholder equity in distressed banks was nulled with shareholders loosing all of their investments. Bond-holders were the only ones protected. After the banks had been restructured and were showing profits again, government capital outlays were recovered by re-privatizing the banks.
  
• The Bad Bank was funded with public sector money. The transfer of assets to the Bad Bank happened at market rates. There was a minimal element of negotiation between the Bad Bank and the bankrupt banks; as all entities became government owned they had the same shareholder. Bankrupt commercial banks were re-capitalized by the government only to regain sufficient capital adequacy ratios.

In Spain, banks will not be forced into bankruptcy and have even made public statements that they will be co-financing the Bad Bank. This undermines the entire principle of a Bad Bank, which is why the Spanish initiative will fail:

1. The banks' equity exposure to the transferred assets continue to exist, just now in the form of an equity stake in the Bad Bank, so it does not completely de-risk the banking sector.

2. Investor's capital outlay's into the Bad Bank cannot be recovered by a future sale of equity of the restructured banks.

3. Transfer of assets will most likely NOT happen at market prices, as doing this will erode capital adequacy ratios for the banks, trigger re-financing.

The currently proposed structure is a political compromise (or a result of the bank's bribing the policy makers?) designed to protect the interest of the country's wealthy, with (again!) Northern European tax-payers paying the price in the form of higher inflation (only financing available is printed money from ECB).