I did a little digging and found an interesting Reuters article that might explain how it could happen. It's a long article, so I bolded the key areas, then wrote a little recap and summation at the end.
MADRID (Reuters) - Spain is reluctant to create a state-backed bank to hold toxic real estate assets from a burst housing bubble while it fights to bring down its deficit, preferring individual institutions to shoulder the risk. But the government will come under increasing pressure to underwrite a capital shortfall in its financial system in a country struggling to emerge from recession and with little sign of private investor interest in its sell-off of regional banks.
Spain, the euro zone's fourth biggest economy, is desperate to avoid taking on more debt as it seeks to distance itself from fellow euro zone members like Greece and Ireland who are seeking better terms for their huge international rescue loans. "The bad bank from the government's point of view would mean that they are taking a loss," said Silvia Paternain, lawyer at Freshfields Bruckhaus Deringer in Madrid.
Ireland's bad bank, NAMA, was set up in 2009 and bought real estate assets from banks at a discount in exchange for bonds.
It thought 40 percent of the loans it was acquiring were income producing but the actual figure was 25 percent. The discounts it demanded triggered huge holes on banks' balance sheets that had to be filled by the government.
This month, NAMA took a one billion euros charge to cover potential losses from the loans it has acquired, sending its fourth-quarter loss up to 678 million euros.
"I think, very rightly, the government has no intention of creating a bad bank," said Luis Arenzana, managing partner of Shelter Island Capital Management in Madrid. "The case of Ireland proves it's a terrible idea."
ELECTORAL IMPERATIVES
Spain's Socialist government may also be unwilling to close down non-performing regional banks one year ahead of general elections, as any sign of attacking the 'cajas' may cost it votes in Spain's powerful, autonomous regions.
"It's all riddled with bad politics, and with the pretext that you have to keep the banking system going," said Pedro Schwartz, economist at San Pablo University in Madrid, adding the worst performing cajas should be allowed to fail.
Spain has already poured around 10 billion euros ($14 billion) into a forced consolidation of the fragmented unlisted savings banks which account for around half the banking system.
The central bank has estimated the banking system has a 15 billion euros capital shortfall, not taking future losses on real estate into account.
Saving banks have about a year to apply for state funds if they fail to attract private investment to plug funding gaps.
Crucially, the state injection is booked as an investment, not as a loan, with no implications for Spain's deficit which it has pledged to cut from 11.1 percent of gross domestic product in 2009 to 3 percent of GDP in 2013.
The banking sector reform has helped to soothe investor fears about Spain's economy with the premium investors demand to hold 10-year Spanish over German debt at around 210 basis points, whereas Greece has to pay about 1,200 bps more.
But confusion still reigns about the scale of losses linked to Spain's decade-long property boom which ended with a crash nearly four years ago, with many of the regional savings banks skimping on detail about what lies on their balance sheets.
"It is very difficult to calculate the final losses due to real estate," said Francisco Uria, financial sector partner at KPMG in Spain.
Analysts' estimates for the capital shortfall in Spain's banking system, taking into account future losses from foreclosed real estate assets and bad loans to bankrupt property developers, average out at around 50 billion euros although some forecasts range as high as 120 billion euros, almost 10 times the central bank's prediction.
The worst-case scenario, if the government had to cover it, would wreck Spain's debt profile and drag it back into the crisis that grips other parts of the euro zone.
GHOST TOWNS
Some savings banks, such as heavyweight Banco Financiero y Ahorros, formed from the merger of Caja Madrid and six other regional banks, are putting foreclosed real estate assets into a separate unit, or 'bad bank', before attempting to attract investors to the stripped banking business.
But empty housing estates which sit like ghost towns on edges of Spanish cities and massive loans to real estate developers which top 300 billion euros in aggregate still weigh.
"I'm not sure whether the idea of creating a good bank and a bad bank would make an investor more keen to invest in the good bank," said Tullia Bucco, economist at UniCredit.
Hopes that real estate assets parked in bad banks will be able to be sold off at a profit, or even break even, over the next few years also seem far fetched.
Spain has the highest unemployment rate amongst developed countries and one of the highest personal debt levels in Europe. Bad loans are at their highest level in over 15 years.
The property market is far from recovery, with Barclays Capital estimating house prices fell 4.7 percent year-on-year in April, the sharpest rate of decline since March 2010.
"If the economy goes back into recession this year, then a lot more attention could focus very quickly on Spain," said David Owen, European economist at Jefferies.
Recap:
1) Spain is reluctant to create a state-backed bank to hold toxic real estate assets from a burst housing bubble while it fights to bring down its deficit, preferring individual institutions to shoulder the risk.
2) Spain, the euro zone's fourth biggest economy, is desperate to avoid taking on more debt as it seeks to distance itself from fellow euro zone members like Greece and Ireland.
3) Spain's government may be unwilling to close down non-performing regional banks one year ahead of general elections, under the pretext that they have to keep the banking system going.
4) The central bank has estimated the banking system has a 15 billion euros capital shortfall, not taking future losses on real estate into account.
5) Analysts' estimates for the capital shortfall in Spain's banking system, taking into account future losses from foreclosed real estate assets and bad loans to bankrupt property developers, average out at around 50 billion euros although some forecasts range as high as 120 billion euros, almost 10 times the central bank's prediction.
Bottom line:
Spain doesn't want to upset the European bond markets so it wants its banks to carry the debt burden which will put extra stress on said banks and which would then freeze them out of the interbank lending market which would then upset the European bond markets.
This is basically what happened to Bear Sterns except on a much larger scale.
Because if Spain's bonds get into trouble, it's over.
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