The victory of Socialist Party (PS) candidate Francois Hollande in the French presidential election on May 6 set off a wave of hope across Europe. On May 9, the Spanish government announced that it was nationalising the country’s fourth biggest bank, Bankia, to keep it from collapsing.
What do these seemingly unrelated events have to do with each other?
Enormous expectations are being loaded onto the shoulders of the former French PS national secretary. In recession-stricken Spain, Portugal and Greece, people hope he will put Europe’s economies on a path to growth and job-creation.
They are hoping he stands up to German Chancellor Angela Merkel and the German Bundesbank’s obsession with reducing public debt at practically any cost.
But the near-collapse of Bankia, and the rottenness exposed in the Spanish financial system, showed how strong the forces of stagnation and job-destruction remain across Europe.
If Hollande is serious about his May 5 Le Monde statement that his challenge is to “make sure democracy is stronger than the markets [and] that politics retakes control of finance”, on what economic battlefield will he have to fight?
Banking black hole
The heart of the European economic crisis lies in Spain and the hole in that heart is the indebtedness of Spain's banking system.
It has inherited hundreds of square kilometres of unsold and depreciating real estate from the collapse of the country’s 1997-2007 housing bubble. It also confronts a growing mountain of non-performing loans to households and small businesses that were thrown on the scrapheap by the subsequent recession.
Europe got a shock reminder of the depth of that indebtedness when Bankia reluctantly surrendered itself into public ownership because it did not have the funds to meet the capital adequacy standards demanded by its auditors.
When the auditors checked Bankia’s books and those of its parent company, the Financial and Savings Bank (BFA), they discovered Bankia’s value on BFA books had been reckoned at 12 billion euros ($15.5 billion), as against a value of 8.5 billion euros on its own books (its Madrid stock market value was just 2 billion euros).
The auditors refused to sign off on the 12 billion euro figure.
They offered the Bankia-BFA board (led by former International Monetary Fund head Rodrigo Rato) three unpalatable options. The 3.5 billion euro difference between the “value” of Bankia as a BFA asset and its book value could be:
deducted from BFA profits (impossible as the company had made only 41 million euros last year);
deducted from BFA assets (assessed at 3.515 billion euros, so that move would leave the parent company practically worthless) or;
covered by converting the 4.465 billion euros in Spanish state loans to BFA into shares (making the state the company’s major shareholder through its Fund for Orderly Bank Restructuring).
After three days of futile resistance and argument, and with its nosediving share price leading the whole finance sector down, the BFA-Bankia board gave up: Rato was replaced as group chairperson and BFA ended up “public”.
The Spanish media are calling this action “nationalisation”, but it is a strange variant. Public ownership does not apply to the whole Bankia-BFA group, only to the mother company where the group’s “toxic assets” have been concentrated.
The “nationalised” company remains under the control of the same gang of senior executives who presided over the group’s decline and fall.
This new phase in the financial crisis is very unnerving for Spanish and European politicians. With three “banking reforms” already implemented since 2008 ― involving 115 billion euros in state support of various kinds ― Spain’s sickly finance sector was supposed to be undergoing slow but steady recovery.
Now the state has to fork out a further 10 billion euros (incidentally, the same amount it plans to cut from health and education in this year's budget), and with no guarantee more assaults on the taxpayer aren’t still to come.
And what has the Bank of Spain (the country’s central bank) been doing?
Rato understandably complained before his fall that Bank of Spain executives had made no objections to Bankia’s restructuring plans and the valuations on which these were based.
The Bank of Spain’s latest figure for “potentially problematic” finance sector assets is alarming enough ― 184 billion euros, 18% of the country’s annual production, with 120 billion euros of this uncovered in case of default. But is this even accurate?
Investors in Spanish public debt and the stock exchange certainly aren’t convinced. The risk premium for 10-year bonds over German debt is close to its highest point since the outbreak of the crisis in 2008. The Madrid stock exchange index is at its lowest point since June 2003.
Nor are the European Union’s treasurers and finance ministers (the “Eurogroup”) persuaded. At the next Eurogroup meeting they will call for an independent evaluation of Spain’s banks and credit unions.
When the European Central Bank (ECB) board met in Barcelona on March 3 ― in a hotel bunker protected by 8000 police and special agents ― governor Mario Draghi also made a point of calling for rapid action to clear up the mess.
On March 10, a “senior European Union executive” told El Pais the EU “calls on the Spanish government to resolve the state of distrust that its banks have produced in the international financial system: that it reveal the exact state of their balance sheets and what, if anything, there is under the carpet, so as to dissipate the strong doubts that presently exist”.
The EU executive is right to be worried. The collapse of the Spanish real estate bubble has exposed the finance system to relatively greater losses than the US, British and Irish bubbles.
It is also not easy in the land of the indignados (“the outraged”), of mass loathing of bankers and politicians, and of entrenched cronyism and corruption within those elites, for any right-wing Popular Party government to clean up a mess made by its best friends.
The most important factor, however, is economic. There are 820,000 flats and houses of the 2.5 million oversupply churned out during the housing bubble that remain unsold, nearly five years after the bubble burst.
These could be shifted quickly enough if prices were allowed to fall sufficiently. But that would only bring down the value of real estate assets, undermining the fragile banking system and increasing the likelihood of more Bankia-style events.
By the same token, if prices are not allowed to fall, the vast oversupply will take longer to clear and the incentive for business to invest in construction and related sectors remains weak.
Given the importance of construction in Mediterranean Europe, that can only deepen the recession.
Data for the last quarter of 2011 shows the recession is rapidly spreading across the 27-country EU (a -0.3% fall). This is led by accelerating economic collapse on its southern flank ― Greece (-7.5%), Portugal (-1.3%), Italy (-0.7%) and Spain (-0.3%).
France will probably enter recession in the next quarter and even Germany may not be spared.
Greece’s nosedive into depression has been so rapid that official unemployment has gone from 14.7% to 20.7% in one year (to end of 2011), followed by Spain (20.8% to 24.1%), Portugal (12.4% to 15.3%) and Italy (8.1% to 9.8%, all over the year to March 2012.
Across the EU official unemployment has risen by 2.1 million to 24.7 millions, with over 50% of people under 25 out of work in Greece and Spain.
The most important feature of the decline is the new collapse in investment, as measured by gross fixed capital formation.
In the last quarter of 2011 this fell by 1.7% in the 17 economies of the euro area, the first decline for two years and the biggest since the second quarter of 2009.
If Europe’s economic slump were “normal”, this decline would be offset by raised public spending. But to date, that option has been ruled out by the determination of the ECB, EU and IMF (the “troika”) to prioritise cutting government budget deficits.
The theory behind their brutal and dangerous policy of “expansionary austerity” is that cutting government deficits is needed to restore business confidence ― that elusive determinant of capitalist investment, growth and jobs.
If this can be relaunched, its exponents such as Spanish Prime Minister Mariano Rajoy say, consumer confidence, consumption and tax receipts will follow ― also lightening the load of government debt.
The past year and a half in Europe has cruelly exposed the theory: everything has been done nationally and at the European level to restore the “animal spirits” of the captains of industry (reversing ECB interest rate rises, 900 billion euros in low-interest ECB bank loans, brutal “labour market reforms”, slashing the public sector).
But the patient just gets feebler and feebler.
The only source of growth has been exports. In Spain, this has prevented the recession from being even more intense, but it will become less and less available if the recession in Europe starts to drag down growth in the rest of the world economy.
Moreover, in the best of scenarios it could help boost growth in the economies of Mediterranean Europe only at the price of even further cuts to wages and living standards.
Contrary to the theory, stagnating demand, worsened by the ongoing financial system instability and overall eurozone fragility, has been making big business very wary about risking money in new investment.
That would seem to leave a huge rise in public investment, focused in Europe’s regions of highest unemployment, as the only way to reverse the diabolical cycle of recession.
How much, if at all, can Hollande’s program help that effort? That will be the subject of the next article in this series.