Spain's biggest hurdle to a bank recovery: public distrust

As Spain keeps the world economy on edge while it scrambles to recapitalize its once-mighty financial sector, it’s losing hold of perhaps its most important asset: citizens’ trust.

"Too-big-to-fail” Spain appears to have averted a complete economic meltdown as Europe rushes to give it more time to recover. But rescuing the banks and averting a full-fledged embarrassing bailout is not enough. Central to Spain's ability to pull out of this crisis is corporate and public willingness to keep money and spending at home, instead of running to foreign banks and markets. And key to that, analysts say, is for the government to explain to Spaniards what went wrong, how the system will be fixed, and how those responsible will be held accountable – instead of stonewalling investigations.

Markets and global governments are concerned about a domino-effect bank run that could severely undermine the European Union financial system, as evidence mounts that Spaniards and investors alike are losing confidence in the country’s institutions, not just its banks.

“I’m really scared,” says Jesús Diaz, a young taxi driver. “If we have to ask Europe for a bailout, I’m pulling my money out because I don’t know if Spain will become Greece. I have my taxi and I’m not going anywhere, but my brother will leave Spain because he has a degree.”

Others know there is little refuge. “I’m not pulling my money out,” says Purificación Ramos, a museum employee. “Where will I put it? Today one bank goes under, and tomorrow it will be another. I can’t trust any of them.”

A Euro bank bailout

Mrs. Ramos is correct. A bank run is unlikely, for now, precisely because the consequences would be global. Europe does not have the money to rescue Spain, an almost-certain scenario if its financial sector implodes.

Paymaster Germany, under pressure from its European partners and other global powers, including the US and China, signaled this week that it is willing to accept a bailout limited to Spain’s banks (as opposed to the country, as was the case with Greece, Ireland, and Portugal). Spain can officially request a bailout this weekend, according to Spanish media and Reuters quoting unnamed sources today, although the government denied it had yet made a decision.

Spain’s plight is not over unsustainable debt levels or its unwillingness to implement the necessary reform to return to growth. The Spanish government already secured most of its credit obligations this year and a bond auction yesterday illustrated that investors are still interested in lending money to Spain, albeit at a higher interest rate.

Furthermore, the European Central Bank has enough firepower to preempt any Spanish bank collapse. “It is possible that people withdraw a lot of money, but banks with little collateral won’t go bust, because they could still go to the ECB,” said Janet Henry, London-based chief European economist with HSBC.

The exact terms of a Spanish bank bailout still have to be negotiated, and the amount will depend on independent bank audits, including one from the International Monetary Fund which will be made public on June 11.

Most analysts put the cost of cleaning up the banking sector at between 80 and 100 billion euros, half of which would come from Europe’s bailout fund, but some estimates are twice as big. Whatever the amount, the government can’t raise the money through debt because it’s already running a deficit that will reach 5.3 percent of gross domestic product this year.

Most of the cash, around 23 billion euros, will go to recapitalize Bankia, which was the third-biggest bank in Spain a year ago, with strong ties to the ruling Popular Party. The government was forced to nationalize it on May 9 to preempt a broader bank run, should people have lost faith in the financial system. When the bank recast its 2011 results shortly after its seizure, the tiny profit it initially reported became an 3.3 billion euro loss. 

On top of that, Spain’s central bank last week reported a record 100 billion euro capital flight in the first quarter of 2012, equivalent to about 10 percent of its gross domestic product. Stock markets also remain near decade lows as investors pull their money to reinvest elsewhere. It’s all but certain that cash flow out of Spain only worsened this quarter after Bankia’s seizure.

An issue of trust

Despite Bankia's seeming deception, the government blocked numerous attempts to investigate its collapse, undermining Spaniards' trust in their government to protect their interests. 

“When we find out everything through the press, we lose our trust. I don’t even think we’ve hit rock bottom,” Mrs. Ramos said. “The government isn’t explaining what it’s doing. What the government has to do is come out and explain absolutely everything.”

With the threat of bank run apparently tamed, the bigger issue is confidence, analysts say. “There’s a limit if you don’t get political commitment,” HSBC’s Mrs. Henry said. “The ECB can address symptoms, like bank runs, but they can’t solve the problems. Solutions have to come from politicians.”

More than 90 percent of Spaniards say the economic situation is either bad or really bad, according to a survey released June 6 by the autonomous government polling institution Center of Sociological Investigations. Nearly 40 percent of Spaniards expect the economy to worsen in the next year.

According to the monthly poll, Spaniards in May identified the political class and political parties as their third most-pressing issue, after unemployment and the economy, significantly more than in December, when Prime Minister Mariano Rajoy came to power. Around 9 percent of people cited corruption and fraud, also a rising concern.

In fact, citizens are already taking things into their own hands. The 15M movement, the Spanish version of the global Occupy Movement, raised more than 20,000 euros via crowdfunding to cover legal fees for a class action suit against Bankia and its deposed chairman Rodrigo Rato, a former IMF director and deputy prime minister of Spain.

They had targeted a 40-day period to raise 16,000 euros, but within 24 hours they had more than enough cash, as well as dozens of Bankia employees, stockholders, and account holders willing to testify against the bank in the upcoming hearing. Hours later, the government’s prosecutor office announced it had opened an official investigation into possible fraud in Bankia’s collapse, opening a second front.

Still, it’s impossible to say when or how people will regain trust in these institutions.

“Our mindset is strange in Spain,” says Pedro Alcalá, a 31-year-old unemployed insurance broker who was in a Bankia office paying interest on gold he pawned. 

“We all live day by day, and unless we are drowning, we don’t do anything about it,” Mr. Alcalá says. “We criticize politicians, but when elections come we don’t change anything. Whether right or left, politicians are the same. We deserve what we are getting.”