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Tuesday, December 4, 2012

Bailouts Without Stimulus: E.U. Policy on Spanish Banks

Directly and indirectly, the housing bust that began in 2007 put “the bailout” on the map in the lexicon of industrial policy both in Europe and North America. Whereas in the U.S., few restrictions were placed on the recipients, the E.U.’s first €37 billion ($47.9 billion) for Spain’s banking sector required the four major state banks “to make sharp cuts in their balance sheets and payrolls,” according to the Wall Street Journal. Bankia, the largest of the banks to be bailed out, planned to cut its number of employees by more than 6,000, close more than 1,000 branches, pass on any further real-estate lending, and reduce its assets by €50 billion as the bank focuses on retail banking—getting back to the knitting, as it were. Presumably the bankers were not allowed to grant themselves bonuses as a condition of the bailout. If so, it would differ appreciably from the U.S. bailout of Wall Street banks.
Avoiding the pitfalls of rewarding banks in trouble with black checks is one thing, however; seeing to it that the downsizing does not hamper the lending market itself is quite another. E.U. officials may have dropped the ball in this regard. At the time, banks based in Spain had a total of €1.7 trillion in outstanding loans, down from a peak of more than €1.8 trillion. A further fall of €300 billion was expected as a result of the cutbacks at the bailed-out banks.
The IMF, a technical adviser on the bailout, suggested that state officials in Spain “must make sure the downsizing . . . can be compensated by expanding lending by other banks.” It is doubtful, however, that the beleaguered state was in any position at the time to stimulate lending by other banks—particularly given that monetary policy was set by the European Central Bank and Spain itself was incurring deficits amid a high unemployment rate.  After all, the bailout funds were coming from the E.U. That the €37 billion was only the first piece of a €100 billion “rescue line of credit for Spanish banks” suggests that more could have been done by the E.U. to encourage smaller, more stable banks in Spain to increase their lending. That in turn could have expanded economic output in the state—a worthy goal given that people under 25 faced a 50% unemployment rate at the time in Spain.
Likewise, the TARP program in the U.S. could have given just enough to the big banks to keep them from following Lehman Brothers (i.e., to stop the conflation enabled by short-sellers), while demanding that those banks downsize. At the very least, being too big to fail would have been reason enough for that policy (plus a cap on bonuses). The disbursement of TARP funds to smaller banks sufficiently solid financially that the funds could serve as a fertilizer of sorts for reasonable (not explosive) growth could have facilitated a basic shift. That is to say, the biggies could have been contracting as the “next generation” was being helped along to take up the slack. The resulting credit in the economy would have acted as a stimulus to economic activity (hence reducing unemployment).
In short, “bailout” could have been viewed both in the E.U. and U.S. as only part of the equation to be applied to trouble-spots in the economy. By analogy, a person can facilitate weight-loss by adding an exercise regime (and a stimulating diet of fruits and vegetables) to cutting the total number of calories ingested. A viable industrial policy favors bright spots while managing problem-children in such a way that their activity is restricted rather than rewarded. This may be one of the principal lessons coming out of the housing bust that began in 2007.


Christopher Bjork and Vanessa Mock, “EU Clears Spanish Bank Rescue,” The Wall Street Journal, November 29, 2012.