Tuesday, September 9, 2014


Last year I wrote about Spanish banks that are still in trouble after the 2008 market collapse. After borrowing and betting on a bubble economy (real estate and toxic crap) Spanish banks were left high and dry when the markets crashed. This left most Spanish banks without enough cash on hand to instill consumer or industry confidence. Worse, they didn't have the capital on hand to comply with new international (Basel III) requirements that say you must have "X" amount of cash on hand to be considered a safe bank. 

Simply put, the Spanish banks were broke.

One of the proposals floated to help the Spanish banks become "healthy" - which I discussed last year - was little more than a smoke & mirrors approach to finance. Here's what was proposed.

Last year Spanish banks asked if they could take the losses that they absorbed after the 2008 market collapse and convert them into hard cash assets. How do you convert a monetary loss into hard cash, you ask? Simple, you get the government to sign off on turning your future tax deductions into hard cash today. So the banks in Spain petitioned the Spanish government to "advance" them future tax deductions with billions in credits.

You might be asking yourself, What's this tax deduction stuff all about? Good question. We do it here in the U.S. all the time. Here's how the concept works here in the U.S.

Imagine that you're a home owner paying off the mortgage. Tax law in the U.S. allows homeowners to deduct a portion of the interest they pay on their mortgage. Let's say you pay $25,000 to your mortgage company every year, with the vast majority of this amount going to interest payments. After adjusting for tax incidentals you find that you can deduct $2,000 of your interest payments from your tax bill each year. 

Now imagine the homeowner going to the IRS and saying, "You know, I've been deducting $2,000 per year in interest for a long time, so why not allow me to claim my deductions for the next five years all at once. But instead of providing me with a $10,000 deduction in one year, just give me the $10,000 and I won't ask for any deductions over the next 5 years." 

How many Americans would ask for this deal if they could? 

It really doesn't matter. The key is understanding that this is precisely what the banks in Spain wanted, and got from the Spanish government. 

They were effectively granted the right to turn straw (their losses) into gold (cash credits).

All of this will be paid for by the Spanish taxpayer, of course.

Specifically, with about $65 billion in losses (a little more than 50 billion Euros) staring them in the face, Spanish banks asked the government to turn about two-thirds of their $65 billion in losses into bank credits. For this to happen the Spanish government credits each private bank account with billions out of government accounts (which might help explain Fed decisions like thisthis, and this). 

To reiterate, after the Spanish government caved, Spanish banks and other "investment service firms" are now allowed to transform post-2008 bank losses - or "deferred tax assets" - into hard cash credits. 

And just like that, bad decision-making and real financial losses are turned into financial gold in Europe. 

But wait, it gets better (or is that worse?).

The European Union likes Spain's financial gimmick so much that they're now smiling on the deferred tax asset game. In August (2014) Portugal joined Spain (and Italy) as European nations that are taking Euro financial trash and converting it into financial credits so that their banks look healthier than they really are. 

If this financial chemistry works the banks are sitting on a financial gold mine. 

History, however, tells us how this ends. And that history is not good.

- Mark

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