Bad banks in a world of bad choices

CNN is quoting me on the Spanish banking crisis. After Bankia was taken over by the government, there will now be bad banks for every Spanish bank by government fiat. The problem is that if the government ends up shouldering the burden (even if only in part), it will blow whatever little credibility it has in bond markets right out of the water. Most of the Spanish banks and cajas are bankrupt today; it is only because the regulators let them pretend that houses in Spain are worth 3 times what they are worth in Germany (yeah right) that they are still in business. If the banks have to do the recapitalizing themselves, this won't really help, except for the illusion of clean accounting -- the reason why we worry about the banks is that they should lend, instead of nursing their wounds from hundreds of billions of misguided lending. There is no clean solution here, short of the banks defaulting on their debts. This would clearly help -- the new financial institutions stepping forward afterwards would find it a lot easier to lend. Of course, this is the step all governments have been avoiding like the plague since Lehman, and it has to be said that it is really hard to gauge the likely consequences.

What I would like to see is a significant shrinking of the Spanish banking system, with a number of bankrupt lenders not taken over, but wound up. That will give the rest more pricing power and the ability to make money off lending money.