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Moody’s downgraded no less than 28 Spanish banks between 1 to 4 notches. The move was expected and joins similar moves by other rating agencies and by Moody’s in the past.

This decision to cut ratings seems illogical: Spain and other European countries will do everything to keep the banks afloat, that these banks seems invincible. They are very safe and deserve a perfect AAA rating.

Original sin – merger of cajas

Spain had a housing boom and bust. During this period, mortgages were given too easily and too many houses were built. During some of the boom years, more houses were built than in Germany, France and Italy combined.

When the party ended, the construction sector collapsed, the economy was badly hurt and the banks were stuck with too many bad loans. Many were small savings banks called cajas.

The previous government had the idea of merging these banks: the stronger ones would balance the weak ones and the bigger mass would help them stay afloat. Well, the size did turn into stability: these new institutions were just too big to fail.

Too big to fail

One of these merged banks was Bankia, recently nationalized in a total sum of 23.5 billion euros. It originally was a loan worth 4.5 billion. The government turned the loan into an investment in mid May. Only two weeks later, it became a full nationalization that included an injection of 19 billion more euros. Spain went Irish.

Another was Banca Civica. It was eventually bought by Caixa Bank, a relatively big and solid bank (at least until this acquisition) that only became bigger. Too big to fail? Caixa Bank was recently rumored to be in deep trouble.

So these became too big to fail, but there’s another reason: the ECB’s LTRO. The European Central Bank gave lent cheap money to Spanish banks, and they bought Spanish bonds. The banks would enjoy a nice arbitrage and Spain’s yields would fall.

Unfortunately, this just triggered an exodus of foreign money out of Spain, and yields rose. The banks, that bought bonds in big quantities, often used high leverage. Margin calls are looming.

European money going to European banks through Spain and its banks

So, apart from helping the banks for the sake of helping the banks and the international banks who they owe money to, the Spanish government wants to avoid a sell off of its bonds by troubled banks.

Mariano Rajoy, Spain’s PM just announced more economic measures (cuts) to meet deficit goals. There’s a good reason why these goals seem unreachable.

Other European countries need stable Spanish banks for the sake of their own banks, but bailing out Spanish banks wouldn’t go well with the public. But helping Spain to help its banks is already OK.

So, Spanish banks have their backs covered. Big time. They are actually very safe.

Ratings agencies are often criticized for being behind the curve and stating what everybody already knows. They missed it this time. Instead of a cutting and assigning negative outlooks, they should all get a perfect AAA rating with a stable outlook…

Further reading:  How Long Can Italy Hide Behind Spain?

Full statement by Moody’s is here.