The scorpion and the abuela, or the end of financialization

I’m heading out of town for the weekend so this will be a bit rushed, but the situation in Spain has me thinking that we need a new frame for understanding where we are both politically and economically. To be more specific, the most recent insults and humiliations being dealt to the citizens of Spain make clear that we have now gone beyond financialization and are in uncharted territory. The most recent outrage is the alleged €100 billion bank bailout (an Orwellian misnomer), for which Europe is imposing terms that are so pathological that they boggle the mind.

The terms of the bailout revolve around the concept of capital structure, which is essentially a vertical hierarchy of risk that is confusingly described in terms of age. Those who are “senior” in the capital structure are those who are higher up, which is to say, most protected from risk in the event that something goes wrong. These are typically lenders who buy bonds that have a lower yield because they need less compensation given the lower risk. The senior lenders are protected in large part because the so-called “junior” capital takes the first hit in the case of nonpayment. As a result of this additional risk, the junior capital receives higher yields, up to and including (presumably higher) stock market returns.

What makes the situation in Spain particularly awful is the way Spanish banks have funded themselves, namely by pushing a kind of high-yield equity shares to everyday bank customers. Although this practice has apparently been common in Spain for some time, it became a lifeline to banks when credit markets dried up, leading to a concerted sales campaign by the banks to push these products onto savers through their networks of branches. From Bloomberg:

As many as 686,296 retail investors held about 22.5 billion euros of preferred shares sold by banks as of May 2011, according to Spain’s stock market regulator, known as CNMV. Out of 73 issues since 1999, 23 were sold in 2009, …as lenders that year raised 11.4 billion euros from branch clients.

It seems safe to say from this that the Spanish banking system was in part bailed out by its own citizens, who shouldered the responsibility for funding their banking system while also being sold a story about the safety of the securities they were investing in. While the banks viewed their customers as a source of “junior” risk capital, to the customers, the banks were selling savings products based on the good word of the bank manager.

This is where the bailout comes in. In return for €100 billion in funding for the banks – not for Spain itself, just the banks – Europe is demanding that the “junior” capital be wiped out, including the bank customers whose funds were crucial to getting the banks through 2009 and 2010. The fact that many of these savers were retirees and others relying on this money appears to be the equivalent of collateral damage, and gets lost in the Teutonic moralizing about “burden sharing.”  Bloomberg yesterday explained more clearly what this will mean for many of these individuals in reality:

Maribel Martinez, 51, was counting on income from the 82,000 euros ($99,810) of savings she invested in Bankia preferred shares two years ago after losing her job cooking meals for nuns in a Barcelona convent.

A 1,435-euro interest payment on the 7 percent securities failed to arrive in the family bank account on July 7, said her husband Paco Valiente. On June 1, the group suspended 52 million euros of payments to holders of 3 billion euros of preferred shares sold in 2009 by Caja Madrid, one of its founding savings banks, after the lender restated 2011 earnings to show a 3.3 billion-euro loss…

“We invested in the preferred shares trusting in the good word of our branch manager, but our money has been effectively sequestered,” said Valiente, 51, who also lost his job last year. “What’s happening to our country now and people like us makes me scared about the economy and the future.” ….

“I ask you with all my heart that you try to give us back our money,” said Mercedes Martinez, a pensioner, who was one of more than 100 shareholders to speak at the meeting. “They told we who invested in preferred shares that they didn’t carry any risk and now we don’t have a single bloody penny left.”

“I speak on behalf of my mother who has 11,965 shares placed with her by force or at least through ignorance,” said Maria Carmen Jaen, another investor who spoke at the meeting. “She spoke to someone who she trusted and this person played on that, tricked her and sold her these preferred shares when my mother thought she was taking out a deposit.”

The banks have become victims of their strategy of raising funds from branch clients who will be more reluctant in future to buy their products, said John Raymond, an analyst at CreditSights Inc. in London.

“The branch networks work like armies that get instructions on the quota of the product they need to sell,” Juan Fernandez-Armesto, a former chairman of the CNMV, said in a phone interview. “The relationship of trust between the branch manager and his customers has now been severely undermined.”

Worse still is the reality of just who is being bailed out. Because the senior lenders to Spanish banks – which if I understand correctly are large German and French banks, among others – are going to be entirely protected, while the people who will suffer the most are Spanish individuals who funded the partial recapitalization of their country’s banking system by purchasing mis-sold securities. It’s telling that the European laws that protect senior bond holders are being respected as valid while Spanish laws that protect the holders of these preferred securities are expected to be rewritten in short order. The entire political, regulatory and social system is being upended to effect a massive transfer of wealth from the poor to an unspecified group of wealthy foreign institutions.

And this is what leads me to believe that we need a new conceptual framework that gets us beyond financialization. Because (to torture the metaphor of the scorpion and the frog) when Spanish retirees carry the scorpion of the banking system on their backs only to be stung, where does that leave them? And looking forward, where does that leave the banks? The idea of financialization is that more and more of the economy is drawn into purely financial activity, which has until very recently meant that the financial sector has assumed a central role in economic and political life. But in a negative-sum world, there aren’t too many resources left for this sort of behavior. What happens when they inevitably run dry?

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