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Resolution of Systemic Financial Problems – How Should Spain do it?

Asli Demirgüç-Kunt's picture

Systemic financial crises require swift and comprehensive solutions by the government.  In 2008 it quickly became clear that characterizing the U.S. securitization crisis as one of liquidity was inaccurate, and hoping that it would be cured by auctioning off increasingly poorly collateralized central bank loans to distressed firms was futile.  That led to -TARP- a plan to repurchase troubled assets from banks, which quickly evolved into a bank recapitalization plan when it became clear pricing toxic assets was nearly impossible. 

More recently, Spanish banking system has seen its situation worsen, partly because of Madrid’s failure to force an earlier cleanup of bad debts stemming from a real estate bust.  Austerity measures to remedy the region’s debt crisis have since led to greater deterioration of Spanish bank balance sheets, as more and more Spanish businesses folded and homeowners went into foreclosure.  Over the weekend Spain became the largest euro-zone nation to seek an international bailout, and the 17-nation currency area agreed to lend Madrid up to $125 billion for its bank rescue fund.  At this point there is little disagreement that there needs to be a broad-based approach to resolve the Spanish bank insolvency problem, but not as much discussion over the form it should take.