Familiar Patterns in Spain's Banking Crisis

The last time I was in Spain, the country was booming. In the spring of 2006, Madrid was bustling with non-stop residential and commercial real estate development and there were tourists everywhere. Spanish-speaking migrants from Central and South America flocked to Spain's cities and coastal resort areas for jobs in construction, restaurants, new hotels, and the service industries.

Life was good.

Unfortunately, when the good life is built on an economic charade of easy liquidity and irresponsible lending it doesn't last forever.

Spain now suffers from the sovereign economic malaise so many other European Union countries – Greece, Ireland, Italy, and Portugal – have already stomached. Spain has its hand out to the European Union due to an overleveraged and undercapitalized banking system combined with high unemployment with no safety net, a significant government deficit and high borrowing costs. Spain now has a full-fledged banking crisis – like the one the U.S. experienced in 2008. The bailout has begun.

If the U.S. and Irish experiences are any indication, the amount needed to bail out the banks will be re-estimated more than once. External auditors will be no help, since financial statement opinions won't signal any trouble with a "going concern warning."

Stress tests published last week conducted by two consulting firms estimate capital needs of 51.8 billion to 62 billion euros for Spanish banks under a "stressed scenario." Matt Lasov of Frontier Strategy Group says take these results with a grain of salt because the consultants were restricted to analyzing only central bank records. "These are the same records that originally showed [the bailed-out] Bankia earning a profit, not a multibillion euro loss."

Bankia, as of the end of May, had already received a 23.5 billion euro injection from the state.

One thing for sure, according to Lasov, is history shows stress tests have underestimated capital needs. "Capital needed after stress tests has tended to be two or three times the stated amount. This was the case in the U.S." Lasov is referring to the total government support eventually needed by Citigroup and Bank of America.

Spain plans to have the four largest public accounting firms – Deloitte, KPMG, PricewaterhouseCoopers and Ernst & Young – perform a full audit of its banks starting in September. That may help the central bank understand how bad it is but the information comes too late for investors and the general public.

Santander and BBVA are the two largest banks in Spain and have supposedly passed the stress tests. Both are audited by Deloitte. What makes the Spanish government, or the European Parliament, think the Big Four audit firms, in particular Deloitte, will give any better view of the banks' condition after another audit than they have already or than they did for investors and regulators in the U.S. and Europe prior to the 2008 crisis?

Deloitte was roundly criticized in the U.K. for suppressing knowledge of the precarious state of audit client Royal Bank of Scotland before that bank was nationalized. Deloitte's CEO, John Connolly, told the House of Lords in November of 2010 that the U.K.'s big four accountancy firms initiated "detailed discussions" in late 2008 soon after the collapse of Lehman Brothers with Lord Paul Myners. Auditors asked Myners if they could sign off on the banks' accounts as "going concerns." Myners was at that time the City minister, a position in the U.K. Treasury with direct responsibility for the financial sector.

Connolly told Parliament: "In the circumstances we were in, it was recognized that the banks would only be 'going concerns' if there was support forthcoming. The consequences of reaching the conclusion that a bank was actually going to go belly up were huge." (Emphasis mine.)

Eventually all of the U.K. banks received clean audit opinions with no qualifications for solvency, even though almost all needed bailouts.

None of the bailed out, failed, or wedded-by-shotgun financial services firms in the U.S. received a "going concern" qualification from their auditors prior to needing significant support from taxpayers. Investors and taxpayers in the U.S. and U.K. were given no warning of the price they would have to pay for irresponsible lending and risk taking.

The results of the Big Four audit firms' review of Spanish banks will not be made public. Will the auditors, at least, be honest with the Spanish government this time? Who will benefit from this advance knowledge? Who will pay the price of Spain's shell game?

Francine McKenna writes the blog re: The Auditors, about the Big Four accounting firms. She worked in consulting, professional services, accounting and financial management for more than 25 years.