Bull runs vs jobs: 

The tale of the scorpion and the frog revisited

During the last weekend, all Spanish media widely covered the peculiar referendum that took place in the village of Guijo de Galisteo and its two depending hamlets1

In this call for voting, inhabitants had to decide weather they preferred to spend the budget originally assigned to local celebrations (bull runs) “to the creation of jobs”.

The budget whose earmark was into question: 15,000 euro.

At this point, it is not very difficult to imagine that this initiative was promoted by the local mayor Javier Antón, whose hand apparently shook when facing such paramount responsibility (annual budget of the village and its two hamlets amounts 1.1 million euro).

According to mayor’s statement he decided to use this formula due to “the difficult economic situation in the municipality, and above all, due to the rise in the unemployment rate that had picked up to more than 25% in the last months.”

Needless to say too, the current local government has remained unchanged since 2008 and at current local debt, only with municipality providers, amounts 206,000 euro, approximately 230 euro per capita.

Bearing in mind the above financials and deducting the costs of the voting (we have used an amount of 500 euro for the sake of simplicity), we could assume that the registered voters were deciding between:

• Whether to devote a net sum of 14,500 euro (15,000 minus 500) to the implementation of a “fiscal stimulus package” to the creation of “local jobs” (to the “glory” of the local mayor, Mr Francisco Javier Antón) or
• to “misuse” these funds in the organization of “local bull runs” during local celebrations.

Yet the outcomes of the voting have been less “rosy” than pictured by Mr Anton’s. The overall results have shown that, out of a total of 423 votes emitted, 242 were in favor of the bull runs while 181 backed a proposal to cut the festivities budget and use 15,000 (14,500) euros “to boost local employment”.

As the young Manuel Garrido expressed "(Bull runs) It's what we like here and why I voted for that option, because we know that the local job here is always for the same people".

Despite these results, mayor has decided to read them separately by hamlet, which will allow the mayor to devote two thirds of the total package euro to bull runs and  the remaining third to the creation of local jobs.

After all, politicians, like scorpions, can't help themselves. The only difference is that more and more frogs are aware of that fact.

1 .http://www.rtve.es/alacarta/videos/telediario/destinar-15000-euros-festejos-taurinos-contratar-trabajadores-eventuales/1424224/
http://www.huffingtonpost.com/2012/06/04/guijo-de-galisteo-bullfight-job-creation_n_1566078.html?ref=business

Biting the hand that feeds you? The case of Bankia brings the relationship between audited company and its auditor back to the public light

In Spain, yesterday's economic headlines were fully covered by news related to Bankia’s rescue, which is going to require an extra injection of 19 billion euros from public funds.

These news about the public intervention of Bankia (this injection is going to take the form of public participation in Bankia’s equity) were jointly released with the fact that Bankia’s 2011 will be substantially reviewed: from the original results announced last February (309 million euros of profit) to a loss of EUR 2.979 million (i.e., a "slight" downward revision in an approximate percentage of 1064%).

Bankia’s auditor (Deloitte) refused to sign the accounts for year end 2011 due to a discrepancy in the equity valuation of 3.5 billion euro in BFA (the parent company of the group), yet the fact is that Deloitte had released positive evaluation reports of Bankia on two previous occasions during 2011: First, in connection with the preparation of the initial public offering (IPO) report dated June 17 and then the intermediate states of this year (report dated July 28, 2011).

On both occasions, the auditor provided a positive report opinion stating that “In our (Deloitte’s) opinion, the financial statements have been prepared properly in all respects, in accordance with accounting standards that are applicable."

Thus according to some inside sources from Bankia’s trade union1, the relationship between Deloitte and Rodrigo Rato (the outgoing president of the entity) had strained when it was discovered that Banco de Valencia's accounts were riddled with holes, accounts which Deloitte signed without any exception.

1.- http://www.ugtbankia.net/index.php/es/acuerdos-circulares/83-noticias/474-deloitte-dio-por-buena-la-valoracion-de-bankia-en-dos-ocasiones-en-2011

Deloitte was the auditor of Caja Madrid (main saving bank origin of the group Bankia), Bancaja and Banco de Valencia, three of the entities involved in the merger process, which, according to financial sources, could mean that when they provided audit services for the IPO they could have been incurring in a case of conflict of interest (Bancaja and Banco de Valencia merged with Caja Madrid after being rescued by the Bank of Spain to avoid their bankruptcy).

All this history brings the relationship between audit firms and their customers back again into the spotlight.

The dual role of the auditor, being responsible of providing an independent professional opinion on the accuracy of company’s accounts while he is being paid by the same company that he is auditing, gives floor to an almost inevitable conflict of interest (where being too harsh with your client means biting the hand that feeds you).

In this situation, it is clearly logical to propose more logical ways to clearly dissociate the client of the audit process from the auditor and the audited company, to break this apparent vicious incentive scheme mentioned above.

One possible way to break this system could be that the Public Administration would hire auditing firms through a competitive tendering process (for instance, in cases such as large companies or at least for listed companies) and that at the time, the Administration would charge a fee (tax) to these companies to cover these costs of audit. This amount could be calculated as the sum of the average market price of conducting this audit plus the proportion that contract costs that would generate the Administration).

This simple mechanism would allow that the contents of the report would not be affect the prospects of the auditor to be elected again as the company's auditor for the following year as the audit firm would only respond to his client (the Administration that hired him to do the job).

The “outsourced”/indirect public audit mechanism would eventually generate positive externalities in aggregated terms for the country, decreasing economy funding costs of the companies thanks to the reduction of the risk associated with the moral hazard caused by the current system of contracting external audit firms.

That way, auditors would not be biting the hand that feeds them when revealing financial inconsistencies in the companies they audit.

Spanish austerity programme is turning self-defeating

Yet during the last years of the Socialist Party (PSOE) government in Spain, Popular Party (PP) had a very clear idea of which should be the main steps that the country should follow to regain the growth path: A deep programme of structural reforms combined with a tight fiscal consolidation effort to cope with the intermediate fiscal deficit objectives compromised with Brussels.

To the eyes of PP leaders and economic policy strategists, the fulfilment of the different intermediate objectives concerning fiscal deficit would return investors’ confidence in Spanish economic fundamentals and growth potential, even if consolidation programme could cause job destruction during its first year of implementation.

However, austerity programme is not showing any signs of success neither in the longer terms perspectives (Spanish economic prospects remain gloomy in the years to come) nor, and that is maybe the scariest part, even in the short-run, since Spanish fiscal position continues deteriorating.

Therefore it may look paradoxical, but austerity is defeating itself and its turning into a sort of lupus for Spanish fiscal consolidation also in the short term.

According to the data provided by Spanish government, even though public receipts have increased by more than 1,1 billion EUR (4%), the aggregate public expenditure has increased by more than 4,7 billion EUR increasing the fiscal deficit in almost a 40% with respect to the same month in the previous year.

As per some estimates of senior public officials in the Ministry of Finance, the expected loss in personal tax receipts  may reach 2 billion EUR. These calculations are based on the 750 thousand extra unemployed forecasted until the end of this year and it does not take into account the unemployment insurance that should be paid to these additional unemployed, so fiscal impact would be considerably worse than this figure. 

See http://www.elmundo.es/elmundo/2012/04/27/economia/1335517741.html

Additionally, this rapid deterioration in current levels of activity is also deeply affecting the quality of loan portfolio held by the Spanish banking sector, and subsequently to the level of provisions on bad loans. According to the estimates of the last “Financial Stability report” for 2011, that has been recently published by the National Bank of Spain, the rate of troubled assets could reached 60% of the current bank real estate loan portfolio (approximately 184 billion EUR).

These rapid levels of deterioration will reduce even more:

• The existing levels of funding available for the companies (with the subsequent cost in terms of shrinking even more current levels of activity)
• The actual demand of sovereign debt from the national banking sector (with the consequent increase of the interest rates paid by Spanish government)

In this bearish picture, the role of hedge funds and other similar actors with market power can only make the situation worse, triggering overshooting effects by taking short positions in operations in the sovereign Credit Default Swaps (CDS) market. 

See http://wallstreetpit.com/91520-whowhat-is-driving-european-sovereign-spreads; and 

http://www.banque-france.fr/fileadmin/user_upload/banque_de_france/publications/Revue_de_la_stabilite_financiere/etude03_rsf_1007.pdf

All in all, if

• all the efforts made by the current austerity programme cannot even ensure that short-term fiscal position will not deteriorate quickly and
• this fact is going to be used by the big players in the financial markets to make short-term profits on the account of Spanish funding costs

then it seems that maybe it is the right moment for Brussels to start reconsidering a reschedule in the fiscal consolidation path for troubled countries in the EU. At the same time, it might be essential to resume quantitative easing plans for the European Central Bank (ECB) as this is the best proven available option to deter big players in the financial markets from betting against sovereign debt markets.

If the willingness to undertake these actions does not come from the European institutions, maybe it is time to start disobeying the austerity mantra, at least until the structural reforms that are being implemented are fully in force. After all, the treatment is getting the patient worse, and, so far, Brussels has never been too harsh with naughty countries.