Rato-Lazard Ties Show How Elite Profited Amid Cajas Loss

Five days before Christmas, ex-Deputy Prime Minister Rodrigo Rato was asked by a prosecutor probing the collapse of Bankia SA whether he’d done business with Jaime Castellanos, chairman of Lazard Ltd.’s Spanish unit.

“No, a business relationship I don’t have,” said Rato, the former Bankia chairman, according to an official recording of the closed session of the National Court in Madrid that was distributed to the parties involved. “Friendship, yes.”

Three weeks later, Ignacio Ayala, Rato’s lawyer, corrected his client’s recollection.

Rato, Castellanos and others jointly own a commercial lot near Madrid that is leased to a third party, according to Ayala’s Jan. 10 statement to the court. They also controlled a company together while Rato, 64, was running Bankia, Ayala said.

At the same time, Lazard billed Bankia 9.2 million euros ($12 million) for work either assigned or executed during Rato’s 27-month tenure at the bank, court documents show.

Their relationship exemplifies how a network of leaders from the governing People’s Party helped their associates among the financial elite to profit while the country’s savings banks, known as cajas, racked up losses. That toxic combination flourished during the boom fueled by Spain’s entry into the euro in 1999 and served to deepen the crash that resulted in a 41 billion-euro bailout of Spanish lenders, according to Jacob Funk Kirkegaard, a senior fellow at the Peterson Institute for International Economics in Washington.

‘Political Racket’

“The things that we need to do to make Spain work require pulling the rug out from under the core interests of everyone” in power, Ken Dubin, a political scientist who teaches in Madrid at IE business school and Carlos III University, said in a May 22 telephone interview. “This is a political racket run for the benefit of politicians who suck the marrow out of the citizenry.”

Rato, a former Lazard managing director and ex-chief of the International Monetary Fund, faces a possible jail term over allegations of false accounting, price fixing, fraud and embezzlement relating to the collapse of Bankia, according to a court filing. Rato and his fellow board members were named as official suspects by the court last year in an investigation examining their compensation packages and their statements about Bankia’s balance sheet before its collapse.

‘Strict Accordance’

Rato says that he and his colleagues are innocent. The bank acted “at all times in strict accordance with the law and the regulation that Spanish and European legislators were producing throughout the process,” Rato told a parliamentary committee in July 2012.

Rato’s lawyer Ayala declined to comment through his assistant following three calls and an e-mail from Bloomberg. Lazard has policies and procedures to review and approve investments by its executives and to monitor potential conflicts, according to a spokesman for the New York-based bank. Neither Lazard nor Castellanos, born in 1952, is under investigation. A Bankia spokesman declined to comment.

Rato earned an annual base salary of $1 million while working for Lazard from December 2007 until he left to join Caja Madrid, according to Castellanos’s Feb. 19 court testimony. After Rato was made chairman of the savings bank on Jan. 28, 2010, the lender awarded contracts to companies headed by Castellanos. Caja Madrid was the biggest of seven savings banks that merged to create Bankia later that year.

The relationship between Lazard and Caja Madrid predated Rato’s tenure. It included Caja Madrid managing Lazard’s corporate checking account, the invoices show.

Insurance Policies

In addition to Lazard’s advisory appointments, Rato’s Bankia also took out three insurance policies through Willis Group Holdings Plc, where Castellanos is chairman of the Spanish unit, spokeswoman Sarah Robson said in an e-mail. The business was won through fair competition, she added, declining to say how much Willis was paid for the work. Willis doesn’t have any record of contracts with Caja Madrid before Rato joined, Robson said.

“Castellanos was Rato’s confidant,” Andres Herzog, a lawyer for Union, Progress & Democracy, the Spanish political party whose complaint triggered the prosecution of Rato and his fellow board members. “They worked directly together and then tried to dress it up as best they could.”

Herzog, who has attended closed-court sessions, said Castellanos’s testimony showed he and Rato took measures to avoid conflict-of-interest laws. Castellanos told the court he delayed signing contracts to avoid rules that might slow deals.

Avoiding Delays

“You can’t delay what a client needs from you” while “the legal department intervenes to see if there is some kind of conflict of interest,” Castellanos said on a recording of his testimony.

As tumbling property prices undermined Bankia’s balance sheet, the friends set up real-estate company Paracuga SL with Pedro Pasquin, Lazard’s chief executive officer in Spain, and Joaquin Guell, a managing director at the investment bank, company filings show.

The company’s purpose was to buy property, according to the filings. At the same time, Bankia was looking to unload foreclosed homes, driving down prices. Paracuga never made any investments, Rato’s lawyer Ayala said in his statement to the court. It was dissolved on the same day Ayala notified the court of its existence.

IPO Advice

Lazard also advised Rato on the initial public offering that raised 3.1 billion euros in July 2011 to keep Bankia afloat. Retail investors bought 60 percent of the equity, the maximum allowed by the stock market regulator, as international investors shunned the deal priced at 3.75 euros a share. The stock was valued at 1 euro cent by the Bank of Spain when Bankia was recapitalized in March.

Before the IPO, Rato telephoned to pressure the regulator to accept nominees for the board as independent directors and the regulator refused because of their links to management, according to a person briefed on the conversations. Two people were left off Bankia’s board as a result, said the person, who declined to be named or to identify the rejected candidates, because the information is confidential.

Herzog’s complaint is that Rato cheated investors in the IPO by misrepresenting the state of Bankia’s balance sheet, according to the June 11 filing that triggered the judicial investigation.

Banks’ Needs

With record unemployment and an economy that is contracting for the fourth year in the past five, Spain, the fourth-biggest euro economy, may need more European money to recapitalize its banks, Charles Wyplosz, director of the International Center for Money and Banking Studies in Geneva, said in a May 16 e-mail.

Meantime, corruption allegations have reached the highest levels. Prime Minister Mariano Rajoy on Feb. 2 denied a report by El Pais newspaper that he accepted secret cash payments from the former party treasurer Luis Barcenas. Barcenas denied making the payments in a statement to Efe news agency. The PP said March 6 it is suing El Pais.

King Juan Carlos’s son-in-law, Inaki Urdangarin, married to Princess Cristina, is under investigation by a court in the Balearic Islands probing allegations he exploited links with PP politicians to embezzle public money. A spokesman for the royal family said they have maximum respect for the legal process. Urdangarin’s lawyer Mario Pascual Vives denied his client has committed any crime in a Jan. 14 submission to the court.

Socialist Scandals

The PP, founded by a minister from the last government of fascist dictator Francisco Franco, isn’t alone. Socialist Premier Felipe Gonzalez was toppled in 1996 after a string of corruption scandals. The first caja that required a rescue in the crash was overseen by a Socialist-controlled government in Castilla La Mancha province.

“The system favors people with connections, whether those are personal or political,” Victor Lapuente, associate professor of political science at Sweden’s Gothenburg University, said in an April 25 telephone interview. “There’s a belief that when someone gains power, the victor takes the spoils. This is one legacy of the dictatorship.”

The failure of Bankia, based in an iconic sloping tower known as the Gateway to Europe on the northern edge of Madrid, was the biggest ever in Spain. Rato resigned May 7, 2012, after auditors refused to sign off on the 2011 results that he published showing net income of 309 million euros. His successor, Jose Ignacio Goirigolzarri, reported a 3 billion-euro loss for the period.

Bad Loans

The bank set aside 26.8 billion euros to cover bad loans last year on top of the rescue package that paved the way for the European Union’s bailout of Spain’s financial industry.

“This was a rupture in the credibility of the system,” said Ismael Crespo, a political scientist at the Fundacion Ortega-Maranon research institute in Madrid. “People discovered that for the past few years we’d been living a giant fiction.”

Bankia was the product of a June 2010 merger orchestrated by regional PP leaders that created the biggest domestic banking group with assets of more than 320 billion euros, almost a third of Spain’s gross domestic product. The aim was to bolster banks after the property-market collapse left them with 180 billion euros of toxic assets.

Lazard earned 2.84 million euros from the Bankia IPO, court filings show. The lender estimated total fees of about 39.5 million euro, according to the prospectus, based on an offer price that was 26 percent more than the final sale price. The going rate for such a deal would have been about 60 million euros, according to data compiled by Bloomberg that show banks in Europe, the Middle East and Africa earned fees averaging 2 percent of IPO value in 2011.

Business Opportunities

There was more business to be gained from the newly merged caja.

Lazard billed 2.36 million euros for advising Caja Madrid on the merger and 1.77 million euros for advising Bankia on dividend policy, invoices submitted to the court show. It also signed an agreement on April 11, 2012 -- less than a month before Rato’s resignation -- for as much as 9 million euros after tax to seek merger candidates for Bankia.

Lazard made nothing from the final assignment as Bankia didn’t complete any deals. The lender also never paid a dividend.

Family Background

Rodrigo Rato was born into the Spanish elite as the second son of Ramon, a businessman who built a portfolio of banking and radio companies during Franco’s 36-year dictatorship that ended in 1975. Ramon was a fascist activist before the civil war, publishing the first of two books calling on Spain to ally with Adolf Hitler in 1935 when he was 27 or 28, Ramon Tijeras wrote in his 2003 history of the family, “Los Rato” (Plaza & Janes).

After the war, he also courted the royal family in exile. His connections helped him recover from a 1967 conviction for smuggling cash out of Spain and the collapse of two of his banks. On the day Franco died in November 1975, Ramon Rato hosted Deputy Prime Minister Manuel Fraga for lunch at his home before traveling to meet Don Juan, the exiled heir to the Spanish throne and the father of the reigning monarch, Tijeras wrote.

In 1977, Fraga founded the People’s Alliance, the forebear of today’s PP, with financial support from Ramon Rato, Tijeras said. Five years later, his son Rodrigo, then aged 33, was elected to represent the party in parliament in the second vote following the country’s return to democracy.

Career Path

Rato rose to become deputy prime minister and finance minister under Jose Maria Aznar from 1996 to 2004. He was in charge of the economy when the country entered the euro and then led the IMF for three years in Washington until 2007.

After leaving public service, Rato held positions on the advisory boards of Banco Santander SA, the country’s largest lender, and Barcelona-based La Caixa’s industrial holding company in addition to his work at Lazard.

The roots of Spain’s system of cajas, which accounted for about half of all lending before the financial crisis, date to the 18th century.

The cajas were mainly local institutions run by priests or bureaucrats. After Franco, they were taken over by politicians who argued they needed to be democratically accountable, according to Jose Ramon Pin, professor of public administration at IESE business school in Madrid.

For elected officials, “the chairmanship of a caja was seen as a golden retirement,” Pin said in an April 9 telephone interview. “It was total disaster.”

Caja Madrid

When Rato joined Caja Madrid in 2010, some were already on the brink of collapse. The Bank of Spain identified 100 billion euros of past-due loans on the balance sheets of the savings banks in February 2011. That’s equivalent to about 10 percent of the country’s entire economic output.

Rato inherited an institution already dominated by associates of the PP and struggling to meet tighter capital requirements imposed by the central bank. His predecessor as chairman, Miguel Blesa, was a personal friend of Aznar, Pin said.

Blesa spent a night in jail this month before posting bail of 2.5 million euros. He was last year named as an official suspect by a judge investigating fraud charges focused on a 24 million-euro loan Caja Madrid made in 2008 to the former head of the Spanish business lobby, Gerardo Diaz Ferran, who was also on the lender’s board. Blesa and Diaz Ferran denied the allegations at a December hearing, Europa Press reported.

Lawyers for Blesa and Diaz Ferran didn’t respond to e-mails and phone calls seeking comment.

Official Suspects

A Spanish judge will name someone as an official suspect when he or she considers there is sufficient evidence of a crime to merit a full investigation. Once that investigation is complete the judge decides whether to formally charge the suspect. At that point the process passes on to a trial. If Rato is charged, he will be tried before a three-judge panel, a court spokesman said.

Rato’s relationship with Castellanos at the heart of the Spanish elite dates back two decades to Rato’s time in opposition, Castellanos told the court. When Rato was in government, Castellanos controlled Expansion, the country’s best-selling business daily as chairman of Recoletos Grupo de Comunicacion SA, alongside his role at Lazard, bringing him into regular contact with Rato.

The friends set up the real estate firm, Paracuga, with their colleagues Pasquin and Guell just before Rato left Lazard. It was incorporated on Oct. 30, 2009, about a month after Esperanza Aguirre, then president of Madrid region, named Rato as a possible candidate to take the Caja Madrid post.

Bankia Advisers

Guell, who also served as chief financial officer of Recoletos under Castellanos, represented Lazard at a September 2010 meeting with Bankia executives to devise a presentation for analysts on its post-merger structure, court documents show. Castellanos, Pasquin and Guell declined to comment when contacted by Bloomberg.

As Bankia began preparing for its 2011 IPO, the bank’s executives sought financial advisers who had operations in the U.S and Europe and weren’t also bookrunners to avoid a potential conflict of interest, Rato said in his December testimony. That narrowed the options to Lazard or Rothschild and his lieutenants proposed Lazard, Rato said.

“If there was a perception of a problem related to interests, they would have told me, I’m sure,” he said to the court. “There wasn’t any conflict of interests. I didn’t then have any relationship with Lazard.”

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