There’s nothing like a sympathetic Supreme Court.

By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.

Spanish bank stocks had their best day’s trading for months on Wednesday, with the MCE Bank Index rising by 2.6%. At one point the stock of interminably troubled Banco Sabadell had soared over 13%, before settling to finish the day up 2.5%. The reason for such market exuberance was perfectly rational: After two days of deliberation, 28 Supreme Court judges on Tuesday evening voted by a thin margin (15 to 13) to strike down a previous ruling by a different set of Supreme Court judges that would have hurt the banks’ lending business by forcing them, rather than mortgage borrowers, to pay the contractual tax on mortgage loans.

It’s the first time in the Supreme Court’s history that it has flip-flopped like this, by overturning a ruling of its own creation.

What terrified the banks was the prospect of the change of law being applied retroactively, resulting in crippling legal costs and compensation. Spain’s legal system allows customers to reclaim compensation from tax authorities for cases going back four years. That could have could come at a cost of €5 billion, Budget Minister Maria Jesus Montero said on Tuesday.

In the worst case scenario for the banks, in which the ruling would have been applied retroactively to the past 15 years, the maximum limitation period for civil claims, the total bill could have run to over €16 billion — almost the equivalent of two years of the banks’ net domestic profits.

After two and a half weeks of legal limbo that had brought Spain’s mortgage market to a virtual standstill, Spanish banks have won a multi-billion euro legal battle that will calm investors, enrage mortgage customers, and inflict serious damage on the already battered reputation of the country’s judiciary.

The Supreme Court’s original decision, taken on Oct. 18, was supposed to be final, but as soon as it was announced Spanish bank stocks began falling like flies, with some hitting new multiyear lows. That was enough to prompt Supreme Court Judge Luis María Díez-Picazo to flip-flip and suspend the ruling less than 24 hours after its passage, citing the acute “economic and social impact” it was having — meaning the banks were in trouble!

But even that did little to calm investors nerves. By the middle of the following week the shares of Spain’s five largest listed banks were down 40% from January. Since then, the banks have been furiously lobbying to minimize the fallout from the Supreme Court ruling, arguing that in other European countries it’s the mortgage customers, not the banks, who pay equivalent taxes.

But even the banks were not expecting such a happy outcome. If recent statements are any indication, most CEOs had more or less come to terms with the notion that in the future lenders would have to foot the bill for the mortgage tax, which would have set them back around €650 million annually — a cost the banks could have been borne quite comfortably, especially if they passed it on to consumers in time-honored fashion.

While the banks celebrate their good fortune, public trust in government, already low, just took another big blow. According to the Spanish consumer association OCU, today’s ruling calls into question the independence of the judiciary vis-á-vis the banking sector while creating a climate of acute legal uncertainty. “Today the banks won and consumers and the rest of society lost,” it lamented.

Given Spain’s Supreme Court’s consistent, unabashed advocacy of the banking industry’s interests, perhaps the biggest surprise in all this legal fiasco is not that it has overturned a rare ruling in favor of bank customers that could have set the sector back billions, but rather that it even produced the ruling in the first place. By Don Quijones.

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