It’s Time to Stop Using Chewing Gum And Chicken Wire In Spain

“Every leg of the eurozone crisis has been marked by denial of the full scale of the problems. Whether Spain’s authorities have been deceitful or wilfully blind makes little difference at this point. The banks will need more capital; the government will need external help, with all the market uncertainty and strings attached that this implies. And the pain in Spain will only get worse”.
The top Line, Financial Times

According to reports now widely circulating the Spanish press (in Spanish only), the EU is pushing Spain hard to accept EU aid on completion of an independent external evaluation of the problems in the banking sector that is to be conduced by Blackrock Solutions and Oliver Wyman. The evaluation has been imposed on Spain by both the ECB and the EU Commission following doubts about just how faithfully the numbers published by the central bank do reflect the likely losses to be sustained by the Spanish banking system. Following this weeks revelations about the extent of potential losses in Bankia (product of the fusion of a number of savings banks, and one of the country’s largest financial institutions by assets) it is not hard to understand why.

Not only has the issue placed in doubt the capacity of the country’s political and financial leaders to handle a crisis of this magnitude, it has once more raised question marks and doubts about the adequacy of data presented in commercial bank annual accounts. What brought matters to ahead was the publication on Friday 4 May of Bankia’s unaudited accounts for 2011 wherein the parent bank BFA still valued Bankia, in its individual accounts, at book value. In fact at the time Bankia was trading at around 0.3 of BV, while listed stakes in companies like Mapfre, NH Hotels, and Indra were by no means fully marked to market. The reason the accounts remained unaudited was that Deloitte, the bank’s auditor during the time of the stock market listing, had refused to sign off on them.

In fact, not only is the bank suffering from the falling value of its property assets, it is also feeling the squeeze of the sharp fall in stock prices, which affect the value of its commercial holdings. The country’s IBEX 35 Index hit its lowest level since October 2003 this week, and with holdings which some describe as the “jewels in the bank’s crown” down sharply, bank capital has taken a hit. Bankia’s holdings include a 5.4% stake in the troubled hydrelectric company Iberdrola, which is now only valued at 21 billion Euros, some 40% down from the 35 billion Euro valuation the company had only one year ago. A back of the envelope calculation suggests this drop alone has cost the bank 800 million euros, making it unlikely that a forced asset sale of all holdings  would bring in anything like the 3 billion euros some are estimating. However hard Mr Goirigolzarri, the new CEO, struggles to put a brave face on things (“contra mal tiempo buena cara”), and no one doubts his good will, the battle in front of him is enormous. Estimates in Spain suggest that in addition to the 4.5 billion Euros in Frob loans converted into equity, the bank may need a further 5 billion Euros in capital injection, just to cover the new provisioning requirements.

Concern about how the whole financial reform process was being handled by the Bank of Spain  only grew with the acknowledgement by Bankia itself that it had renegotiated €9.9bn of assets in 2011 to avoid them from going bad. This is a practice which external observers had often suspected regulators at the Bank of Spain were permitting, but the latest revelations only confirm suspicions and raise worries that more of Spain’s  banks are  understating their problematic loans, particularly along the sensitive line which divides “good” from “bad” developer loans. Indeed, many ask how five years into the crisis there can still be good developer loans in the system once guaranteees are adequately valued .

Naturally the whole BFA/Bankia edifice is the first good example I will point to of the use of chewing gum and chicken wire in Spain, since it is hard to imagine a more complicated way of doing something that is almost guaranteed not to work. Basically BFA, the parent bank, was created as a bad bank, where the toxic property assets (largely land) of the seven participating savings banks were to be warehoused, supported by a mixture of preference shares, subordinated debt and own resources in terms of company shares, equity etc, plus a 4.5 billion euro “hybrid capital” loan from the government restructuring fund (FROB), which was to be paid 8% a year. Naturally the value of the toxic assets was bound to drop as time past, and I suppose the hope must have been to tranfer earnings from new (“better” – not “good”) bank Bankia to both offset losses and service the FROB loan. But things weren’t to work out that way (as could have been anticipated), since Bankia itself was created with its own property exposure (especially in the form of developer loans, many of which were on the point of “souring”) as there simply were not enough resources available  to wharehouse everything. And when the new government introduced a law requiring more provisioning, well it was all over, bar the large injection of public money now needed to clean up the mess. Others were given the opportunity to kick the can a little further down the road by entering a merger, and thus offseting the write-downs against capital rather than having to charge them directly to profit and loss. But Bankia was already too big, and too about to fall over, to be able to find a “dancing partner”.

Beyond the fact that what was created was a flawed structure from the start, especially given the lacklustre economic environment facing Spain over the coming years, and the ongoing downward adjustment in property values, the whole Bankia affair raises important issues. Just what did regulators at the Bank of Spain think they were doing when they gave approval not only to the bank’s business plan, but to the stock market flotation? Didn’t they realise there was a high probability of failure, and that hundreds of thousands of small savers – many of them clients of the bank itself, who were sold the idea of buying shares in their local bank on the basis of the promise that it was going to be a “great opportunity”, especially when normal deposits were paying so little – would almost certainly lose a lot of their money. Weren’t the Bank of Spain aware of just how vulnerable those “good” developer loans really were?

But the root of the problem here is not one irresponsible decision, it is a whole comedy of errors, going back to the early days of the financial crisis in 2007, and the constant declarations that due to their substantial provisioning programme, Spain’s banks were among the most sound and solid on the globe. These provisions were indeed important, but their existence and the constant comparison with the property slump of 1992 to 1995 lead regulators at the central bank and policymakers in the Economy Ministry to have a false sense of security. They were simply determined to put that brave face on, keep trying to maintain confidence, and simply ride the thing out. How many times over these years have I heard bankers lament that one day all the property assets will offer a valuable legacy for their children if they can only find a way to get through the present storm intact. Unfortunately, looking at the youth unemployment numbers, many of their children will be long gone to work in another country by the time property prices start to recover, if – looking over at Japan – they ever do.

EU Rescue Needed

In one sense Spain is too big to rescue, but in another it is also too big just to let it go to the dogs. In fact, when I say it is too big to rescue, I mean it is too big to rescue using the now classic model put into practice in Greece, Ireland and Portugal. Spain and Italy are simply too large (both in terms of GDP and in terms of population) to put under the tuteledge of the Troika in this way. The political risks of facing a runaway train are just too great. In addition taking Spain completely out of the sovereign bond market, in the way Greece, Ireland and Portugal have been, would be very expensive, and is probably not necessary.

On the other hand, if we think about it, Spain has already had a partial bailout, first via the ECB SMP (the Spain government bond purchases,which began last August), and then via the more recent support for the banking system offered by the two 3year ECB “liquidity” LTROs. According to data from the Bank of Spain, Spanish banks have borrowed something like 316 billion Euros in these offerings, of which (and as of March) some 89 billion Euros had been left with the ECB deposit facility.

Also, when we talk about rescues, it should also be borne in mind that the EU is progressively implementing a whole new set of governance procedures which will leave individual Euro Area countries with a lot less freedom to decide for themselves on key economic matters, as Mariano Rajoy discovered to his cost when he went to Brussels and asserted that his country, being sovereign, could decide its own deficit target. So rather than one dramatic intervention what I expect to see is the application of a steadily tightening set of pincers, and a growing number of controls over the freedom of action of both the Spanish government and the Bank of Spain.

In essence the liquidity measures implemented by the ECB via the LTROs have solved one problem – the difficulties the country’s banks were having financing themselves, and helped with another by enabling the banks to buy more Spain government bonds, although if the objective here was to resolve Spain’s financing issues they have been less successful, since 10 year bond yields are still constantly pushing against the 6% mark.

On the other hand the LTROs have done nothing to help with the other key issue, the lack of credit in the economy. Indeed by making it easier and more profitable for the banks to buy government debt they have arguably made it even more difficult for the private sector to obtain credit. In some ways what we are seeing is truly a form of “crowding out” of new investment projects by a combination of zombie property developers and the public sector. According to data from the bank of Spain, credit to the private sector fell for the 18th consecutive month in March – by an annual 1.7% to corporates, and by 2.7% to households.

So obviously something needs doing to resolve issues in the financial sector, since in the meanwhile unemployment only goes up – for the 60th consecutive month in March (on a seasonally adjusted calculation) – hitting just under 25%, or nearly one in four of the workforce.

While house prices, the key variable around which the Spanish economy hangs, go down and down. It is impossible to say at this point just how far they will fall, this in part depends on how many years Spain needs to get back to job creation, and how many young people leave in the meantime, but 2002 looks to be a critical level in terms of the likely impact on the mortgage book.

Part of the solution to the problem, but only part of it, lies in cleaning up the balance sheet of Spain’s banks. This is the part that Mr de Guindos is currently trying to address. The other part is the absence of solvent demand for credit, even were the balance sheet to be less encumbered, given the high levels of unemployment and corporate bankruptcy, and the low levels of income security prevelent in the current depressionary environment.

The main point which stands out is that Spain’s banks badly need to deleverage, in terms of reducing their loan to deposit ratio – a hard thing to do when all the insecurity which accompanies the crisis is leading the system as a whole to lose deposits. The loan to deposit ratio is still way to high in Spain, and the banks need to deleverage in some way or other to bring this down on aggregate – liquidating toxic property assets from their balance sheets to independent management companies would be one way to start. Simply reducing credit to the private sector wouldn’t be.

There are currently about 2 trillion loans issued by the Spaining banking sector, and about 1.2 trillion deposits. That’s about 165% leveraging. The ECB LTROs are to some extent masking this situation by allowing the banks to refinance. The only way forward is to raise savings and hence deposits, and write down loans. Otherwise, Spain’s banks may have a huge balance sheet, but be able to give few loans because one way or another large parts of it a permanently encumbered. It may, or may not, be obvious to those responsible for taking decisions, but from a macroeconomic point of view the key to achieving this balance sheet restructuring passes through having a lot more export capacity, and a large goods trade surplus.

In Ireland loans to deposits had reached 180% before the bailout. Here’s what the central bank intoduction to the BlackRock stress tests says:

“The Central Bank has agreed with the External Partners that a sustainable Loan to Deposit Ratio for the aggregate domestic banking system is 122.5%, meaning a surplus of some €70bn of loans. Deleveraging these loans will reduce dependence on wholesale funding and set the foundation for a sustainable banking sector. It will help to create smaller, cleaner banks that are capable of providing the new lending necessary to support economic activity in Ireland”.

I thoroughly agree with these Bank Of Ireland objectives, and these very same ones ought to be the objectives in Spain too. Removing the 90 billion euros in acquired real estate assets and the 400 billion in developer and construction loans (see Barcap Table below) from the books would be one huge step in the right direction, the trouble is the quantities of money required to finance this would need to come from Europe. The idea that foreign investors would put money in, if the assets weren’t priced below 30 cents on the Euro, is simply laughable.

The background to the latest episode in the crisis is that Spain urgently needs to find the finance to completely clean up its banking sector, and not come up with yet another 30 billion euro chewing gum and chicken wire provisioning job simply to avoid EU involvement. There is too much at stake for everyone now.

And if all of this wasn’t enough, the most tacky piece of chewing gum is still to come, in the form of the idea of leveraging Spain’s Fondo de Garantía de Depósitos de Entidades de Crédito to finance an asset guarantee scheme for each of the banks that buys one of the more troubled ones which have been taken over by the FROB.  The FdGdD was set up in 2011 to, guess what, guarantee deposits. I think it is worth citing the actual objectives of this organisation as set out in the Decreto Ley which set it up:

El Fondo tiene por objeto garantizar los depósitos en dinero y en valores u otros instrumentos financieros constituidos en las entidades de crédito, con el límite de 100.000 euros para los depósitos en dinero o, en el caso de depósitos nominados en otra divisa, su equivalente aplicando los tipos de cambio correspondientes, y de 100.000 euros para los inversores que hayan confiado a una entidad de crédito valores u otros instrumentos financieros.

Well, I won’t translate all the jargon, but what the Spanish says is that the Fund’s objective is to guarantee deposits up to 100,000 Euros. This is the protection most Spaniards think they have, and they do, but how much is there in the Fund to guarantee those deposits? Well, almost nothing, since the money has been spent on paying off the FROB participation in CAM and UNIM when they were sold to Bank Sabadell and BBVA respectively, for 1 Euro in each case. And why was the financing of the operation done in this peculiar way, using a Fund whose intention was to guarantee deposits in case of bank failure? The answer is obvious, it was done in this way due to the high priority given by Mr de Guindos and the government he represents to trying to maintain that no public money is being put into banks. The FdGdD is financed by a 0.2% levy on bank deposits, and it is the income stream from this levy over the next 8 years that “experts” in the Economy Ministry are now reportedly thinking of securitising in order to pay for the coming Asset Guarantee Schemes. The banks are going, Baron von Munchausen style, to pay for their own clean up. Clever isn’t it? So now you see why the I said the chewing gum in this case was particularly tacky. Yet one more piggy bank has now been raided, and the only guarantee for deposits will be the Spanish government, which itself has trouble financing. You see why I say they need to get into an EU harbour, and quickly.

Indeed such are the lengths to which Mr de Guindos seems prepared to go to fool all of the people all of the time when it comes to whether or not public money is being spent that last Friday he even burst through what the FT’s John Dizard calls the Harold Wilson standard for  public doubletalk and evasion. The British Prime Minister, it will be recalled, told the British public that even though the Pound Sterling was being devalued by 14%, the pound in their pocket would not be affected. Well Spain’s Economy Minister has now gone one better. To an astonished group of journalists at last Friday’s government press conference he calmly explained how the new bank provisioning rules would not mean that any public money was being spent, since in the first place the estimated 15 billion Euros that FROB would inject into banks who couldn’t manage from their own resources would be in the form of a loan at a penal rate of interest (and this is supposed to help them), while in the case of Bankia the existing FROB loan which was being converted into equity wouldn’t be an injection of public money, since – drum roll – the money had already been leant to the bank. How you square these two statements, well, you’d better ask Mr de Guindos that.

How Big Is Big?

So, if the extra 30 billion Euros in provisioning is but a drop in the ocean, how much do the banks really need? Well the prestigious Brussels based think tank CEPS came up with a 250 billion Euro number during the week, and since they are not only geographically but intellectually close to the Commission, it wouldn’t be unreasonable to think this number isn’t far from what EU policymakers have in mind. Certainly 200 – 250 billion euros seems to be in the right ballpark, especially when you take into account not only the problematic developer loans, but also the stock of properties on bank books, the need to help householders who will increasingly struggle to finance their mortgages and the growing numbers of small and medium sized enterprises facing bankruptcy.

Over 1.5 million housholds in Spain now have no one working, and have exhausted their unemployment benefit entitlement. They simply live from savings, family support and the 420 euros a month minimum payment. Clearly it is hard for such people to meet there repayment commitments, and their number is growing. Finance Minister Noonan deliberately over capitalised the Irish banks because he could see this problem coming – even though even in that case more may now be needed –  and it would be a good idea for Spain to follow his lead. Spain’s banks have more than a trillion euros in property-related assets, and simply deriding those who are pointing to the potential problem this constitutes by suggesting doing this is  stupid because “mortgages get paid in good times and bad”, as Santander CEO Alfredo Saenz did recently, seems to me to be just another case of the kind of Spanish bank denial the country now needs to put behind it.

Then There Is The Deficit Issue

According to one popular current of opinion the Spanish economy is now rebalancing nicely, competitiveness is being steadily restored while exports are going well. The strange thing, if this is so, is how the economy continues to go so badly. Even though undoubted progress has been made with the trade and current account deficits, and exports have improved, there is obviously still a long hard road to travel. Indeed, in general terms the situation is worsening, and we face two years of recession at least, while 2011 saw very modest growth.

I don’t suppose the continuing rise in unemployment and the ongoing fall in house prices have something to do with the way this bad outcome continues to go on and on.

On the “things are steadily improving” kind of view there is only thing, apparently, which is standing in the way of full blown recovery, and that is the lack of investor confidence. This, apart from limiting inward investment, is behind  the rising cost of financing government debt (the huge quantities of money the commercial banks need from the ECB – 220 billion Euros in March -apparently isn’t that much of an issue to worry to much about in this context). So Spain needs help from European partners to bring down borrowing costs on government debt, then all will be well, and “comeremos perdices” (we will all live happily ever after).

The question I ask myself is which world these people are living in. The biggest source of increase in government borrowing costs comes from the rapid growth in the size of the debt. So why is the debt growing so quickly? Aha, that must be a trick question, since normally the argument gets stuck precisely at this point.

The sad truth is that despite all the marvellous progress, the root of the problem still lies in the fact that Spain’s economy still isn’t sufficiently internationally competitive for the export sector to grow fast enough to pull GDP growth forward. Blaming the problems the periphery economies are having on a negative external environment is to miss the point, since the real issue here is why some countries are able to maintain some semblance of growth even in this context while others collapse into full blown recession. The only explanation can be that those who don’t fall back at the first hurdle are better able to survive in the negative environment because they are more competitive. People can show me all the charts they want showing what magnificant progress has been made on unit labour costs, etc, etc, but the real Northern Blot test is this one: who is growing and who isn’t?

So while earlier levels of government spending which are now unsustainable steadily retrench, and the private sector deleverages from all that accumulated debt, the economy struggles constantly for breath, with the result that attempts to reduce the deficit prove to be a source of eternal frustration as revenue constantly falls faster than expected.

In this context it is hard not to see the latest EU forecast for Spain as an attempt to pile on the pressure, and force the country into some sort of rescue, and indeed this is how it is widely interpreted in many parts of the press.  The Commission said that without additional measures the country is set to have a budget deficit of 6.4 percent of GDP in 2012 and 6.3 percent in 2013, way above the agreed Stability Programme targets of 5.3 percent and 3 percent respectively. The 5.3 percent figure was itself an increase from earlier commitments, agreed with Spain’s new government to give it some leeway. So it looks very much as if by drawing attention to the country’s difficulties in the way Europe’s leaders are trying to get the Spanish ones to see sense and come in and talk about things, and especially the needs of the financial system.

This looks doubly true when you take a hard look at the numbers for growth and gross debt, since the EU expect Spain to have a 1.8% GDP contraction this year followed by a 0.3% one next year. They also expect the recession to be at its worst in the second half of this year as the already-in-place austerity measures really start to bite, following the respite Spain leaders allowed themselves for the Andalusian elections in the first half.

Government gross debt, on the other hand, is expected to continue to rise, hitting 87% of GDP in 2013. This is getting near to the kind of numbers I was talking about in my recent post on this topic. Some of the unpaid bills have now been factored in, how many are left we will have to wait for future publications of the financial accounts to see. There is still of course the debt hanging about on the books of state owned companies like railway operator RENFE or airports controller AENA  (maybe another 5% of GDP) to be consolidated, and resolution of this will become especially important if any of these are ever to be privatised, as the government has said is its intention.

But more importantly than this I would draw attention to two additional  factors people need to think hard about, and these are the longer run impact of additional costs in the financial sector, and the consequences for Spanish debt if the country hits a bout of Japan style deflation  at some point. Both these risks are hard to calculate, but they do exist nonetheless. The Commission forecast is based on a no policy change assumption, which means they have not projected any additional impact on the debt of financial system reform. There will undoubtedly be some, but how much is a hotly contested issue, with estimates ranging from 5% to 20%. Given that everything we have seen in Greece, Portugal and Ireland suggest numbers suddenly go out when national accounts are subjected to intense scrutiny I would veer towards the higher end,  especially given the recent debt/deficit revelations together with the now known inadequacies of Bank of Spain public reports.

The second, the impact of low growth with deflation or strong disinflation with negative growth also seems to be a scenario which is not widely contemplated, but which has a probability well above zero. Indeed, in this year’s projections for gross debt increase this factor is already at work, since nominal GDP will likely shrink (lowering the denominator in the calculation). If GDP falls by 1.9% and the GDP deflator only rises 0.9% then debt automatically rises around 0.9% as a percentage of GDP. What is hard to quantify is how important this factor might be between now and 2020. Certainly raising competitiveness implies disinflation/deflation while lack of competitiveness, debt and fiscal adjustment imply near zero average growth over a number of years, and, as we are seeing, more frequent than normal recessions.

Then there is another item I touched on in my recent Spain debt report, the impact of outstanding pension liabilities on deficit reduction efforts. In fact the Commission itself have explicitly singled this issue out in their forecast.

“Whereas the (5.3 percent) target of the central government should be within reach, deviations are projected at this stage for regional governments,” the Commission said. “Moreover, the social security system is projected to record a deficit again this year in line with a deteriorating labour market outlook.”

I will come back to the regional governments issue in a minute, but let’s think about the other item, the social security system. I went into all this in some depth in my debt post, but basically Spain has a problem that as the economy deteriorates, fewer and fewer people are paying into the pension fund, while more and more people are retiring. In addition, more people are becoming entitled to pensions than are dying, and those who retire tend to be entitled to a significantly higher  pension than those who expire. Hence there is a growing annual deficit. The problem is structural, and not simply cyclical, given the ageing population phenomenon, but it is also doubly structural given the fact that any early recovery in employment is not to be anticipated.

Now normally, what would happen in these circumstances is that the social security system would dig into the reserve fund to cover the differences for a time. But, aha, this is just the issue, since the fund, which currently has a nominal 65 billion Euros in it, really has very little, since now something like 90% of the investment which has been made has been in Spain government bonds (see pie chart below), and due to the complicated accounting rules of Eurostat these bonds to not count towards EDP Spanish debt, unless, unless – wait for it, drum roll – they are sold externally, to a non government third party. In this latter case they raise liquidity to help pay pensions without impacting the deficit, but they do add to debt. So here comes another 5% debt to GDP at some point, not to mention the loss the fund may have to take in selling, and in the meantime (ie before a decision to bite the bullet is taken on this) the shortfall rows in the opposite direction  to attempts to reduce the deficit.

Obviously this is another case of chewing gum and chicken wire accounting, and it puts me in mind of the little child who tries to save money in a variety of piggy banks, but each time he/she wants an icecream or a visit to the fairground she takes some of the money and leaves an IOU. Hemmingway reportedly said the bankruptcy creeps up on you slowly at first, and finally seizes you all of a sudden. I guess it is due to the operation of this kind of process, with widespread recourse to robbing Peter to pay Paul accounting.

Spain’s Regions
Spain’s regions are widely held to be behind the “uncontrollable” deficit story. To some extent I have already gone over the topic in this post, and Raymond Zhong adds a local Catalan perspective here, but still, lets have a quick run over some of the ground one more time. The story so far was offered by EU Commissioner Olli Rehn at the economic forecast press briefing:

“The Commission has full confidence in the determination of the Spanish government to meet the fiscal target in line with the pact. For Spain, the key to restoring confidence and growth is to tackle the immediate fiscal and financial challenges with full determination,” Rehn told a news briefing.”This calls for a very firm grip to curb the excessive spending of regional governments.”

The real question, however, is whether this overspending stems from the decentralised structure in and of itself, or is largely a consequence of the kinds of areas which the regions are responsible for together with the extent to which the central government itself adequately provides finance for these.

Obviously everyone has their favourite unnecessary airport story, and it is clear that during the boom years there was massive and irresponsible overspending. But it is important not to get carried away with all this. In a way I don’t consider either the regions or the town halls to be the big culprits here. They are victims in the same way many ordinary Spaniards are. That is to say they are the victims of their own ability to borrow and spend during the good times without thinking about the future.

But they are not the big players in the Spanish story, and the issue in Spain is mainly in the private and not the public sector. Public debt is rising uncontrollably because the economy is bust, which is very different from, say, Greece, where the economy is bust because government debt is rising uncontrollably.

On the other hand I do think the way the Partido Popular  are leveraging the regions’ situation is interesting, along with the growing power-elbowing going on inside the PP itself. President of the Madrid Autonomous Community  Esperanza Aguirre – a leading figure on the right of the PP, and a key actor in the background to the Caja Madrid/Bankia saga – has been out and about of late, campaigning for more centralisation. Now this – given her declared ideology – was not surprising, what was surprising was what she wanted to centralise – education, health and justice. What she didn’t want to do was abolish 15 of the 17 regional parliaments, which is one of the things many observers consider could help. There is duplication of politicians all across Spain, and not all Spain’s regions have a separate national identity like the Catalans and Basques do. Letting these latter two retain their poitical autonomy while centralising the rest of Spain would seem like national minority favouritism to the majority of Spaniards, so it is seen as politically undoable. But if a government had sufficient will it could happen. The UK has a decentralised health service without the need for so many parliaments, and it seems strange to me that someone wants to leave the parliaments and centralise health. Only Wales and Scotland have parliaments. Does anyone else smell a political agenda being advanced here?

The same thing goes for many of Finance Minister Montoro’s proposals. Most of them are perfectly reasonable as techniques for getting spending in hand, but they end up leaving me with the feeling that he is just itching to get inside Andalusia (controlled by the opposition PSOE) and Catalonia (where the government is lead by the nationalist party CiU) and start laying the law down. Since some of the worst cases of extravagant overspending have been in regions contolled by the PP itself (like Valencia, which nearly had to go bankrupt around Xmas) it will be interesting to see just how impartial his actions are at the end of the day.

But the key point to “get” is that Spain’s regions have a spending problem due to the competences they have – like heath, education and care of the elderly – which account for over 50% of their budgets (in Catalonia this year they amount to nearly 70% of the total). It isn’t simply a question of them being spendthrift in these areas, but rather it is Spain’s demography that is working against them. A growing elderly dependent population – ten years from now Spain could be the oldest country on the planet – means the health budget rises every year (possibly by 3%) just to offer the same level of care, while the recent influx of immigrants pushed up the birth rate and lead to more demand for education. This latter phenomenon, while being one of the keys to the solution in the long run, only adds to the country’s problems in the short term since the dependent population is rising at both ends of the age scale. Now the crisis has once more reversed the birth trend, and new intake at the infant level fell last year for the first time in a decade, but it will still be another decade before the knock-on effect works its way through. Leads and lags in demography are much longer than in normal economics.

So the problem is not the regional structure, arguably this is a much better way to organise service provision, but entitlement, which is often decided at the national level, and which is often derived through rights guaranteed via the country’s constitution. Central government passes laws, which underfunded regions then have to pay to implement. Take the new Care Law, which ratings agency S&P’s warned in 2010 would lead to growing pressure on regional finances. This provides entitlement to assistance in the care of an elderly dependent relative or disabled person, it provides entitlement but it does not provide funding, which the regions have to find from their already overstrained budgets. And this is the main complaint you will hear from the regions, that they are systematically underfunded in a way which makes central government deficit figures look a lot better, and their’s a lot worse. This is one of the key reasons that Catalonia is pushing for its own tax agency, so that it can raise the revenue itself – as the Basque region already do – and then forward to the central government what is agreed to each year.

So central government also needs to be more responsible. Spaniards have been lead to expect world class health care, and while this was possible during the boom years, it isn’t now, given the economic slump and the growing demographic headwinds. But someone has to tell Spain’s voters that their pensions, health support and aid for their elderly relative is going to be reduced, and since no one has the courage to come forward and do this we have the “regional overspending” issue on the table.

Austerity Weariness In Spain?

I think austerity and why it is necessary is largely misunderstood in Spain. No one likes pain, and it is nice to think that there is a way out of all this that is relatively painless. The fact that the insistence on austerity comes from Germany adds to the problem, since it only serves to highlight a religious fault line that has long divided Europe.

Next Tuesday will be the first anniversary of the foundation of the 15 May movement (known colloquially as the “indignados”), and young (and not so young) people are demonstrating this weekend in cities all across Spain. There are no burning rubbish containers for the international press to photograph and the marches are largely pacific and earnest in their expectations. My feeling is that they are quite similar in composition to the supporters of the Greek Syriza movement, who did so well in the last elections in that country. And with the Bankia scandal ricocheting around Spanish public life, and the government unable to identify anyone especially responsible for the mess, anger and indignation is growing even among the PPs own supporters, many of whom were enticed into buying Bankia shares.

Part of the problem is that this situation has all become so complex that it is hard for people to understand. There is the Euro, the developed economy debt, the rise of emerging markets,China and, just to confuse things further, plummeting house prices. There is little in the way of employment opportunities, and young people are being forced to leave in growing numbers and look for work abroad. To cap it all, Spaniards are now having to drive along their motorways at night in the dark. “Who turned the lights out” is the question they are increasingly asking.

Naturally arguments and countearguments abound – would, for example, Eurobonds hep? Some say they would, while other experts are totally opposed. The dividing line between political opinion and technical expertise has become totally blurred. The layman or woman has no way of making a decision over many of the issues presented. What we do know, however, is that popular sentiment will eventually tire of making sacrifices and seeing no progress. This is the key factor which makes me fear demagogic outcomes.

The situation in the United States is often contrasted with that in Europe, but it is far from clear that the US economy has actually recovered. This is an election year, and double digit deficits are still permitted, but what about next year? Somehow I doubt even the United States will be able to avoid its own share of austerity.

The recent general strike was understandable on the one hand, people are feeling frustrated, and sense that austerity alone won’t work, but on the other the idea that the answer is more government spending also isn’t too convincing. Japan has had expansionary fiscal policy for over a decade now. We have seen little in the way of sustainable economic recovery there, but we have seen a huge explosion in government debt. Is that an advisable path to go down? Is Japan stable in the longer run? There are too many questions lurking here to buy the simplistic solutions. Once you strip the anti-austerity arguments down, they are based on an idealisation of the US and Japanese experiences.

So Where Are The Long Run Solutions?

Well, my opinions on the solutions front haven’t changed much in recent weeks. The scenario I outlined in my Wolfson prize submission is still my baseline expectation.  I think there are no perfect solutions, we are in the midst of a huge demographic transition which compounds the debt crisis due to its impact on population pyramids, on growth rates and on what is sustainable and stable in the longer run in terms of public spending. The Euro is not the root of the problem – which affects all developed market economies to a greater or lesser extent – but it is certainly an aggravational element. That is to say, the countries on Europe’s periphery could be a lot more effective in confronting the problems they face if they weren’t in the Euro, but they are, and we need to live in this world, not some imaginary one that would be a lot nicer. Leaving the Euro would be an option if it could be consensually agreed, with a sharing of the collective losses, but this isn’t going to happen, since core Europe won’t agree.

On the other hand, the austerity measures are dividing Europe down the middle, and the continents democratic foundations are being shaken. Hungary is an even clearer example than Greece. The Euro is a kind of Doomsday Machine which is neither stable in itself, nor can it be dismantled. As I have often said, whom the gods would destroy they first make mad. Funny how that is a phrase which has its origins in Greek literature.

Having said all of that, we here in Europe could be doing much better than we actually are. A common fiscal treasury and joint and several Eurobonds on their own won’t entirely resolve the difficulties countries like Spain find themselves in – due to the existence of the competitiveness and growth problem – but both of these certainly would help. Another alternative would be a structural change in the Eurozone – dividing the Euro in two, for example. But, anyway you look at it, losses need to be crystalised, and shared, and hard core Europe isn’t ready or willing to talk about this. And so we head for disaster.

While the attitude to Eurobonds could change following elections in France and Germany this year and next, I am not optimistic that the changes will move fast enough and deep enough to bring that much needed  relief. And meantime the “high noon” moment is fast approaching in Greece.

Democracy is coming under threat along the periphery as people become steadily more and more frustrated and search for alternative “unorthodox” policies that can offer a miracle cure. As Paul Krugman said in a New York Times Op-ed recently, “The question then was whether this brave and effective action (the ECB LTROs) would be the start of a broader rethink, whether European leaders would use the breathing space the bank had created to reconsider the policies that brought matters to a head in the first place. But they didn’t. Instead, they doubled down on their failed policies and ideas. And it’s getting harder and harder to believe that anything will get them to change course”.

And Whither Spain?

In the Spanish case doing a bank recapitalisation which wasn’t just based on working back from the number the country could manage to fund unaided would help a lot. The bank balance sheets need freeing up so the commercial banks can go back to their more normal activities, and help that part of the company sector which is able to grow and create employment. A large sum of money needs to be injected, and this can only come from a common European effort. Having the Bank of Spain accept two external valuations of bank assets and likely losses under a variety of scenarios is a step in the right direction. Having European auditors installed inside both the Ministry of Finance and the Bank of Spain would be another, given the doubts which have been raised about how Spain packages sensitive data for public consumption. Europeans who put their money in need some sort of guarantee about the effectiveness of implementation.

On the political level, Mariano Rajoy’s leadership is obviously wobbling. This was always coming, but I hadn’t seen it happening so quickly. But then I hadn’t forseen the mediocrity of the present Spanish administration, and the difficulty they would have speaking with one voice. The latest performance surrounding the Bankia crisis, with Rodrigo Rato saying one thing (that he was forced to go) and Luis de Guindos saying another (that he wasn’t) while the government have still not “detected any reprehensible behaviour” in the whole affair simply serves to underline the country’s lack of credible leadership – a factor which only makes Europe and the markets even more nervous. Manuel Arias Maldonado, politics professor at the University of Málaga summed the situation up in a quote in a Financial Times article recently, “There’s no single voice explaining clearly to the citizens what’s going on,” he told Spain correspondent Victor Mallet, “I think Rajoy lacks the qualities needed for this job – to be self-possessed and clear, and to transmit the confidence that is needed now.”

Basically this administration has easily excelled the last one in its ability to contradict itself. Perhaps the best recent example was that of Jaime Garcia-Lehaz, Secretary of State at the Economy Ministry, calling for ECB intervention with bond purchases almost exactly the same time as Mariano Rajoy was in Poland arguing that Spain could manage on its own. “Talking about a rescue makes no sense”, he told his audience, “Spain is not going to be rescued, Spain can’t be rescued. There’s no intention, and no need and so Spain will not be rescued.”

The bickering between PP aparatchick and Finance Minister Cristobal Montoro and the far more independent Luis de Guindos has been constant, and the big fear investors have is that the Economy Minister is not able to carry through the sort of financial reform he must be able to see Spain needs due to his being overruled by the Finance Minister, who is much more sensitive to what accepting a bailout and injecting public money into the financial system would do for his party’s electoral outlook. 

Again arguing in public about the actual size of last years deficit didn’t help. But surely the turning point in the perception of this government  came when Mariano Rajoy went to Brussels to give press conference asserting his country’s sovereignty and his ability to decide his country’s budget for himself. The irony, of course, was that he was in the EU capital to sign an agreement for greater cooperation between Euro Area member states, and he completely omitted to inform his peers of his intentions, thus highlighting the ineffectiveness of the measures being agreed to. The end result was to put in question both his abilities and judgement and the capacity of his country to fulfil its deficit targets. Since that day he has been fighting hard to recover lost ground.

Previously my hopes would have been on what people in Spain call a new version of the Pactos de la Moncloa, these were the agreements reached between all Spain’s political parties and social partners in 1977 (with the King playing a decisive intermediating role) and laid the basis for the framework of the new Spain following the ending of the Franco dictatorship. I say previously because, apart from the apparent absence of anyone with the calibre and moral authority to lead the country in this difficult moment, a recent unfortunate accident in Botswana has effectively ruled out one of the key participants.It is hard not to get the feeling that Spain is “jinxed” right now, especially with Cristina Fernandez also deciding now is a good moment to start a vendetta with the country.

If at first you don’t succeed…………….

In the meantime, this is now the fourth attempt at financial reform since the crisis started, and it surely won’t be the last.  “All the previous efforts have been announced with a drumroll and a big clash of cymbals but they weren’t credible in the end,” Javier Diaz-Gimenez, an economics professor at the University of Navarra’s IESE business school in Madrid told Bloomberg news.

Dare I say it, the current proposals run the risk of suffering the same fate as all the earlier ones. There is a difference though, previous reform efforts had been based on working backwards from the level of provisioning the banking system could provide without breaking it. This one is based on a reverse engineering calculation about how much provisioning the Spanish state can afford to support without going to Europe for help.

What is needed now, however, as Europe’s leaders are demanding, is a full, frank and independent assessment of the true extent of the provisioning needed to withstand a realistic shock scenario – real estate prices hitting 2002 levels and staying there, unemployment over 20% till the end of the decade, Spain’s population falling by 2 million young people as they leave due to lack of work, etc – and then go and get the EU to provide the funds needed – under conditionality of close and constant EU inspection of Spain government and Spanish bank numbers, this is the only way to now get credibility back, and this way Spain could really demonstrate it is making the progress it claims to be making.

As a friend of mine said to me yesterday, the goalposts are moving, and that is good, but they still have some way to move yet awhile. Simply allowing Spain’s reform efforts to degenerate into a debate between PP and PSOE about who is more responsible for the Bankia mess – Mariano Rajoy and Esperanza Aguirre (PP leaders who put Rodrigo Rato at the front of Caja Madrid) or Bank of Spain governor Miguel Angel Fernandez Ordoñez (a card carrying PSOE member, and former aide to Pedro Solbes in the 1990s) is a childish and stupid waste of time. All of Spanish society is somehow implicated here, since almost everyone either actively or passively (by not allowing themselves to see what they should have seen) has participated in the charade. Blimey, only a couple of months ago the Spanish press were even leading their readers to believe that BBVA in buying Unim were grasping a good business opportunity. And almost everyone was trying to argue that Spain is not Ireland, let alone Greece. Time will tell, but the bank numbers now look more and more like Ireland, while the statistical issues increasingly resemble Greece, even if the difference between Spain and Greece is that Spain’s bankers and politicians do know perfectly well what they numbers are, they simply don’t want to admit them in public.

Going back to gum and chicken wire, I remember reading in the report on the Three Mile Island nuclear accident, that in the run-in to the problem maintenance had either been neglected or was completely ad hoc. The archetypal example for this was the discovery that a hole in a cooling pipe had been plugged using a basketball. There you go Mr de Guindos, that’s the missing link in your chain of half-thought-out botched jobs, go find a basketball!

This post first appeared on my Roubini Global Economonitor Blog “Don’t Shoot The Messenger“.

This entry was posted in A Fistful Of Euros, Economics, Economics: Country briefings by Edward Hugh. Bookmark the permalink.

About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

42 thoughts on “It’s Time to Stop Using Chewing Gum And Chicken Wire In Spain

  1. Jeronimo: Why is it important? Edward Hugh wrote about Spanish economics and banks decades before he became a board member at CatalunyaCaixa, and he became a board member, before the bank was taken over by the government. I don’t see a difference in his writings before and after these events.

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  3. It is very disturbing to read Edward´s ignorance about Spain for someone that lives in Spain. For example this thing he says that there is no “national identity” in regions other than Cataluña or the Basque country. I mean Valencia was an independent kingdom, as were Leon or Navarra. Something that Cataluña or the Basque country never were. In Galicia they speak their own language. And so on and so forth. But one has to listen to this mumble.
    My mention of his membership of Catalunya Bank board is important: he mentions how politicians and not technocrats have been placed in bank boards. In Edwards bank out of the 14 members of the board only one (!) has been seated by the central government, the owner of 100% of the capital. The rest, including Edward, were placed following political localist interest. Yet he does not mention this case as a prime example of his criticisms.
    His articles are as always just too long to answer point by point, but there is nonsense in almost all paragraphs.

  4. Maybe, Jeronimo, you’re are not that experienced in taking things as they are written, so you’re fighting against gianst where only windmills are. Let’s take only the one example you quote.
    You say: “He says that there is no “national identity” in regions other than Cataluña or the Basque country.”
    Edward Hugh has written:
    “Not all Spain’s regions have a separate national identity like the Catalans and Basques do.”
    That’s true e.g. for Andalucia, the region I know best: it has no separate national identity. Maybe we could argue about Valencia or Galicia, but that’s not the point: The point is that you have quoted Edward Hugh incorrectly. That doesn’t make me too fond of waiting for the “nonsense” you claim to have found in the article.

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  6. Detlef Guertler,
    Really there is no need for your to brat about your ignorance of spanish history and sociology. Andalucia has had an independentist claims for as long as the Basque country. Since XIX century. You could just have checked in the wikipedia:
    You can certainly have the same argument, as you say, about Valencia, Galicia, Aragon, Asturias, Leon, Navarra, the Canary islands,… Maybe your knowledge about Andalucia as deep as you claim it to be is very superficial.
    Please understand what I am saying: this does not mean that people don´t feel that the whole country is their´s. The whole of Spain. I am Basque and feel that I have soveraignty on cataluña and on the rest of the spanish regions. But please do not tell me that there is not a national feeling in other regions than cataluña or the basque country.

  7. Gosh. History. The Partido Andalucista gets less than 3% at the regional elections, there’s no school in Andalucia where they claim to teach Andaluz instead of Castellano, and the people and the politicians are as far from declaring their independenca from Spain as far can be.
    And concerning your last phrase: I did NOT say that. Neither did Edward Hugh.
    Of course you (and I) might feel sorry for all that rubbish and debris that people like Hugh find all over Spain. But (as the title of his column at Roubini’s econoMonitor is called) Don’t shoot the messenger. Start cleaning the country and its banks’ balance sheets.

  8. Edward says that there is no claim to “national identity” and there certainly is.
    Of course there is no school of andalusian. Man, there is not such language! Would you say that there is no Argentinian “national identity” because they speak castellano? or no Canadian identity because they speak english?
    Read again the article from the wikipedia. It is very basic but you do not seem to grasp what it says. Is not the electoral results of the Partido Andalucista, the national feeling is embroided in all parties in the spectrum. Other nationalist parties present their list in coalition with central parties.
    I am not sorry about the debris that Edward claims to find in Spain. Im am sorry about his ignorance and his lack of understanding of the realities infront of his eyes. I do not shoot the messenger, I shoot the message. I am sorry about the readers that might think there is any truth in what he writes. I am sorry of how bended his arguments are.

  9. So we are talking economics and banks in particular. So here is another example of Edwards misleading arguments: he says that spanish banking system is becoming very much like the irish one. Now, do you know in relation to its GDP how much money has Germany, France, the UK or Belgium spent propping up their financial system, their banks, since 2009? Make a wild guess. You´ll find that none of those countries have spent less than double what Spain has spent so far. Some of them, like Germany or the UK have spent four times as much.
    Before being like Ireland, Spain will have to be like France, then like Belgium, then like Germany and then like the UK. Then we will see. But why wait, Edward tells us, lets jump the queue.

  10. Castilian spanish!
    Always so obsessed with the spanish unity! It’s impossible to talk about the differences in Spain…! Cofee for everyone without asking if you worked in there, the union of mediocres is better for him than the justice of effort. That’s the cultural reason of the non productivity.

  11. Interesting question, Jeronimo, how many “national identities” will arise on the Iberian peninsula, as soon as the Kingdom of Spain disappears under its debt burden. 5? 10? 17? How many different nations, countries, populations will they form, how many different languages will they have, how many wars will they fight, before we get a new equilibrium?

  12. Hello Jeronimo,

    Nice to see you are riding my tail as ever. Yes, I am on the Board of government owned Catalunya Caixa. Does that mean I should shut up? Is that how you think things should be done in Spain?

    Naturally I can’t talk about the specific affairs of Catalunya Caixa, because I would be breaking the law, since as a board member I have access to priviledged information. So, as you well know, I only cite public sources like the Bank of Spain, or the INE, of the Spanish Economy Ministry. I am revealing no state or bank secrets.

    But are you saying that Spain would be a better place without people in positions of responsibility airing their concerns in public? Is that your point?

    I would also point out that I was brought onto the board as in independent expert after the Caixas involved got into the mess they are in, not before. Do you think people should not try to clean up the mess, and simply let banks fail? Is that your point? As I make clear in the article, I want to see the Spanish banking system brought back into a state where the economy can give credit, and people can be put back to work. I think Spain needs European help to do this, and hence this is what I am arguing for.

    You are perfectly entitled to your assessment that the 30 billion euros now on the table is enough, I simply disagree, and fail to see how the fact of being on a board influences this one way or the other.

    Bottom line, do you think more bank executives or less should speak out as I do?

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  14. Actually Jeronimo, this is just wrong:

    “My mention of his membership of Catalunya Bank board is important: he mentions how politicians and not technocrats have been placed in bank boards. In Edwards bank out of the 14 members of the board only one (!) has been seated by the central government, the owner of 100% of the capital. The rest, including Edward, were placed following political localist interest”.

    This may have been how things were before the FROB were first brought in, but I was brought in after, as an independent expert with no political ties. In fact, directly or indirectly I have given advice to all the main parties in Catalonia. Of the present board – which was reconstituted after the nationalisation and creation of a bank (before this it was a caixa) – four members represent Catalunya Caixa Obra Social (the former Caixa), five are totally independent experts – like me – chosen between the FROB, the Bank of Spain, and the bank management, two work for the bank itself and three represent FROB, although those there only have one vote, which constitutes 95% of the total due to the size of their share.

  15. And this:

    “It is very disturbing to read Edward´s ignorance about Spain for someone that lives in Spain. For example this thing he says that there is no “national identity” in regions other than Cataluña or the Basque country. I mean Valencia was an independent kingdom, as were Leon or Navarra. Something that Cataluña or the Basque country never were. In Galicia they speak their own language. And so on and so forth. But one has to listen to this mumble”.

    Is very typical of what you will hear generally from people in Spain, opinions that we in Catalunya have to put up with. Basically the point I am making is there are 17 regional governments and not two because each region wants its own (so Catalunya and the basque country doun’t enjoy some special priviledge), even though they do not want to have in their autonomous statute a claim to having a separate national identity, and there is no real need for them to have a parliament. People in Yorkshire have a very strong accent and a strong personality, but very few would claim they were a separate nation. This silly bickering is what is splitting Spain apart.

  16. Jeronimo

    You keep missing the point of the article it is about the banking mess in Spain not nationalism or Edward Hugh.

    Your point about UK and Ireland bailout costs is silly. These countries recognised the problem and tried to fix it (at great cost). The big problem here in Spain is denial of the size of the problem and what it will costs to fix.

  17. solutions:
    eurozone – fiscal transfers under the aegis of a directly-elected eu presidency
    demographics – raising the retirement age in line with life expectancy
    western stagnation – public investment, especially in infrastructure
    china – democratic transition plus privatisation of soe’s
    japan – stop trying to prop up industry, sit and wait

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  19. Hello Edward,
    Three comments so I will answer them one by one,
    1st, I am sure you know about the straw man fallacy. Why do you put words in my mouth and answer them and not what I actually said?
    I did not make any assessment on wether 30 billion would be sufficient. I did not even mention any amount.
    I did not say that people in responsibility should not air their concerns, on the contrary I said they should disclose their knowledge.
    I have never doubted your good will. I hope you don´t doubt of my own.
    Breaking the law? come on please! Are you doing it now then? I just pointed you should disclose for your readers something that is public record, affects you and is related to the question you are dealing with.

    2nd, yes, as pointed out (by me!) the FROB (the owners of the bank!) only have one vote in the Board.
    Just as you are happy to inform your readers how mr. Rato (the ex-chairman of Bankia) is a member of Popular Party (apart from being ex-president of the IMF) which he is, why don’t your tell us how many of the members of that board have a long history associated with CiU (the controlling party in catalonia for decades) I started counting and stopped at eight, but just because I was tired.
    You, as an independent advisor, bring the pride of your catalan feelings and a long list of doom economic blogging. No experience in banking, in having been member of any board of any kind previously or having ever run any business what so ever for that matter, or any academic record, any books written, anything. But you have good powerful nationalist friends. To some you might look just as a puppet with those credentials.
    3rd. Oh, Edward, I know, bickering is only when others do it. So you are complaining that I say that Catalans aren’t that special. Isn’t that bickering too?To make your point you have to invent that people do not want their own regional parliament, so lets get rid of them. Except the Catalan one, of course.
    Yorkshire people do certainly have a strong accent. But Yorkshire has never been an independent kingdom as Valencia, León, Aragón, Navarra have been. (Catalunya or the Basque region haven’t either for that matter) or has never had any historic claims for independence as Galicia, Andalucía, the Canary Islands, Murcia,… or have their own language like Asturias, Valencia, Balearic Islands, Aragón (did you know that Euskara comes from Huesca in Aragón?)…
    Coincidentally you do also have a strong accent, when you don’t speak english (could you point me towards anything you have ever written in spanish, in catalan or in welsh (your home land tong) or are you still not that confident in the breath of you vocabulary or the mastery of the grammar in those languages) and that does not preclude you from having a national identity.

    Now I will make my straw man: Are you saying I cannot criticise your, in my opinion, outrageous claims on spanish sociology, economy and politics, because that is ridding your tail?

  20. Mr. Hugh, who´s interest are you representing with this article? When I hear that companies like BlackRock Solutions and Oliver Wyman are conducting external, “independent” evaluations of troubled Spanish bank´s real estate holdings, I can smell already that you are representing the interests of the vulture companies out there. In the last 2 years dozens of so called “special situation” hedge funds have formed – waiting for “independent auditors” (cough, cough, cough). Trying to get real estate in Spain – let´s say extraordinary “cheap”. I know personally some fund managers already booking in gains of 25-40% for the next 10 years. Welcome in a system called “free markets” (cough, cougj, cough).

  21. Hein Behrens,

    I think that you’re the one that misses the point by simply repeating and repeating the same mantra an ignoring the facts:
    Of course there is a huge difference between the spanish and the british financial system. To start with in spanish banks had to maintain a “good times” countercyclical reserve (*) by order of the Bank of Spain. That is why in 2009 none of them needed any public help. As a matter of fact they could even help themselves to buy falling banks in other countries: for example Alliance and Leicester or Bradford and Bingley in the UK, or the polish branch of Allied Irish Bank or other banks in the US, Turkey, Brazil or China bought in these last three years. Spanish banks were and are forbidden by law to keep out of balance assets. That is why none of them had the problems of Northern Rock or the Irish Banks. If this was not enough in these three years the spanish banks had been able to increase their capital by more than 150 billion just by issuing more shares in the open markets or divesting some of their foreign assets . That would be a dream for british banks. Spanish banks did not have a subprime mortgage problem because in Spain mortgages are full recourse loans, you cannot just give the keys and walk away. Spanish banks did not invest in american subprime mortgages as british, german, belgium, french and swiss banks did. There are no big investment banks in Spain, so we don’t have the problems with rogue traders as Swiss banks, or Barclays or JP Morgan or RBS or the now defunct Lehman or Bear Stearns did and some still do just these days.

    You can ignore these facts from reality and just repeat that spanish banks do need the same treatment as others that operated differently just because those people recognised problems that they had, but spanish banks do not have. I will not dispute that you can reach the point of a self fulfilling prophecy just by repeating the same thing over and over. But there is a huge difference in the things that you try to compare.

    (*) Some of that reserve money has been used to re-capitalice the bank were Edward holds a chair in the Board.

  22. So the maths of saying 70% plus home ownership and 24% unemployments says people pay their mortgages, because they are full recourse. That does not make sense. The Irish and English have the same system in theory you cannot walk away. In practice it is different.

    If people are not working they cannot pay full recourse or not.

    If people are paying why are the banks restructuring 20000+ mortgages a month?
    Moving people to interest only 40 year mortgages?

  23. Hein Behrens,

    The problem in Spain is definitely unemployment.
    It is a huge problem… but not as big as it might look. For example at the end of 2011 with unemployment at 20% there was a larger percentage of the population working than in 2004 with 10% unemployment. How? well because people now work longer years, there has been a huge amount of women coming to the labour force, many youngsters have dropped earlier from their education,… So people that before were not counted as unemployed now are. There is also a very large amount of hidden economy which doesn’t pay taxes which is structural.
    Still unemployment is by far the largest problem of spanish economy. Of course this does have implications in the banking system but so far Spain hasn’t have the rate of arrears that its rate of unemployment would imply in other countries.
    It is not true that banks are restructuring 20.000+ mortgages a month. That information can be simply labeled as utter bollocks.
    Look, I have six brothers and sisters in Spain and a mortgage in London. For my brothers to pay in Spain the rate I am paying in London to my (state owned huge) bank, their banks would have to divide by four the interest rates they charge them. The margin spanish banks have there is enormous. So no, not moving people to interest only 40 years mortgages.
    Still I won´t argue that unemployment is the problem and if the economic policies do not go towards growth in all its areas, that is not only exports (which are doing well) but also internal public and private consumption then the situation will be unsustainable and all the doom prophecies will be right for all the wrong reasons.

  24. It’s very interesting what he says about national identity: in Spain ( I mean in the European Spain, not in the African Spain) there are three national projects, two of them also including people living under France administration. Threre are plenty of “historical” nations but only two national communities of people who are not “Spanish”: Basques and Catalans with a national project for their futures which may be in separate states. This is not “nationalism” this is democracy as we can see in the results of the political parties: PP and PSOE are the only two parties that Spanish vote. Catalan and Basque people vote their own parties. There are other culteres like the Portuguese linked one in Galicia, the occitan in the val d’Aran but only two nations not enough recognized. Only these two nations deserve a national Parliament with a clear separation of areas of sovereignty, the rest, the regions should be ruled only by their Spanish Paraliament (they are Spanish !!!). The saving will be huge.

  25. Dear Jeronimo, when you add the fact of being a staunch supporter of the true true soundness of the spanish banking system and your not-so-national basque condition, we soon recognize it.
    The strong cash flow of the typical spanish loans can be easily described; euribor más 0.5%, as all prouds spaniards were eager to show off. Margins were way higher in the rest of countries. To deny, as Mr Saéz, the indulted criminal of Banco de Santander, that mortgages won´t be paid in full, is as foolproof as saying that here, in Hidalgos Land, gravity law doesn´t apply.
    Your talking about nationals identity is really utter rubbish and you DO hubristicly display a wide ignorance. Euskara, didn´t originated in Huesca ( some far away mountain in Pyrenees. Maybe you mistook a well known fact; that some medieval regulations forbad the use of basque, algarabía ( an arab creole) in some of Huesca´s markets, which is only proof that in some valleys euskara was indeed spoken ( but of course not only there)

  26. “It is a huge problem… but not as big as it might look. For example at the end of 2011 with unemployment at 20% there was a larger percentage of the population working than in 2004 with 10% unemployment. ” Spain had then 44.5 m. and right now 47.

    So sure? It seems INE really contradicts and falsify your assertion:

  27. Taras,

    Thank you for the chart. I think it cannot be more eloquent
    Unemployment Rate People at work Occupation rate
    2001 (Q1) 10.94% 15.866 52.57%
    2004 (Q1) 11.50% 17.600 55.89%
    2010 (Q4) 20.33% 18.408 59.94%

    Total Population Employed Employed/Population
    2001 (Q1) 33.886 15.866 46.80%
    2004 (Q1) 35.582 17.600 49.46%
    2010 (Q4) 38.513 18.408 47.80%

    A larger percentage of the population is at work with 20.3% unemployment, in 2010, than when unemployment was 10.94% in 2001. (!)

    I am not saying that the situation is good but it is very different to say that in 2004 unemployment was 10% and at the end of 2010 was above 20% than mentioning that the rate of people employed related to the whole population has dropped less than two percentage points from 49.5% to 47.8%.

    PS: Regarding our issue; Edward cannot tell you, he is under sworn secrecy, but apparently the auditors at “his” bank cannot approve the accounts, they have found some irregularities:

  28. Taras,

    I don’t know why you have to be so proud about your ignorance.
    In the UK rates were fixed not against Euribor but agains Bank of England.
    Bank of England rate has been 0.5% for the last three years.
    So if you have 0.5 plus BoE deal you would be paying 1.00%
    On top of that interests are calculated daily, therefor your last payment subtract debt from the capital. And if you have an offset mortgage, like you should, any money in your current account or your savings pot is subtracted towards payment of interests for your mortgage. You can also get two months of payment holidays every year: those months you simply don’t pay anything and the interests are added to the principal. No questions asked.
    There is no one in Spain even dreaming about paying 1.00% for their mortgage. Forget about the rest of conditions.

  29. One of the reasons for the rise in economically active people is the lack of children. Ageing poulation and number of workers rise. Big problem in a few years here in Spain. No kids to pay those pensions…..

    Look at this:

    And now nearly half the kids born here are foreign. So the fun in Spain is only starting. Never mind the vulture hedge funds what about all these children with funny names who are supposed to pay all future pensions, who will they vote for?

  30. Every single day of the week about 1000 mortgages in Spain run their course to completion. This is a fact. Mortgages that started 10, 15, 20 years ago make their last payment. Well, according to Taras saying this is denying the Law of Gravity. This running to completion has been happening for decades, every day of every week. In Taras world if you say so you are lying because in some imaginary world, that exists in the future, this, apparently, does not happen.

    Anyway. Yes, euskara was spoken in many valleys. But not only that, it was spoken in Huesca (doesn’t the name ring a bell? Huesca, euskara) many years before it was ever spoken near the bay of Biscay or anywhere else. The Basque people lived for thousands of years up the mountains in Huesca, then they went down towards the river Ebro, they mingled around with Romans, went up the river and settled in the new hills they found around Alaba, Navarra, Bizcay. (This is just a theory with many reasons behind, but there are other theories. None of them are final. There are bitter discussions about this.)
    Another curiosity for our non spanish readers, Castillian, the language, was first spoken around what is now the Basque country by basque people. (this is a commonly acknowledged fact). The cradle of spanish is in the basque country. We, the basque people, imposed the language southward to the rest of the Iberian peninsula.

  31. Please Jeronimo…
    4thq 2004, 18.288.000 working, 41.09% of total population.
    4thq 2011, 17.800.000, 37.88%
    1rstq 2012, 17.400.00, 37.09%!!!!!

    And very interesting the niceties of british mortgages, except the most important and relevant fact that the very bulk of spanish mortgages, as (almost)everybody knows, is more than three years old. Spanish bank do have a VERY big mismatch.

  32. And pertaining Huesca et alia. No, it doesn´t ring a bell, it raises a red flag. Its ethimology is iberian.
    There are lots of inscriptions in basque in Aquitaine, prerromans, in what we could call Le pay basque.
    And that theory of vascongados, Sánchez Albornoz et tutti quanti, let´s relegate to the very far right of the political spectrum. So be it the ” basque ” origin of castilian language.

  33. Dear Edward,

    What do you think about the ideas Paul de Grauwe presents in this paper?

    As far as I remember you have mainly focused on the fiscal side of Spain’s current problems and not on the monetary side, while ECB action to significantly reduce the borrowing costs for Spain (and other troubled countries) could take away this source of stress. The ECB could pursue this policy (clearing stating that it will, and, also act like a lender of last resort) on condition that Spain continues its budgettary, banking and structural reforms.

  34. European banks are running out of collateral. Unless the ECB is mandated to print money outright Europe is hitting the wall near-term. If the ECB is allowed to simply create money out of thin air then you folks can enjoy the same multi-year train wreck we Americans are experiencing. Either way the forecast is for pain.

  35. I love that a discussion of economics and banking in Spain continually switches/devolves into a debate about nationality and national origins. Pretty much making Edward’s argument.

    Definitely a huge part of fixing Spain requires increasing transparency (as on Wall Street and numerous other economic problem spots around the world). People cannot begin to have a frank and open debate about Spain’s and Europe’s economic problems when the full extent and nature of those problems are not known. Although to me, I think there should be more talk about getting the creditors who caused these problems with their loose credit over the past 15 years (be they German, Spanish, or Wall Street) to absorb more of the pain, rather than focusing on the borrowers.

    I just came from a trip to Asia, where I lived during the financial crisis of the late 1990s. It is amazing to see how different they responded to their problems back then and rebounded (especially Korea … Japan, not so much). Korea especially, despite having huge regional and political differences, really did rally and get behind some tough solutions, and a few years later the country was booming again.

    As for Mr. Hugh’s position on a bank board, I think it would be good if he added that information to his biography. I love his writings and agree with much of them, but disclosure and transparency are for the best.

  36. Hello James,

    And thanks for the compliments. I understand what you are saying about my position on the board. Really I tread a delicate line and am aware of it, but am willing to accept the risk. Given that I am a vocal critic of Spain’s government, the Bank of Spain and the way things are done in Spain’s financial system my main preoccupation is not to have Catalunya Caixa associated with my opinions. If this means that people think my opinions are somehow motivated by my being on the board, then this is simply a risk I am willing to take. I actually make no secret of my position in TV appearances etc, since I am always able to stress I am not talking on behalf of anyone.

    Basically, I was asked to join the board of the savings bank as part of an attempt to professionalize it, despite the silly things some commenters say about this. The thing is, I don’t think one of my views has changed as a result of my being on the point – if anyone thinks they have I’d be grateful is they would point this out – and I think this is the important thing. The Bank is now up for sale, and is likely to be sold to a larger Spanish bank. The sale is scheduled for July, and once it is finally completed it is quite likely there will no longer be a board for me to be on. In the meantime, you are right: in the interests of transparency I have amended my bio.

    As you can see, debate in Spain tends to get very personal, and a discussion of how to get credit moving becomes as discussion about me, and what my interests are. Meantime the country is going to the dogs.

  37. Incidentally, it is curious to find that in some of the comments I have seen it is thought my opinions about Bankia may not be objective since I represent a competitor. Bankia is now nationalised, and thus could be considered a “brother in arms” with CX or CaixaNovaGalicia. Indeed, Mr de Guindos’s latest remarks suggests that one option he is considering is fusing the three into one public “megabank”.

    In any event, this “criticism of a competitor” stuff is all well off base, since my points were directed to the regulators at the Bank of Spain and the CNMV would were, in my opinion, irresponsible in allowing Bankia to go to IPO. That is my opinion, and I am sticking by it.

  38. Well, it’s very easy to criticize, but as we are seeing much harder to get things right. Some have questioned my understanding of the BFA/Bankia structure, others have queried my claim that Bankia shareholders were about to get wiped out, while others have suggested my whole argument in this regard was solely motivated by the fact I am an adviser to the nationalised bank Catalunya Caixa. Well, here we go, from the FT this morning.

    Spain to inject €19bn into Bankia

    Spain will make an emergency €19bn investment in Bankia, the stricken savings bank, in a bold bid to restore confidence in the stability of the country’s financial sector.
    Madrid’s biggest bank nationalisation will take the total amount of state aid pumped into Bankia to €23.5bn, and will give the government as much as 90 per cent control of Spain’s second-largest bank by domestic deposits.

    Bankia, which requested the aid on Friday night, said the bulk of the injected capital will be used to boost provisions against real estate losses to a so-called coverage ratio of nearly 49 per cent. The bank’s core tier one capital ratio is set to rise to 9.6 per cent, in line with better capitalised rivals.

    The €19bn being pumped into Bankia raises the total amount injected into Spain’s banks since the crisis began to more than €33bn, or about 3 per cent of gross domestic product. That figure is expected to rise as the economy continues to struggle and smaller banks ask for state aid.

    It will also all but wipe out thousands of small savers and clients of Bankia that bought into a Madrid stock market listing in July that was endorsed by Spain’s then government and the Bank of Spain.

  39. Hi Edward – only just stubbled upon your blog – excellent read!
    I apologise if you’ve covered this topic before… the recent unemployment number for Spain came in at 24.4%. What are your thoughts are on the authenticity of this number?
    I understand Spain structurally has long had a higher unemployment percentage, but surely it must be reaching a ‘tipping point’ soon? …And of course – what of the impact of the ‘cash-in-hand’ workers who are not contributing taxes to assist the government in clearing its debt load?

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