Two Graphs That Tell It All On Spain

First, the one year Euribor reference rate, which has been falling since the ECB started lowering interest rates in the autumn of last year.

And secondly the chart showing the average rate of interest charged by Spanish banks on new mortgages, which as we can see, has been rising steadily since December 2007.

The average interest rate charged by Spanish banks for new mortgages in January 2009 was 5.64%, meaning that the average cost of a new mortgage had gone up by 10.2% over January 2008 (when the rate was 5.1%), and by 1.1% when compared with December 2008. Meanwhile the Euribor reference rate looks set to close this month at all time record lows of 1.91%. In January – the last month for which we have data on mortgage lending – the Euribor rate was 2.27%.

The reasons lying behind this upward movement in Spanish mortgages are twofold. On the one hand the Spanish banks are having increasing difficulty raising finance due to their perceived risk level, and on the other they themselves have have been forced to raise the risk premium they charge to clients due to the rising levels of non performing mortgages they have on their books.

Basically what this means is that the ECB policy isn’t working in Spain, and that despite the massive quantities of liquidity provided, the monetary conditions continue to tighten, and doubly so give that the real value of the rates charged (ie the inflation adjusted value) keeps rising automatically as inflation falls.

Mortgage lending in Spain more than halved in January while the number of homes started in the fourth quarter dropped an annualy 62 percent. The 51.7 percent year on year fall in mortgage lending for urban dwellings was the steepest in 12 straight months of decline.

House sales fell in January by 38.6 percent, figures published earlier this month showed, and Housing Ministry data showed the foundations of only 40,737 homes were laid in the fourth quarter – 62 percent fewer than in the fourth quarter of 2007, and 27 percent down on the preceding quarter. During 2008 as a whole, Spanish builders started 360,044 homes – a 41.5 percent fall on 2008. On the other hand 633,228 homes were completed last year, reflecting the optimist which prevailed in 2006/07 when the buildings were started at the height of the boom in 2006-07.

Spain has a supply overhang estimated at almost any number you like over 1 million unsold homes (the minimum estimate, and no one really knows), or more than three times the number of new households created each year in Spain.

The number of mortgages offered has crashed as banks restrict credit given forecasts non-performing loans will reach around 9 percent next year, while unemployment is now likely to rise above 4.5 million by years end, up from the current 3.5 million.

As I indicated in this post yesterday, we are moving from a situation where people the banks were afraid to lend, to one where people become increasingly afraid to borrow (since they don’t know when they will lose their jobs, or even their homes), with Spain’s citizens becoming more and more reluctant to take on additional debt due to fears they could be caught in the next round of job losses.

As a result January mortgage lending falling to 6.47 billion euros, while the rate of new bank lending to households dropped to 3.9% year on year.

Spanish debt defaults leapt 197 percent in 2008, with construction and property firms accounting for 4 of every 10 failures. The number of firms and individuals that filed for administration rose to 2,902, the highest level on record, according to Spain’s National Statistics Institute. Also bad loans at Spanish banks rose by 15.3 percent in January, the sharpest monthly increase since property developer Martinsa Fadesa filed for administration in July. Bad loans rose more than 9 billion euros to 68.18 billion in January compared with an average monthly rise in the last six months of around 5 billion euros.

The non-performing loans (NPL) ratio for all institutions was at 3.8 percent in January, up from 3.3 percent in December, with rates among savings banks the highest at 4.45 percent compared with 3.79 percent a month earlier. Commercial banks had an NPL ratio of 3.17 percent, up from 2.81 percent. In fact Spain’s financial institutions have seen NPLs more than quadruple in the last 12 months from 16.23 billion euros in January 2008.

Spain’s savings banks, responsible for about half the country’s loans and the most exposed to the property market downturn, could see NPLs rise to 9 percent by 2010, according to the saving banks association.

What To Do With The Bad Banks?

As a result of all this a rather high profile and pretty public row (unusual in Spain) has broken out over what to do with the broken banks.

The Spanish Economy Minister Pedro Solbes has said the government is prepared to recapitalise healthy banks but suggested that those with serious solvency problems should seek a merger rather than look for state aid.

“In cases where banks have acted correctly in relation to solvency and the health of their accounts…logically they could receive support,” Solbes said in a speech to an economic conference in Madrid. “Banks that are unable to remain solvent and clean up their accounts should cease to be players in the financial system so they don’t generate distortions in the public sector.”

What Solbes has in mind is that the troubled banks should turn to Spain’s privately-funded Deposit Guarantee Fund (FGD) should they need capital injections to make tie-ups viable. However, the insurance fund holds only 7.2 billion euros in bank contributions, and since this is orders of magnitude less than the size of the problem it is obvious the government will end up having to putting money into the recapitalisation process, and especially into the Savings Bank sector, since the Spanish press has been reporting that 20 of Spain’s 45 savings banks are now considering mergers. And it is obviously only a matter of time before one of the mid-sized Spanish banks like Popular, Sabadell or Banesto joins the consolidation process.

Clearly many of those most directly involved in the banking industry are laothe to accept the Solbes formula, since wuite simply they cannot afford it. And this was made pretty clear by Francisco Gonzalez, chairman of Spain’s second largest bank BBVA, when he pointed out last week that nationalisation of the bad banks was the only realistic way forward.

“When a bank shows signs of extreme weakness the authorities should take control of it, which implies removing the directors and reducing or eliminating share capital in the institution,” Gonzalez said at a conference in Madrid.Governments should then appoint a new team to separate toxic assets from healthy ones and quarantine them in publicly controlled funds, the chairman said, advocating a level of state intervention not yet seen in Spain. “Then the bank would be privatised again through a transparent sale to private companies,” he said, without making specific reference to Spanish banks.

Two Spanish regional savings banks have already reached a preliminary merger deal – Unicaja, based in Spain’s southern Andalucia region, and the smaller Caja Castilla La Mancha (CCM), located in the central-southern province of the same name – following talks which were carefully brokered by the Bank of Spain. Clearly this merger willl need to be followed by a capital injection from Spain’s Deposit Guarantee Fund to help them clean up the “troubled assets” which will naturally be found in the combined accounts of the new bank which emerges. Many other such regional caja “weddings” are obviously soon to follow. But the big question is, where will all the financing come from? It is pretty clear that the problem which is building up is bigger than Spain can handle alone, and finance (not loans) from the European Union will be needed, with centrally backed EU Bonds being the most likely mechanism with which to fund the injection.

This entry was posted in A Fistful Of Euros, 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".

11 thoughts on “Two Graphs That Tell It All On Spain

  1. Edward, is this “discordance” between reference rates set by the ECB and rates banks apply to their mortgages only a Spanish problem or is it happening also elsewhere in Western Europe (and to which extent)? Is it therefore keeping on cutting rates utterly useless as banks won’t lend and investors won’t invest? As far as I’ve understood what you’re saying to EU countries is “Either you get out of the euro or you pull together and issue EUbonds to bail out banks and countries.” If they, for political reasons, don’t opt for the latter choice, do you think that leaving the euro is better that staying in this situation?

  2. Hello Horace,

    “only a Spanish problem or is it happening also elsewhere in Western Europe (and to which extent)?”

    I don’t know, basically, since I don’t have the data. I would doubt it – in Ireland or Greece perhaps – since there aren’t the same quantities of bad assets piling up everywhere. Anyone reading this have any input to offer?

    “If they, for political reasons, don’t opt for the latter choice, do you think that leaving the euro is better that staying in this situation?”

    Well I think if they don’t, for political reasons, opt for this, then we are all, collectively commiting hari-kiri (or ritual suicide), as far as I can see. But then they are quite free to decide to do that.

    Basically – look at the Almunia Syllogism post – my view is that any country voluntarily leaving the eurozone at this point (from the bottom, bankrupt, end) would be crazy, since it would get torn apart by the markets, since leaving would be an open admission that it couldn’t keep up the pace).

    The only country that I could envisage leaving from the “top” end would be France (which is reasonably healthy under our new definition of “healthy”), but if the healthy country left, that would also be sending a strong signal to the markets that they could eat the rest for breakfast, and since France isn’t an island (not even the UK is that) then it needs an environment, so it isn’t very clear to me that even someone like France leaving would be a rational act.

    So, if we can imagine that none of the ones about to go bankrupt are going to leave, we reach the much more to the point question as to whether countries can be allowed to go bankrupt inside the zone.

    If the only reasonable answer is that we can’t have an “Argentina” in the zone, then this country either needs to be bailed out, or the zone needs to cease to exist.

    Since bailouts without strings are absolutely useless, then we are pushed towards strong political union.

    So the question is, who would “opt” to leave? I think no one. The risk is that the thing simply blows up. Remember the causal chain:

    Financial crisis -> real economic crisis -> political crisis

    (with feedback loops)

    Well basically we are about to move on to the political crisis stage (we are already begining to see signs of this in the East) as people in one country after another get angry about a mixture of being unemployed, losing their home, and unemployment benefit running out.

    So we may well then get a bout of “irrationalism”, and who knows how all that would end up. I have no crystal ball, I just hope someone does something before we get there.

    But you can see where Spain is headed from the charts, the more time passes, the more mortgage and commercial loan defaults there are, the more the country risk level (sovereign spread) rises and the more the bank risk level rises, resulting in higher borrowing costs for the government, the banks and the individual household, regardless of interest rate policy at the ECB.

    So either you clean out all those bad loans piling up, or this explodes. I obviously hope we will go down the former route.

    If things do just blow up though, then there would simply be a huge crater left on Kaiserstrasse where the ECB building used to be, as no one individual country would be willing to take on the responsibilities left (think of all those bit of paper they are buing up).

    Basically the whole is greater than the sum of the parts, and the total debt which has been generated by having the eurozone is much, much greater than what would have been created by individual states (all added up). So no one is going to be capable of taking it on.

    So then we would have the counterparty risk element (remember Lehman Bros) and it would be look out Tokyo, look out New York time.

    So basically, no one would benefit from either leaving the zone, or from the zone disintegrating, although many market participants and “groupie” cheerleaders look more like children playing with matches near a box of ready-primed dynamite to me, as I say somewhere “gee, its gone dark in here, let’s strike one of these……..boom”

    @ Don,

    I hope, in passing, I have answered your question. Basically, getting its own curerncy back wouldn’t help at this point, since all the debts would need to be repaid in another currency, or you default, and become a cross between Argentina, Cuba and Serbia.

    Flat broke, and no one willing to lend you any money.

  3. Look, someone could say “better the eurozone had never been created”, and they could have a good argument. But it has been created, and it exists, and we can’t simply turn back the clock. Or at least we can, but there will be a very high price to pay.

    It’s like the mum who says “I wish I hadn’t gotten pregnant so young”, but she had, and that is that.

  4. Edward,

    Banks virtually everywhere are seeing their lending spreads widening, and their profits from loan operations going through the roof. This is not a Spain or EU issue. And it is precisely what you want to have happen – unless you think that euribor+30 on overvalued collateral was a viable business model. It is how banking should be done.

    Among the other considerations is that there is very little legitimate investment demand for money, so the stats are not merely a result of credit being unavailable. Clamouring for cash to pay off other debts and move the day of reckoning out the line does not really count. We are in a period in which people and businesses attempt to pay down debt and see very few investment opportunities that merit the risk of taking on debt in a non-inflationary environment cum recession.

    Current eurozone yield spreads tell a different story. They continue to tighten as the yield on the bund actually rises – 20 bps (as much as 30 at one point) in the last two weeks. That might be construed to be convergence in advance of an ECB bond. Germany’s export economy cannot risk the development of impediments to trade in the ECM.

  5. Hello Charles,

    Nice to see you over here.

    “This is not a Spain or EU issue. And it is precisely what you want to have happen – unless you think that euribor+30 on overvalued collateral was a viable business model. It is how banking should be done.”

    Well I agree, but Spain (and Ireland) have specific issues here. They are being steadily throttled to death. Of course I agree about the unustainability of the old business model, we should never have gotten here in the first place, but we are here, and Spain needs some relief.

    With rising costs on new mortgages those million on backlog of new houses will just never get sold.

    Of course, you could take a bulldozer out and knock them all down again, that, I would agree, would be another solution.

    But you still have to pay for the bulldozers, and clearing the rubble, and then write off all the debt the banks are holding. Spain did build way more than anyone else apart from Ireland, and at the new higher mortgage levels and lower housing costs this housing stock simply isn’t needed.

    Plus we have the whole issue of what to do with that fraction of Spain’s workforce (a large one) that is now supernumery while a new business model is invented.

    Which is why I’d be trying to get the mortage rate down a little to facilitate the transition.

    But on the whole, I don’t disagree, we are into several years of balance sheet repair mode, and I doubt there is much way round this.

    What I would like to do is try and hold the eurozone together while all this is going off.

    Also, Europe’s problems certainly *seem* to be the worst right now (with the possible exception of Japan).

    “Current eurozone yield spreads tell a different story. They continue to tighten as the yield on the bund actually rises – 20 bps (as much as 30 at one point) in the last two weeks. That might be construed to be convergence in advance of an ECB bond.”

    This is interesting, and can be read in two ways. It could be that the risk level of German debt is rising (they do have one hell of a bailout on their hands, they just took a dircet hit from Eastern Europe, and they have the biggest aging on costs looming on their health and pensions systems, which will obviously now need another “reform”). This is why Merkel is being so fussy about stimulus programmes, since Germany (unlike France) simply can’t afford much more (nor can Japan, nor can Italy, people really shouldn’t have let their populations get so old so fast, they have been playing with fire here). So this is the view I would go for, German risk is itself rising. I have posted on this.

    But, another view is possible. S&Ps suggested that if we had collective bonds, then the average yield would rise towards that of the weakest members (rather than the weaker being aided by the stronger). If this latter is what is happening, then we are cooked, I’m afraid, no doubt about it.

    And this on the day that Soros warned that the UK may well have to go to the IMF for help, along with Hungary and Latvia.

  6. Of course there would be a kind of indexing of euro yields in an ECB bond. But the two EMU basket cases are pretty small stuff and the rates they pay would come right down precisely because of the bond. S&P is way off the mark.

    Aside from the face-saving act that Germany continues to perform when faced with the facts, it’s evident that they may end up suffering as badly as the worst of them here. The fact is that their industry is tooled up to sell to the fringe dullards not only making them complicit, but worse, dependant. They have the most integrated of the EU economies and will have to go with what serves the rest. As usual in this part of the world, local politics will make the ECB bond into a funny looking beast, but it will happen.

    Ignore Soros. He’s talking various books.


  7. Edward, thanks for your analysis. As I’m also learning Spanish, I often read Spanish online newspapers. My impression is that, while British ones tend to say it more like it is, in both Italian and Spanish press, you can’t feel the same pressure. Things like “default”, “eurozone split” etc. are carefully avoided.

  8. Pingback: And So It Begins, The Bank Of Spain “Intervenes” In A Spanish Savings Bank | afoe | A Fistful of Euros | European Opinion

  9. Pingback: Spain bank bail-out hits shares « Business News

Comments are closed.