Eric Reguly
ROME— From Thursday’s Globe and Mail
Published Wednesday, Apr. 13, 2011 7:25PM EDT
Last updated Thursday, Apr. 14, 2011 6:54AM EDT
Spain is a nervous wreck, and that’s a good thing. It means the complacency is gone.
For the better part of the last two years, the Madrid government protested its inclusion among the PIGS – Portugal, Ireland, Greece, Spain – the four European Union countries considered most likely to collapse under the sheer mass of debt and require a bailout. Not us, said Madrid.
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Then the debt crisis closed in on Spain like a military pincer movement. To the east, Greece exploded, then Ireland in the north. Last week, to the west, it was Portugal’s turn to imitate a Libyan tank hit by a smart bomb.
As Spain became hemmed in, something close to panic set in and Madrid launched aggressive austerity and economic liberalization programs that, at minimum, have bought it some breathing room. While Spanish bond yields climbed last year and early this year, they went nowhere near the nose-bleed levels of the three other piggies. Spanish yields have dropped in recent days, even as its hapless neighbour negotiates bailout terms.
Spain has kept a strong investment grade rating, unlike the other three. Its big banks are paragons of virtue; its small savings banks far less so, though they are merging and sucking in new capital (albeit at a leisurely pace).
There is a good possibility that Spanish bond yields will continue to ease, if only because the selling pressure appears to be gone. At the peak of the debt crisis, the British and American investment funds bolted from euro zone debt, while the European funds, which have a better appreciation of the political will to keep the euro alive, largely stayed put. The danger is that falling yields will convince Madrid to declare victory.
That would be premature, because Spain still faces a potential economic disaster, one that may not necessarily trigger a bailout but could plunge the country into a fresh banking crisis and stall its recovery for years. It’s called housing and there’s way too much of it cluttering the cities and resorts. While down from its peak, the housing market may still land with a tremendous thud.
Spain’s property bubble was the biggest in Europe. Stuffed with ultracheap credit, the construction companies and condo developers went crazy and Spain turned into a job-creation juggernaut. The Spanish, like the Irish, decided that flipping houses constituted genuine wealth creation and speculative developments were built in the middle of nowhere. When the housing bubble burst, Spain’s unemployment rate doubled to 20 per cent.
Determining the actual price fall is not easy, since buying and selling activity has slowed. But Tinsa Espana, Spain’s biggest appraisals company, in conjunction with Madrid financial consultancy AFI, estimates prices have dropped on average 19 per cent from their peak, with the biggest falls (27 per cent) on the concrete jungle along the once lovely Mediterranean coast.
While 19 per cent may sound like a lot, it’s relatively benign compared to Ireland, where prices are down more than 40 per cent from their peak and still falling, and the United States, where they are down by almost a quarter. Spain’s glut of vacant housing, estimated at one million units, weak economy, high unemployment rate and stunningly high private sector debt – nearly twice the size of gross domestic product – point to a second leg down in housing values.
If that were to happen, the Spanish banking crisis, so far largely confined to the savings banks (known as cajas), might tear through the whole industry, putting the hundreds of billions of euros in loans made to the real estate and construction sectors at risk. Spain just might be able to manage a full-blown banking crisis, if only because of its relatively low debt to GDP ratio of 70 per cent (Britain’s is climbing above 80 per cent). But it wouldn’t be pleasant.
Now for the kicker. Interest rates in Europe are rising as inflation shoots above the target rate of 2 per cent. Last week the European Central Bank raised rates by a quarter of a percentage point, the first time it has done so since mid-2008 and the direction is clearly up from here. Rising central bank rates eventually translate into more expensive mortgages. Watch mortgage default rates tick up.
Spain is certainly no Greece, Portugal or Ireland. Those countries are basket cases, swamped with debt they cannot afford to repay, deprived of their economic sovereignty and almost certainly headed for a default and debt restructuring. Spain has been muddling through. The Portuguese disaster has terrified the Spanish government and people. May the fear last.