Spain’s issue is not with its fiscal policy, nor with a particularly overextended welfare state. It was not profligate in the years before the credit crisis and entered it with outstanding government debt of only about 40 per cent of gross domestic product. The UK had debt of 94 per cent of GDP.
Spain’s problem is a speculative bubble, driven largely by a European local version of “global imbalances”, that has yet to deflate properly because its banks and authorities have been slow to recognise realities.
Spain enjoyed a construction splurge in the middle of the last decade, egged on by low interest rates that were appropriate for the German economy (sluggish at the time), but not for a country where credit was growing fast. Just as the US credit bubble was helped by low rates driven by Chinese demand for US Treasury bonds, so Spain’s domestic property bubble had its roots abroad.
Indeed it did, and those roots were sourced in Brussels and in the decision by its oligarchs that a one-sized currency would indeed fit all, an irresponsible, astoundingly speculative gamble for which no-one has been held accountable but for which many—including the unemployed in Spain, and (now) taxpayers in Germany—have been punished.
Spain’s interests were too low (for Spanish conditions) because they were largely driven by conditions in the euro zone’s Franco-German core as well as the belief (cheered along by officialdom) that economic conditions within the single currency’s member states were converging when, in reality they were doing anything but.
But why is Spain now in crisis, while the US is not?
Because its banks have not yet admitted the scale of the writedowns they must take in the wake of the bubble. In terms of their book value (the value of assets minus liabilities on balance sheets), Spain’s banks have multiplied eightfold since 1998, according to an analysis of MSCI data by David Morris of Global Wealth Allocation in London. That is twice the growth for the rest of Europe, and 80 per cent more than in the US.
Meanwhile, Spanish banks’ earnings are at about half their peak levels, much as in the UK and the US. The difference is that in those countries earnings are recovering after taking huge writedowns to take account of the burst credit bubble. Spanish banks have yet to do this, and the market plainly expects more writedowns before they are done.
The news of the past few weeks shows that this is ever harder to postpone. House prices are falling. Spain’s banking regulator also announced that non-performing loans had risen to 8.16 per cent of banks’ portfolios, the worst figure in 18 years. Entering the crisis, less than 1 per cent of loans were non-performing.
Of course, Spain is not in crisis purely because of its banks. There is also, for example, the not-so little matter of the way that Spain’s membership of a shoddily-constructed currency union makes it inherently more susceptible to financial panic.
But there is a reason that the problems in the country’s banks are attracting so much attention. As noted the other day, this report from the invaluable Open Europe is a must-read, and, in particular, this:
Given its size, the fate of the Spanish economy will also largely decide the fate of the euro. €80bn of €396bn (1/5) in loans that Spanish banks have made to the bust construction and real estate sectors is considered ‘doubtful’ and potentially toxic, meaning at serious risk of default, with the banks only holding €50bn in reserves to cover potential losses. Already dropping, house prices could potentially fall another 35%, meaning that Spanish banks will almost certainly face hefty losses as more households default on their mortgages.
In such a scenario, the Spanish state is unlikely to be able to afford to recapitalise its banks, meaning that the eurozone’s permanent bailout fund (the ESM) would have to step in, shifting the cost to eurozone taxpayers.
As domestic banks are currently the main buyers of Spanish government debt, this could also lead to major funding problems for Spain. The chances of a self-fulfilling bond run on Spanish debt would increase massively in this scenario, threatening to push the whole country into a full bailout.