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Falling Bricks

by Kevin D. Williamson

The proverb that murdered the Spanish economy

Madrid — Just off the Plaza Mayor in the Spanish capital, there stands an abandoned Santander bank branch, shuttered, vandalized, and covered in graffiti. “Murderers!” is spray-painted on the edifice in foot-high, blood-red script. The Spanish are not shy about sharing their low opinion of bankers. Down the street is a smaller square upon which weathered Romanian whores hawk their services with the sort of dogged fervor usually associated with door-to-door evangelists. A flyer sternly warns against soliciting sex on the square, and it is supplemented by more graffiti commentary: “Here, only the banks are allowed to screw us.”

Greece was an appetizer, but Spain is Europe’s heaping helping of poison paella: Standard & Poor’s recently handed down another round of credit downgrades to the country’s biggest banks and to the government itself. Many of the banks are now well into junk territory, and the credit-rating firm Egan Jones, which is known to be a bit more skeptical of sovereign finances than the Big Three (it was the first to downgrade U.S. Treasury debt), already has consigned the Spanish government’s debt to junk-bond status. Borrowing costs are skyrocketing. Many forecasters believe that Spain is on the downward slope into the second half of a double-dip recession, and the quality of bank assets is deteriorating rapidly. The Spanish government does not have anything like sufficient resources to recapitalize the banks. Capital equivalent to a tenth of GDP fled the country in the last quarter alone.

But while Spain’s credit rating and economic confidence may remind some observers of conditions on the ground in Greece, the underlying economics are not the same. Greece is exactly what it appears to be: an economic, fiscal, political, and moral basket case that never should have been admitted to the European Monetary Union in the first place. It is a profligate spender, a prodigal waster, and a pitiable tax man, a country with no desire to set itself right. It is the suicide bomber of European economies, one that has managed to command the attention of all Europe and the financial world by engaging in a hostage-taking exercise in which the hostage is itself. The only reason to keep Greece in the union is that it will hurt just as much to kick it out.

Spain’s situation is fundamentally different. Though Madrid has trouble policing fiscal affairs in its highly decentralized system of government, Spain has not been a particularly ambitious spender or borrower by European standards, or indeed by North American standards: Before its present crisis, Spain’s ratio of government debt to GDP was 42 percent, compared with 62 percent in the United States. And it was on the way down, having been reduced by four percentage points from the year before, while U.S. government debt was climbing. In 2007, Spain’s public debt was not only lower than the OECD average but lower than that of Sweden, the Netherlands, Austria, and — take note — Germany, where the government debt level was half again as large as in Spain. The level of public debt in Italy and Greece was more than two and a half times that of Spain. There is much to lament in Spanish public finances and in European public finances in general, but those looking for a morality tale in which spending and borrowing are the villains and thrift the potential hero would do better to look elsewhere, say to the relative spendthrifts up in sober Canada (2007 debt-to-GDP ratio of 66.5 percent). Spain’s debt-to-GDP ratio has skyrocketed since the crisis, but that is mostly the result of a collapsing denominator, not a spending spree.

It is just barely plausible that Greece could leave the monetary union without nuking the entire euro zone. For Spain, a much larger and more integrated economy, no such exit strategy exists. No Spain, no euro.

‘El ladrillo nunca baja” — “The brick never comes down.” For years, that proverb expressed the conventional wisdom about real estate in Spain: If it’s built of bricks and mortar, it’s a solid investment, and the price will never really fall. There were plenty of bad political decisions to go around, both from Spanish authorities and from the European Central Bank, but Spain’s housing bubble seems to have been particularly severe because of national psychological factors exogenous to policy. As one longtime Madrid resident tells the story, the boom sent so much money sloshing around the Spanish real-estate market that a kind of stigma developed around renting: Of course you owned — only losers rented. Banks were getting it wrong on both sides of the real-estate game, financing ridiculous levels of housing development — three houses built for every one sold at the bubble’s peak — and offering subprime loans to borrowers so dodgy that they’d have had to be elected officials and “Friends of Angelo” to get a decent mortgage in the United States. This in a country that already had one of Europe’s highest rates of homeownership.

The relatively high demand for purchasing properties and the relatively low demand for renting them produced its own set of perverse effects as landlords allowed their holdings to go untenanted rather than let them out for little money. So long as the on-paper price was climbing, landlords regarded their vacant properties as assets producing returns. Rents declined or stagnated, but sales prices leapt ever higher — so while the total stock of Spanish housing was growing at an unprecedented rate, the active inventory was restricted by owners’ sitting on their hands waiting for soaring prices to soar even higher. “You could rent an apartment for five years for less than half of the closing costs to buy it,” a Madrid-based banker says. “Plus, Spain is one of the best places in the world to be a renter: Landlords are forced to renew your lease for up to five years. But nobody wanted to rent. It was insane.” Renting, he says, was “almost socially taboo.” As a result, “the distortion between salary and price point was more pronounced than anything I’d seen. Florida was nothing by comparison.”

In the United States, the rule of thumb holds that a prudent borrower (and a prudent lender) will agree to a mortgage no more than approximately 2.5 times the homebuyer’s income. In some Spanish cities, the mortgage-to-income ratio was running 8:1. And a lot of those mortgages were zero- or negative-equity from Day One, with loans exceeding even the inflated nominal values of the properties. Those who argue that European-style banking regulation would have prevented the U.S. bubble and crash cannot account for Spain.

As for los ladrillos, they began to fall, literal bricks bringing down the Spanish economy like so many countless tons of metaphorical ones.

Which is to say, Spain’s situation is analogous to that of the United States, except with less government debt and fewer policy options: a housing bubble, the inevitable bust, and a banking system inadequate to dealing with the fallout. There are a million good reasons to hate the 2008–09 bailouts of U.S. banks and financial institutions, and one good reason not to: The U.S. banking system did not collapse. Spain is what happens when you can’t do TARP — or at least cannot do it on your own terms. Spain was able to secure help in maintaining temporary liquidity in its financial system, but at a very high price.

“In a normal economic crisis, you have fiscal or monetary tools available, or a flexible currency that you can depreciate and allow yourself some respite,” says one Spain specialist at a household-name global bank. “But if you take away the key macro tools that you have to adjust demand, your hands are completely tied. Spain cannot do anything — there is absolutely nothing they can do.” Except follow orders — orders that are coming in German.

That Germany has emerged as Europe’s fiscal disciplinarian is not lost on the young and unemployed in Spain, where Angela Merkel routinely is compared unfavorably with another famous German chancellor from some years back. Neither has Spain failed to appreciate that the No. 1 beneficiary of European monetary policy has been Germany. Germany’s impressive productivity gains and its enormous current-account surplus both owe as much to the adoption of the euro as to any macroeconomic policy emanating from Berlin. Replacing a relatively strong currency (the Deutschmark) with a relatively weak one (the euro) gave the Germans a critical edge in the export market. Professor John Doukas, a financial economist at Old Dominion University, argues that Germany may have been the only country to experience significant economic gain from the adoption of the euro: “Germany experienced a depreciating real exchange rate, while the GIIPS countries experienced an appreciating real exchange rate by adopting the euro. This, in turn, induced a current-account deficit for the GIIPS financed by capital inflows (net borrowing), which led to their external debt burden. Germany, on the other hand, with a rising current-account surplus, became a net-creditor country. In brief, Germany is, perhaps, the only EU country that benefited.”

That being the case, it is not surprising that there is a distinct sense among the Spanish economic laity that this is all some sort of Teutonic plot. “The Germans have always dreamed of conquering all of Europe,” says one young Spaniard in a Madrid café. “Now they are.” And Frau Merkel? “Hitler in a dress.”

But Berlin has as much to lose from a Spanish collapse as Madrid does. Its banks are exposed to Spanish risks, and the streets of Madrid are filled with BMWs and Audis, even if a great many of them are running on visibly bald spare tires these days. Germany cannot write off southern Europe without writing off a very large chunk of its own export-driven economy. It’s a Quentin Tarantino–style Mexican standoff, everybody holding a gun to everybody else’s head.

‘Thank God for the termites, eh?” Pablo is taking a long, long lunch break from his job as an exterminator, drinking an espresso and smoking Marlboros at a table on the sidewalk next to his death van. (The Spanish may not be the fun-in-the-sun Euro-layabouts of Anglo-Saxon imagination, but this is still not the place to be if you detest a siesta.) “I thought I would be an architect or an engineer, but then I went into this business. Now, I am the only one of my friends making any money. Lawyer, banker, teacher — nothing, nothing, nothing. But always we have termites. I buy all the drinks.” He hears that New York City is suffering from a bedbug epidemic, and he looks a little envious. “Bedbugs are very good.”

The visual effects of mass joblessness are somewhat camouflaged in Spain. There may have been a stigma attached to renting, but there is not one attached to living at home with one’s parents well into one’s thirties, and that’s what Pablo and a lot of young Spaniards are doing. Unemployment in Spain is running around 23 percent, and outside the relatively wealthy urban centers it is estimated to be more like 35 percent. The numbers are higher for the young and the less educated — and for immigrants, who tend to be both young and less educated.

Nowhere is that contrast more pronounced than in Cañada Real Galiana, a sprawling illegal slum that has grown up on the outskirts of Madrid, about a half hour’s drive from the cervecerias and discos of the city center. Tens of thousands of immigrants and a growing number of native Spaniards live in squalor in this sliver of the Third World abutting the continent’s second-largest city. The driver I hire to take me there requires some serious persuasion before he will agree to make the trip. He asks if I am looking to buy drugs, and does so in that subtle way that suggests he knows a better place to score some heroin, if that’s my thing. Indeed, drugs seem to be not only the largest business in Cañada Real Galiana but the only business — there is not a gas station or food stand to be seen, and hardly a shop of any kind. There is knee-high garbage, smoke from open fires, scrofulous dogs, women in chadors, and young men who squat between cars to transact their narcotics business. Occasionally, the government sends through bulldozers to level the squatters’ shacks and inspectors to hand out hilariously large fines that never will be paid.

If Spain ever had much of a chance of assimilating its large population of Muslim immigrants from Morocco, the downturn has made it a remote one indeed. The black-market economy is their only economy. A bust in the slum two years ago found 120 people transacting business in a single building — and €12,000 in cash, thought to be a single morning’s take. Spain has been a regular target of Islamist terror attacks, and the national police worry that Cañada Real Galiana has become a recruiting center for al-Qaeda or other terrorist elements. There is more to an economic collapse than economics.

And yet . . . it doesn’t seem so bad. At 9:30 p.m., the beautiful people are still wearing their Prada sunglasses at the Cerveceria Santa Ana, and not just to pose: There is still plenty of sun as the afternoon stretches out, impossibly long. They lounge under umbrellas at the tables on the square and at the sidewalk cafés, picking at Russian salads, smoking cigarettes, and sipping blond beer. A well-built young man wearing flip-flops and a pink tutu, and nothing else, dances artfully with a life-sized stuffed ape as a flamenco singer wails about the state of his corazón. A beautiful young woman joins a party in progress at one of the tables, fair and slender and a perfect explanation of why Europhilia persists in the United States and elsewhere. She is wearing a T-shirt that reads: “We Still Have Time Left. Let’s Make the Most of What We Have.” Still time, indeed — but how much? Parties end, and tabs must be settled. Even the seemingly endless Spanish afternoon does not last forever. Nightfall is coming.

What will the darkness bring? The two most likely possibilities are total economic collapse or total loss of economic sovereignty. It has long been remarked that a European monetary union without a European fiscal union is a guarantee of disaster, and now the disaster is upon us. If an anarchic meltdown of southern Europe is going to be averted, northern Europe, Germany above all, is going to have to put up the money. That idea is wildly unpopular in the north, but for Berlin, the real choice seems to be to take a hit up front and calm the waters or to let the storm rage and take a hit, possibly a more severe one, on the backside as its trading partners go under and the debt tsunami rolls over European finances. There is talk of the issuance of Europe-wide bonds or, short of that, Europe-wide short-term bills. It is not clear whether even that will be enough.

The distance between the slum of Cañada Real Galiana and the charming squares of Madrid, only a few miles, is very much on my mind as I depart, making my way through the massive labyrinth of Barajas Airport. Between the Iberia airline check-in and the Iberian jet there are: seven escalators; about a mile of corridors, each impressive expanse covered with about as many square feet of marble as the floor of the Taj Mahal; five of those moving-sidewalk contraptions; a subway ride about as long as my morning commute in New York; a short bus trip; and, finally, a run up the stairs — connecting the jets to the jetways apparently is beyond Iberian powers. Like the trip from Madrid to Cañada Real Galiana, it’s about a half hour’s journey, not counting the inevitable delays at security and customs. The security screenings are handled with dispatch — the problem with the airport is not bureaucracy or personnel, but the scale of the thing: It is a pointless and counterproductive exercise in high-modernist aesthetic giganticism built by a government-run airport authority facing billions of euros in debt that it cannot pay, with a million signs marked “Salida” but no easy way out. Cervantes himself could not have imagined a more perfect metaphor for the European Union. But Spain is very old, while this new thing called “Europe” is a postmodern phenomenon. Only one of them is going to survive.

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