Spain: Can the House Resist the Storm?

JOJO P. JAVIER

Spain’s crisis was caused by, among a series of events, the collapse of its housing
bubble and the unsustainably high GDP growth rate. The economy, which grew 3.7 percent per
year on average from 1999 to 2007, has shrunk at an annual rate of 1 percent since then. As its
economy grew rapidly before 2008, the country’s debt-to-GDP ratio was declining.

After Spain joined the European Union (EU), the country experienced a long housing
boom financed by cheap loans to builders and homebuyers. Housing prices rose 44% from
2004-2008. Housing represented a majority of national wealth. Increases in housing prices led
to a dramatic increase in national wealth. Spain’s citizenry began consuming more and the
demand boosted economic growth. Car sales and other luxuries dramatically increased as well.

Eighty percent of its residents own houses. This was encouraged in the 60s and 70s and
has become a part of Spanish psyche. Tax regulations encouraged ownership. Up to 15% of a
resident’s mortgage payments are even deductible from personal income taxes. Banks even
offered 40 to 50 year mortgages.

Local governments made millions by reclassifying land from rural to urban. Corruption
made millionaires out of politicians and developers.But while house prices continued to
increase, salaries did not. In the 1990s and 2000s, banks invested strongly in the real estate
sector. The construction industry accounted for 12% of GDP, more than double than UK or
France. Most workers were immigrants or youth that opted for the quick money instead of
furthering their education. The ratio of housing price to average salary in Spain became almost
triple that of EU-15 countries.

As Spanish banks' risk profiles began rising, it seemed the government was in denial”
and refused to accept the fact that its economic fundamentals are flawed. As President
Zapatero stated to the Spanish Congress “Let nobody doubt it; there is already a wide
consensus about the origin of the crisis: It is in the US and its subprime mortgages.” The denial
was so easy to sell to Congress considering that nearly all of its memberrs had large
Investments in the housing sector, some owning up to twenty houses at a time.

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 For the banks, it was a familiar tale of high-living in the boom years, followed by
an uncomfortable return to reality. Before the crisis, the banks had been thriving
because of the rapid expansion of the property sector. But its collapse caused a plunge
in the value of the assets the loans were based on, and meant borrowers had difficulty
with their outstanding obligations. To even further aggravate the situation, banks
borrowed money on the international markets to lend to developers and homebuyers, a
much riskier strategy than using the deposits they get from savers. That has left many
banks struggling with massive losses. But not all of the banks are in this situation,
however. The International Monetary Fund said a large part of the banking sector,
including Santander and BBVA, is well run and resilient.

Spain has begun to restructure its banking sector. Many of its smaller, weaker banks
have had to merge or have been rescued by larger ones. The number of branches has been cut
by 15%, and 11% of the jobs in the industry have gone. Bankia, Spain's fourth-largest bank, has
been part-nationalised and billions of euros of public money pumped into it. Bankia itself was
formed when several regional banks, or cajas, were brought together because they were
deemed too small to survive the economic downturn. However, the size of the banks' problems
and the weakness of the recession-hit Spanish economy, meant the country had to turn to its
fellow eurozone members for help. Borrowing the funds from the international markets would
have cost too much. Like credit card companies, investors demand higher interest the riskier a
prospect they think you are.

Though this case study was published in 2010, it’s hard not to research on the
developments that ensued after 2010. In June 2012, Spain became a prime concern for the
Euro-zone when interest on Spain's 10-year bonds reached the 7% level and it faced difficulty in
accessing bond markets. This led the Eurogroup on 9 June 2012 to grant Spain a financial
support package of up to €100 billion. The funds will not go directly to Spanish banks, but be
transferred to a government-owned Spanish fund responsible to conduct the needed bank
recapitalisations (FROB), and thus it will be counted for as additional sovereign debt in Spain's
national account. An economic forecast in June 2012 highlighted the need for the arranged
bank recapitalisation support package, as the outlook promised a negative growth rate of 1.7%,
unemployment rising to 25%, and a continued declining trend for housing prices.

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 Though Spain suffered 27% unemployment and an economy that shrunk by 1.4% in
2013, the government has pledged to speed up reforms. Madrid is reviewing its labour market
and pension reforms and has promised by the end of this year to liberalize its heavily regulated
professions. But Spain is benefiting from improved labour cost competitiveness.They have not
lost export market share.

On 23 January 2014, as foreign investor confidence in the country has been restored,
Spain formally exited the EU/IMF bailout mechanism

Will the EU Succeed?

Like any organization in its infancy stage, there will always be growing-up pains. The EU
is smart enough not to back out from these challenges. The several bailout crisis of Portugal,
Ireland, Greece and Spain has led the EU to further strengthen its policies and strategies to
improve the region.The crisis is pressuring the Euro to move beyond a regulatory state and towards
a more federal EU with fiscal powers. European integration giving a central body increased control
over the budgets of member states was proposed on 14 June 2012 by Jens Weidmann President of
the Deutsche Bundesbank, expanding on ideas first proposed by Jean-Claude Trichet, former
president of the European Central Bank. Control, including requirements that taxes be raised or
budgets cut, would be exercised only when fiscal imbalances developed. This proposal is similar to
contemporary calls by Angela Merkel for increased political and fiscal union which would "allow
Europe oversight possibilities.

A lot of effort is being put in to strengthen the EU. The bailouts should even provide a
certain degree of leverage to the EU over Portugal, Ireland, Greece and Spain. Think tanks,
economists and political strategists are banding together to thresh out differences and unifying
ideas that would benefit the entire region. On 20 October 2011, the Austrian Institute of
Economic Research published an article that suggests transforming the EFSF into a European
Monetary Fund (EMF), which could provide governments with fixed interest rate Eurobonds at a
rate slightly below medium-term economic growth (in nominal terms). These bonds would not be
tradable but could be held by investors with the EMF and liquidated at any time. Given the
backing of all eurozone countries and the ECB, the EMU would achieve a similarly strong
position vis-à-vis financial investors as the US where the Fed backs government bonds to an
unlimited extent. To ensure fiscal discipline despite lack of market pressure, the EMF would
operate according to strict rules, providing funds only to countries that meet fiscal and
macroeconomic criteria. Governments lacking sound financial policies would be forced to rely

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on traditional (national) governmental bonds with less favourable market rates. Its sucess in the
long run depends on a sustained rate of real growth. Low growth or variable growth rates across
different regions and countries could generate fiscal pressure against the Euro. In addition to
fiscal discipline, there must be provisions for flexibility that encourages sustainable growth.