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Edward Hugh is only able to update this blog from time to time, but he does run a lively Twitter account with plenty of Spain related comment. He also maintains a collection of constantly updated Spain charts with short updates on a Storify dedicated page Spain's Economic Recovery - Glass Half Full or Glass Half Empty?

Wednesday, April 09, 2008

The Spanish Government Response

The Spanish government is preparing a 22 billion euro ($34.38 billion) stimulus package as a response to the economic problems the country is facing. This was the substance of the statement by José Luis Rodríguez Zapatero, Spain’s acting prime minister, to the Spanish parliament yesterday. The package constitutes the new government's response to its electoral promise of emergency measures to reactivate Spain's faltering economy, which has been severely affected by the sudden collapse of construction activity after a 10-year property boom and the continuing turmoil in global financial system which has meant the international wholesale money markets effectively remain closed to mortgage backed securities issued by Spanish banks.

Outlining his government’s priorities for the next four years, Zapatero told the Spanish parliament he would speed up government infrastructure projects such as high-speed train links, promote more state-subsidised housing and extend government guarantees for some mortgage securitisations. Property developers with unsold stock are going to be able to place their empty homes with a state rental agency, and there will be retraining schemes for tens of thousands of unemployed construction workers. Spain's new government will also ramp up home-building programs and offer mortgage-repayment relief as part of a U.S.-style fiscal-stimulus package.

The roughly €22 billion ($35 billion) plan, representing about 0.5% of gross domestic product, aims to ease the bite of the credit crunch on debt-laden households that has brought the Spanish housing sector to a virtual standstill.

"Our government will immediately, as soon as it is constituted, take measures to counter the economic slowdown," Spanish Prime Minister-Elect José Luis Rodríguez Zapatero said in Parliament, which is set to approve his nomination this week.


Zapatero promised his government would build 1.5 million new price-protected homes for low income families in order to offset a sharp drop in home-building activity. He said he would also like to make it easier for homeowners with difficulties to meet their mortgage repayment obligations to extend the terms of their loans.

In his speech, Zapatero also pledged a 400-euro rebate for tax payers, speedier payment of VAT rebates for businesses and tax breaks to encourage Spain's struggling construction sector to renovate old town centres. He also announced a programme to help building workers find new jobs and a plan to meet unions and business leaders to find ways to boost productivity.

Zapatero announced an ambitious public works programme, including the idea of putting millions of euros into building 150,000 affordable homes a year in an effort to sustain a now very beleagured construction industry.

Despite criticism that this is just a "short-fix" solution to deeper economic ills, the government will also invest in major road- and rail-building programmes.

There was however evident disappointment among many analysts that Zapatero failed to announce any new measures - other than those already included in the Socialist party's manifesto - to deal with a rapid deterioration in the economy since a general election last month. Some economists estimate the country is growing at only half the rate it was this time last year, when the economy was expanding at a 3.8 per cent rate. If the market for Spanish mortgage-backed securities continues to remains closed, growth could fall to just 1 per cent this year, according to some forecasts. If this were to happen unemployment would evidently rise sharply.

Spanish banks are reining in credit - particularly to builders and property developers - because they can no longer fund themselves in the international capital markets, and this has accentuated the crisis in the construction sector, once the motor for growth.

Although Mr Zapatero has promised to speed up infrastructure projects, economists say government spending will not be able to replace private sector investment in housing, which totalled 9 per cent of gross domestic product at the height of the construction boom.


The government draws confidence from a budget surplus which totalled 2.2 percent of gross domestic product last year. But falling tax revenues have already slashed that to 0.8 percent of GDP in the first two months of the year and the Bank of Spain has said that - even without government stimulus programmes - the surplus would virtually disappear in 2009 simply as a result of the slowdown.

6 comments:

ndrmd.andromeda1 said...

Dear Edward,

My name is Jaime and first of all I would like to congratulate you for the great analysises and comments on the Spanish bloq. I think it is one of the most complete economic overviews out there (and neutral too)
I am Spanish and I compare what I read in different sources and What I see back home when I go back.

I have one question, not related directly with the Spanish bloq, but nevetherless interesting for me. How do you see the Swiss Frank CHF vs EUR in the short/medium term? Since the financial turmoil started back in August, the Swiss Frank has been gaining value (probably due to the end of carry trades). DO you think the CHF will become stronger or lose value as it had done during the last 5 years?

Thank you and Kind Regards

Jaime

Edward Hugh said...

Hello Jaime,

Thanks for the comments.

"I have one question, not related directly with the Spanish bloq, but nevetherless interesting for me. How do you see the Swiss Frank CHF vs EUR in the short/medium term?"

This is a very hard question to answer. My guess is no one can answer it for you honestly. This is because we don't know what will be the magnitude of the EUR/USD movement once the ECB starts to lower rates (which may not be till the autumn now, but it will come).

Normally the dollar would bounce back quite strongly, but there are reasons for thinking that this time round things might not be so simple. A high euro is going to be a special problem for the Spanish economy in this situation, since Spain now needs to move towrds being an export driven economy.

So there is a higher than normal level of uncertaintly attached to currency movements at the moment even in the short term. On top of this the CHF and the Japanese yen are what are known as "carry currencies", which means they tend to have low domestic ineterest rates (for a variety of reasons, see my Japanese blog) and thus the currencies go down during strong expansions as people borrow in that currency and then sell BUT tend to rise diring periods of global risk aversion, like the one we are seeing now. So really all I can say is that this is very complicated, and I'm sorry, but I have really no idea.

I imagine CHF-Euro can strengthen as global growth slows and the ECB lowers rates, but even I wouldn't be betting anything on my opinions here. I am a macro economist more than a financial markets person. Maybe you have a CHF mortgage, I have friends here in Barcelona who have a yen mortgage and they are asking the same question.

Charles Butler said...

Edward,

The VPO solution is a little more complicated than it looks because, with no buyers for what's on the market now, it probably marks to market unsellable current developments, with all that applies for the mortgage issuers - not to mention that it dilutes the housing stock even more.

The better solution for the banks and cajas (but not the unemployment rate or current owners) would be conversion of finished or partially completed developments that qualify to VPO's, and spend the proposed construction money on doing something about the fact that Spanish labour has few internationally marketable skills.

The solvency of the cajas is the same as the solvency of the autonomous communities, so it has to come first.

Edward Hugh said...

Hi Charles,

"The VPO solution is a little more complicated than it looks because, with no buyers for what's on the market now, it probably marks to market unsellable current developments,"

Oh, I thoroughly agree. What the Spanish government is up to could be described as too little, too late, and by a mile. I was simply really reporting their thinking here.

I have a very large post I am working on from time to time about all this, but with Italian elections and more referendums in Hungary I just don't get the time to finish it off.

Basically there are four issues:

1) The builders and the unsold houses.

2) The cedulas

3) the balance of payments and dependence on external energy

4) the immigrants and what to do to try and encourage them to stay in Spain.

To take the last one first, since it is not so obvious as the rest, people need to bear in mind that Spain's "birth deficit" over the last 20 years with such low fertility has been largely covered by importing immigrants, but if conditions were to deteriorate sufficiently for large numbers to have to leave, then Spains population would age - in median age terms - rapidly, and this would have all sorts of consequences, not least of them that urban rents in the most affected areas - remember part of the ownership boom here was produced by the distortion in the rent/mortgage relation which resulted from the strong urban pressure on rented flats. And then of course these migrants are the "seedcorn" for any future small recovery in construction activity, since at some point many of them could become buyers. If Spain loses a lot of migrants the situation is only going to aggravate even further. And on the government fiscal side too, since contribution increases coming from migrants have been important in recent years - while of course the Spanish themselves have been busy taking early retirement.

Something much bigger than the government is currently envisioning needs to be done about the builders. Most of them are now facing some sort of bankruptcy, and left untouched this will only get worse. Basically I think a large (and I mean LARGE) amount of public money needs to be pumped in, to carry out a structural downsize without bankruptcies. Remember if they go bankrupt all at once, then the million or so properties they have between them will hit the bank balance sheets, just like a million delinquent sub-prime householders, and the impact would be just as dramatic.

Public money needs to be pumped in here - and how. I think you need a national land agency - along the Japanese lines - to buy up all the land that Sr Martin and others have been steadily accumulating, and basically take it of the books by reclassifying it as "not for construction". Encouraging agriculture wouldn't be a bad bet at this time, since prices are structurally high, and are going to stay there, but then, you need water!

The govt also need to buy up a big chunk of the housing, but not for cheap resale or rent, since this way the market will never clear. So they need something like the old Keynesian type solution - paying unemployed to knock it all down again - for eg - or converting some of those large empty estates into "museums of folly". Basically the Spanish (and I imagine Irish) governments need some equivalent of the Common Agricultural Policy, treating the excess houses as if they were excess milk.

The situation is rather different from the US one here, since the underlying fertility is so different, and future demand for houses, and especially if in the UK they have their own issues, and people make a longer term change in buying behaviour, may be much lower than any constructor is currently contemplating. Basically we are not - and I mean probably ever - going back to 100% of vluation mortgages. And banks are going to have to start lending on the basis deposits, and not on the nack of securitesed bits of paper. Moves in the last few weeks in the UK have been significant here I think, which means the Spanish are now going to have to start saving again.

The cedulas present the same sort of issue. Basically these can be temporarily "eaten" over at the ECB to keep the Spanish banking system liquid, but eventually a solution will have to be found, since I doubt - like the US securitised mortgages the fed is currently eating - these can ever come mout again. So public money will be needed - how much, my guess is 150 billion euro plus - to buy these bits of paper, since the ECB simply isn't allowed to sustain capital loses. The only real issue is whose public money will be used - Spanish only, or pan European. The Spanish can argue that if they hadn't had the ultra low "one size fits all" monetary policy that goes with the euro then they wouldn't be in this mess (and they would be right) so they could say, "why should we pay it all". On the other hand I doubt - eg - the Germans, facing ongoing cuts in their wages, pensions and health system, will be so ready to agree.

Then we come to the trade balance. Basically Spain needs a whole new energy plan. They simply can't afford to be important so much energy without more exports. So they need to reduce energy consumption substantially AND increase exports. This needs some sort of national strategic plan, to downsize construction and financial services, and increase sya agriculture (in the short term) and manufacturing industry (start to compete - eg - with Eastern Europe on cars again). In the longer run Latin America can be important, but all of this will need time and energy. Of course this will involve a huge change in mindset, and Spain will need to move towards being an export dependent economy, since domestic demand is now finished as a driver of growth - and I imagine given the ageing population issues that this change is now permanent.

OK, well I guess you could now call these my working notes towards the article which will come.

Martin said...

A couple of points:

I can't really see why it would be critical to stop the large construction firms and potentially a few of the lending banks going bust to the extent that it would be worth pumping in huge amounts of public money to mop up excess supply of housing (socialising the losses). Much better in the long run to go through a (painful) period of price discovery and let the market clear naturally.

The external deficit is not really driven by energy deficits but by an excess of expenditure over savings Up until now overseas investors (including the ECB) have been content to fund this excess but not for much longer ...

The rapid reduction in final consumption and investment currently underway was inevitable given the size of the deficit (and the inability to devalue our way out of trouble any more).

Edward Hugh said...

Hello Martin

"Much better in the long run to go through a (painful) period of price discovery and let the market clear naturally."

I understand your point of view, and normally I would be inclined to agree with you. The thing is what does all this mean in the Spanish context? I mean how long will the correction process last, and what is the extent of the price correction which is needed?

I mean at this point there isn't really much sense in bandying about numbers, since the truth of the matter is none of us really know - either how for long, or by how much prices will fall, or whether we will get a short sharp shock and a lengthy recovery process, or whether we will have a steady downward adjustment in property prices and Spanish economic growth lasting for many years - but do I would want to stress that the Spanish situation is, in my opinion, far and away the most serious (comparable with Ireland, but Ireland has a much better external position) problem of its kind we have on our hands in the developed world at this point in time.

Essentially the only real comparable case I have been able to identify in terms of the "sudden stop" in mortgage funding availability is Kazakhstan, and the Kazakhstan government is able to leverage the wealth available from oil and other resources to bail out the banks, and help householders on a very substantial scale.

Spain, of course, is not in such a fortunate position since it is not an energy exporter - although of course, if interest had focused on developing large scale solar energy technology and on solving the domestic water distribution problem over the last decade (instead of all the mindless infighting between the two main parties about what to do about ETA and all the obsession with buying homes) then Spain could have clawed its way into the energy market and have been better able to leverage agricultural potential (the new high value added activity it seems) to offset the downturn in construction.

But for things like this you need not only well functioning capital markets (and not simply cheap credit for household property speculation made available courtesy of the ECB), but also visionary government policy.

I would say that the problem in Spain is of a rather higher order of magnitude than elsewhere for three principal reasons.

Firstly, the existence of the eurosystem and the distortions that this has produced via negative interest rates - and over such a comparatively long period of time - means that the upside here was enormous, both in terms of the quantity of building and the upward movement in prices. I think it is very important to remember that Spain last had a recession in 1992 - that is 18 years ago - and so in many ways the creation of the eurozone took the Spanish economy off its normal cyclical path. Arguable everything which happened post 2001 is "upside" and needs correcting. This is massive. Basically Spain should - like virtually everyone else - have had a recession in 2001, but the arrival of the eurozone and cheap credit cut across this. There was a "bust" in the stock market as elsewhere, but since the ECB was offering money at 2% while inflation was around 4% the money simply left bank accounts and the stock market and went into property.

This is eerily similar to what happened in Japan with a bust in the stock market in 1989 which fuelled a property boom which burst in 1992, the only big difference is that the Spanish property boom lasted longer, so the downside will probably be worse.

Secondly Spain has a major issue of population ageing (after many years of very low fertility) an issue which has only been masked in recent years by massive immigration. One part of the indication of the extent of the excesses which have occured in Spain can be found in the fact that Spain has been far and away the world champ in per capita inward migration since the turn of the century, with more than 5 million migrants arriving in the last decade. What happens to these migrants now is crucial to Spain's future.

Thirdly, the structural nature of the problem which Spain has in its financial system.

Spain's dramatic "slowdown" is - at this point - the result of a "breakdown" in its financial system and not the result of a slow but sure tightening of interest rates on the demand for housing. The demand is to a large extent still there, since people are adapting their expectations very slowly, and still expect all of this to get back to "normal" again in a couple of years. The problem is that the banks do not have the finance to lend them the money, and almost no one has the 20% deposit now being demanded up front. This "breakdown" is unlikely to be repaired (ie Spain's banks are unlikely to be able to sell cedulas or anything resembling them on the open market) until prices have substantially corrected, and we don't know how big at this point the correction will need to be.


It is not incidental to note here that the German Pfandebriefe on which the cedulas were initially modelled became popular with the German banks precisely after the property boom bust there in 1995 - ie the pools of mortgages which backed them were already priced at a low level - and since German property prices have subsequently not risen (nor are they likely to for demographic reasons) the whole situation has proved to be very stable. Hence the potential attraction in the early days of cedulas. The thing people didn't think about at the time (who ever does, think about things at the time, I mean) was that the Pfandebriefe were a way of rescuing bank financing after a crash (and bank deposits were guaranteed by the government) while the cedulas were been created to facilitate the bubble which leads to the crash.


Basically what all this tells me is that the issue of long term funding for Spanish mortgages now needs to be addressed. As you say, at the end of the day this means that the Spanish are going to have to start saving rather than attempting to play monopoly and accumulate property, but wow, the scale of this transition is going to be enormous since Spain is going to have to move from being an internal demand driven economy to being an export lead one, and this process is obviously going to need a number of years, probably a considerable number.

To give us some measure of the situation, we could note that the problem really got started last August when the wholesale money markets effectively became closed to the Spanish banks for raising funds for mortgage lending. I don't think that this situation is going to change anytime soon, nor do I think that it is desireable that it should do so, since the whole problem would only start up again, with even more serious consequences - if those are conceivable - at some indeterminate point in the future.

But this means we are already into the slowdown and the correction has barely started. So I think it is not unreasonable to assume that Spain has now entered a transition which last a good number of years - and these years could easily become a decade. And the amounts of money which both have to be covered in outsanding debts owed to the banks by builders and constructors are not small (circa 300 billion euros??) and the cedulas which have to be rolled over during the next 5 to 7 years are of roughly the same order of value. The total could easily add up to 40 to 50% of annual Spanish GDP.

Clearly the Spanish government alone cannot stand this kind of increase in its debt to GDP ratio - and in particular if it is getting virtually zero growth and paying out unemployment benefit - ie if it is already running fiscal deficit.

So my guess is this will be an issue for the whole EU and eurosytem, since of course it was the absence of an autonous monetary policy which lead Spain to get into this mess in the first place.

"The external deficit is not really driven by energy deficits but by an excess of expenditure over savings"

Well at the end of the day this simply amounts to the same question. I am only taking energy as it provides a convenient illustration. I doubt Spain has paid for a barrel of oil since 2000, and it all has now to be paid for - that's what happens when you borrow money, you have at some point to pay it back. To solve the savings question means a big reduction in the level of short term domestic consumption, and this means if the economy is to be able to grow at all it will need to be export driven, and hence the trade deficit will disappear of its own accord (or there will be no grwoth whatsoever).

But this is an enormous change, and for Spain to contract its construction sector and develop (or reopen) export industries is going to need time and investment.

And this all becomes doubly complicated if structurally rising global food and energy prices mean that most of Spain's main current export markets are suffering from stagflation and low growth themselves.

This is why I see a major role for the government in facilitating much of the coming transition. If this doesn't happen - and of course it may not - then the Spanish economy can just get broken and stay broken. I wouldn't imagine that there is a simple automatic correction mechanism available here, since the whole problem was artificially produced via the eurosystem.

Which brings me back to the migration issue. Before 2000 Spain was set to have the most rapidly ageing population on the planet. ( years and 5 million migrants later this is not the case. Most demographers are agreed that these migrants effectively replace the "missing children" who were simply not born as a result of Spain's very low fertility.

They add stability to the population pyramid, and in someways guarantee Spain's future. If we get a mass exodus of migrants because there is no work for them and their entitlement to benefits runs out, Spain is going to have a huge problem as a result.

To give just one example: urban rents. These have been driven up to very high rent to income levels by the demand from migrants, who normally break housing units down into individual rooms to let and thus push the rents up. If the migrants leave en masse then rents in cities like Barcelona, Madrid and Valencia will simply plummet. This will mean that those who depend on income from these rents will have trouble maintaining there mortage payments on their "investments".

Basically Spain already has too much hosuing relative to its forward looking population. If part of the present population ups and leaves this will only further aggravate things. And you need to think about second homeowners from the UK - those who got more or less 100% mortgages - as things in the UK itself get more difficult, and as property prices in Spain fall and their negative equity increases, just how many of these are going to keep up the payments?


So for all these reasons I think Spain needs a very systematic plan, and it needs it soon, and one of the ingredients will be public money from the Spanish government and from the EU (since the ECB cannot simply absorb the cedulas. it is not permitted to make capital losses, someone is eventually going to have to buy them and burn them, to some extent this responsibility will need to fall on the entire EU, since at the end of the day the EU created the eurozone).

And part of the plan will involve addressing the long term fertility issue.

Charles said in a comment on an earlier post:

"Spain's very long and sordid history of debasing its currency has infiltrated itself into the country's soul and real estate here is what gold is to people holed up in bunkers in Wyoming."

Or as someone else put it the Spanish need to learn that speculating isn't saving, and speculating on a volatile, but very illiquid, asset like housing even less so. People should basically buy houses if they want to live in them.

If the Spanish want to save for the future then having more children (or facilitating that people who want to do so can) would be a much better way of going about it than buying blocks of potentially virtually valueless blocks of concrete, IMHO.

And the fact that people in Spain would like to have more children, but keep putting it off and off until it is too late, is illustrated by yet one more area where Spain is in fact world (per capita) champ: international adoption. The big danger now is that if the economy sinks into what could better be called a depresion rather than a recession, then even more postponenment of births will take place as young couples stuggle to pay their debts and maintain their (ever less valuable) homes, the placing Spain's fragile future in even more jeopardy.

Ben Bernanke describes the eurozone as "a great experiment". Normally scientists get round at some point to publishing the findings of the experiments they get public funding and support to carry out. I wonder when we will get to see the final write-up on this one?