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Friday, July 18, 2008

What Is The Risk Of A Serious Melt-Down In The Spanish Economy?

Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past, the ocean is flat again
John Maynard Keynes

'As far as I am concerned, this is ... the most complex crisis we've ever seen due to the number of factors in play'
Spanish Economy Minister Pedro Solbes speaking this week to Spanish radio station Punto Radio



Jose Luis Borges tells a story about two rascally villains, eternal rivals, who - under sentence of death - are offered one last bet: rather than accepting a conventional execution they can agree to have their throats slit simultaneously, just to see who is a able to run the farthest. Immortality, rather than fame, in an instant. Now I mention this since tale I can readily anticipate the immediate feelings many will have on reading what follows (I am at the end of the day going to argue that it is necessary to inject money - and I do mean rather a lot of money - into a banking and construction system which many will want to argue is largely responsible for Spain's present distress, and indeed, that having made a good deal of money out of the operation, these are the very people who should now be forced to don that sackcloth and ashes costume which so behoves them (actually the way things stand they are much more likely to find themselves reduced to a sporting a loincloth, but still). I understand why many ordinary Spanish people may have such feeling, but I do think this is a time for cool heads, and that what is most needed here is an extreme dose of pragmatism coupled with a lot of emotional intelligence. There is no point in agreeing to have your own throat slit just to see people you don't like have their's slit first.

Martinsa Fadesa The First To Go

This week's filing by the Spanish property developer Martinsa-Fadesa for protection from its creditors has brought Spain's ongoing economic agony back to the headlines. The decision follows a request from Martinsa Fadesa last Friday to its creditor banks for a postponement of the deadline on their requirement that the company obtain a 150 million euro ($235.7 million) loan. The banks refused the request and the rest is now, as they say, history. The failure of Martinsa - Fadesa whose debts are in the region of 5 billion euros - is not only the largest corporate bankruptcy in Spanish history, it is also a reflection of the pain which must now be being felt in Spain's troubled banking and construction sectors, and a harbinger of what is, in all probability, going to be much worse to come.

Spain At Risk

So to come directly to the matter which has provided me with the header to this post, just what is the risk that the present recession in Spain is something a bit more than a mere recession? What is the risk of a real and serious economic melt down just across France's Southern border, a mere stone's throw away (by plane) from Brussels or Frankfurt, yet still on the other side of that intellectual and cultural divide which seems to be formed by that ever so picturesque natural barrier known as the Pyrennees? Well it is a non-negligable one, in my view. Let me explain a bit.

First, as background it would be worth reading my Artemio Cruz Syndrome post, since all the main macroeconomic arguments are presented there (and those who seriously want to know what is going on should definitely read the excellent "Spain:Bubble Bursting - We now expect a full-blown recession" desknote from PNB Paribas).

Secondly, we need a bit of vocabulary clarification, since the terminology being used has become somewhat confusing of late. We could reasonably break things down as follows I think:

i) Soft Landing
ii) Hard Landing
iii) Melt Down

Now, in terms of the available semantic space, why don't we allow that "soft landing" means a recession of the more or less garden variety (as Portugal or Italy have at this moment, or as say France may anticipate, or Denmark) and not consider this to mean avoiding recession completely, which is how some seem to have used the term in recent times (I think it is hard to imagine any EU 15 economy avoiding recession completely between now and Q2 2009). Possibly Hungary up to this point could also be said to have had a comparatively soft landing.

"Hard Landing", on the other hand would be what they are currently experiencing over in the Baltics, what they may well soon experience in Romania, Bulgaria, the UK, and Ireland, and what is now most certainly taking place in Spain. Thus by "hard landing" I mean a very sharp slowdown in growth, a medium sized contraction in consumption, financial distress and bankruptcy in some areas, and a recession which drags itself on for more than a mere two quarters (in and out of negative growth) and probably results in annualised negative growth for a period of at least 12 consecutive months. What happened in Turkey in 2000 was certainly a hard landing in this sense.

iii) "Melt Down", following such definitions, would then be a Hard Landing plus, a Hard Landing plus a shock (or in Hungary's case, where the shock would be a run on the forint, you could imagine what initially is only a Soft Landing being converted into a melt down, but arguably Hungary's case is very special given the very high level of exposure of household balance sheets to CHF denominated forex loans).

Such a shock could be a banking crisis, a run on the currency, a sovereign default (this is where Italy's series of perpetual soft landings could move decisively into meltdown mode one of these fine days if something isn't done to correct the low growth/high sovereign debt to GDP dynamic while there is still time).

Now in this sense, Spain's economy is at some significant level in danger of having a melt down - lets define this as more than two years of negative GDP growth with a magnitude of more than one percentage point, coupled with (in the case of countries which have their own currency) very sharp devaluations, and in the case of those that don't severe and extended price deflation (ie a mini version of what happened in the USA in 1930).

Now the recession in Spain is, I think, more or less most certainly already served. The Spanish press were talking earlier in the week about a quarter on quarter contraction of 0.3% in Q2, and it is hard to see any acceleration of the economy in Q3. Pedro Solbes, when questioned explicitly by Punto Radio on the possibility that whole year growth for 2008 could turn negative replied diplomatically "It's not my feeling at the moment", which means basically that it might well turn out to be the case.

If this expectation if fulfilled then Paribas may have to revise their latest forecast slightly (see above link) since - in what is really an excellent general analysis - they pencil-in the recession to start in Q3 2008 and then move on to anticipate a contraction in the Spanish economy of 0.75% in 2009 (although as they freely admit all the risks here are skewed to the downside). My own personal call at this point is that the recession may well have started in Q2 (we will soon know) and that the contraction in whole year 2009 will be over 1 percentage point. Further than that I am not willing to go at this stage, since it all depends, and in particular it depends on whether or not we get a nasty "event" or series of events which send the economy hurtling out of the "hard landing" bracket and into the "melt down" one. It is because I strongly believe we be should doing everything we possibly can to avoid that eventuality that (and not continue to languish under our blankets with a heavy dose of the Artemio Cruz syndrome) that I am writing this post now.

Before continuing, however, I should point out that even the Paribas idea of negative growth in 2009 is still very nonconsensual, despite the widespread pessimism which currently surrounds the Spanish economy. The consensus economic survey for June gives a median 2009 growth forecast of 1.5%. The lowest forecast in the survey is 0.4% but most are grouped in the range 1.0-1.8%. Maybe the consensus will catch up with the curve in due course.

Structural Unwind

So what would be my justification for making such an apparently gloomy forecast? Well as I argue in my Artemio Cruz piece, and as Paribas re-iterate in their study, this is no ordinary crisis. It is taking place against a background of a severe credit crunch which affects the entire financial sector, in a country with an enormous external deficit (CA deficit over 1o% of GDP and rising), which has a strong external energy dependence, and at a time when food and energy prices have been rising sharply. All of this is bound to exert a very strong downward pressure on internal consumer demand, and as a knock-on impact on investment spending. At the same time slowing growth globally, and in the EU and eurozone economies in particular, makes for a very difficult external environment where increasing exports (even assuming Spanish export prices were currently competitive, which they aren't) becomes difficult, if not well nigh impossible.

Serious Structural Distortions

So let's take a quick look at some of the underlying structural issues. In the first place both Spanish households and corporates are extremely highly leveraged at this point in terms of their outstanding debt obligations. The levels of debt to GDP are really extraordinarily high when compared with their eurozone peers.



So how did Spain get into this rather precarious situation? Well I don't think you need to look too far to discover the answer. As can be seen in the chart below, Spain effectively had negative interest rates throughout the entire period between the start of 2002 and the autumn of 2006. That this state of affairs was produced in the very earliest years of the history of the eurozone was indeed, in my opinion, truly unfortunate, since it meant that inflation expectations had not had time to be "steered down" by a central bank track record. Thus a very widespread reaction on the part of ordinary Spaniards to what were generally perceived to be derisory interest rates for savers was to withdraw money from longer term deposit accounts and to place it in what was considered to be the safest of safe inflation hedges: property. Thus began what may well turn out to have been one of the most serious property bubbles in recent history.


The situation was also doubly unfortunate, since the ECB along with other central banks had lowered interest rates in an attempt to support economic weakness produced by a drop in stock market values following the collapse of the internet boom. In Spain's case however, the excesses caused by the internet boom never really had the opportunity to unwind, since as one boom ended, another one simply got going in its place. This effect can be clearly seen in the chart for long term quarterly GDP growth produced below, where we can see that following the 1992/93 recession (and up to Q2 2008) Spain simply hasn't had one single quarter of negative growth - that is during 15 years. Hence the legend of the Spanish economic miracle was born. But as with all legends, we should also really be asking ourselves what the reality was which lay behind it, since as we can now see, the absence of recession - and in particular the absence of recession in 2002/03 - simply means that we now have a lot of extra "distortion" lying out there and waiting to be "corrected" (the waste-pipes were effectively never flushed, which is why we are now faced with such a peculiar smell emmanating from the sewage system). This would be the main reason why I would argue that what we cannot now expect is a relatively smooth "return to trend" in 12 to 18 months time, since Spain has effectively been "off trend" for some six or seven years now, and the magnitude of the excesses (10%+ CA deficit, 5 million immigrants in eight years, corporate indebtedness pushing the 120% of GDP mark etc etc) is prima facie evidence for this. So even in the best of cases we are almost certainly now facing a significant period of negative and then very low headline GDP growth. But we may not be lucky enough to get away from all this with a simple best case scenario.



The last piece of structural evidence I would offer in this post refers to the CA deficit situation. Since I deal with that reasonably exhaustively in the Artemio Cruz piece, I will only refer to one item here: the deteriorating balance on the income account.

Now this is important in my opinion. It is important since obviously any of the remedies to Spain's short term financing problems imply borrowing money (in some way, shape or form via the support which is offered by belonging to the eurosystem). Spain needs one of those proverbial "bailouts", even though since Spain does not have its own idependent currency this position is somewhat masked by the fact that everything is denominated in euros. But debts incur interest, and the more you borrow, the more you effectively have to pay, not only in capital, but also in interest. And if Spain country risk rises sharply in any way - as some analysts are suggesting it may have to - well then what is already a serious problem is only going to become a more serious one.

Land Prices


So where are the risks? Well I think it is no simple accident that Martinsa-Fadesa has been the first major developer to go, since a very large part of their portfolio is composed of land. According to press reports Martinsa Fadesa had land totalling 28.67 million square metres, 41 percent of which is outside Spain (and 50% of which is not "zoned", that is it is without the necessary premission to build). They also have a stock of more than 173,000 newly-built and unsold properties (again by no means all of these are in Spain). Now land is going to be a very important component in this whole "correction", since a lot of land (as we can see) has been accumulated with intent to build, and much of this land may now become virtually worthless. And land prices are already falling faster than house prices. Data from the Ministry of Housing shows that land for building fell to 251 Euros/m2 in March, a 7.7% drop when compared with March 2007. Land prices had fallen for 3 consecutive months by March with the average cost of land in Spain now being back somewhere around where it was at the end of 2004.

So I would say this is one of the first issues the Spanish government needs to tackle, and quite urgently. Frankly I can see little alternative to having the government intervene and take this land off the books of those who are holding it - not at market prices, they can handle some sort of "haircut" - but I don't think the government should be sitting idly back and watch one developer after another simply fold, since the end result of this is that the problem then moves over into an already overstretched banking sector.

Which brings me to my exhibit one: Japan land prices.





One of the key features in Japan's ongoing battle against deflation has been the way in which land prices were simply allowed to fall after the property bubble burst in 1991. The above chart shows the sharp rise in Japanese land prices from 1986 to 1990 - a period during which they more than doubled - and how they subsequently fell - albeit more gradually — by roughly two thirds from 1990-91 to 2005. Although urban land prices started to turn up slightly post 2006, land prices still continue to fall elsewhere, and of course we still haven't seen how the latest construction "bust" in Japan is going to leave things. Unsurprisingly, residential construction has remained virtually dormant in Japan over this entire deflationary period.So the question is, what is to stop this happening in Spain. I would be grateful to anyone who can present me with a reasoned argument as to why what happened in Japan won't happen here. Meanwhile the risk is evidently there.

The Builders In General

Obviously even if the most immediate and pressing problem in Spain is arising in the area of land prices, the rest of the housing related construction sector will not be far behind. This is a problem that is simply waiting to happen. According to the latest data from the Spanish housing ministry, average Spanish property prices fell by 0.3% in the 3 months to the end of June, but they were still 2% up on prices in Q2 2007, a factor which is leading many to question the reliability of the Spanish data (one more time Artemio Cruz strikes, since Spanish institutions are far from swift in responding to problems, and would seem to prefer denying that they exist). One explanation for the present situation may be that prices are being measured in terms of the initial asking price and not the final selling price. Whatever the explanation prices are certainly set to tumble, and even the the G-14 developers’ association, traditionally a staunch upholder of the immobility of property values, has had to admit that new-build prices have fallen by 15% in the last 6 months alone, while Cue Mariano Miguel, ex-president and present board member of the much troubled developer Colonial, is already predicting a fall in the region of 25% to 30% over the next two years. And new property in Barcelona (which is where I live) is now taking ten times longer to sell than it was only a year ago, according to real estate consultancy Aguirre Newman.

Meanwhile we learn from Jose Luis Malo de Molina, director general at the Bank of Spain (speaking at a recent conference in Valencia) that the number of new homes which will be completed in Spain in 2008 will beat all previous records (I said this was a system which was slow to react), simply piling one more house after another in order to add to that glut of newly completed homes that is already idly languishing and casting its long shadow over the Spanish property market. Muñoz's explanation for this phenomenon is simply that “the real estate sector can’t turn around quickly, it works in the medium and long term, so this year the properties started at the end of 2005 and beginning of 2006 will be completed, which means the number of new properties on the market will hit an all time high.” As I say, "just in time" may be an idea that has entered the heads of the more agile companies like the textile consortium Inditex, but most of Spain is a very, very long way from being able to offer an agile response. On the anecdotal front, a friend of mine recently went to visit family homes in the North West of Spain. In Vigo he spoke to the owner of a brick factory, and in Leon someone who had a quarry. In both cases production was continuing (there is simply no on/off switch here) but the inventory already had piled up to the extent of being now prepared to satisfy normal requirements for the whole of 2009 (in both cases), and of course, in 2009 requirements will not be normal, since housing starts in 2008 have collapsed to a forecast of below 200,000 (down from 600,000 plus in 2007).

At this point estimating the volume of unsold housing in Spain is really a question of "its anyone's guess" rather than a matter of scientific fact. The number 1 million is popular, but I suspect this is more a question of serving up an easily managed factoid than one of accurately measuring empty houses one by one. The same applies to the estimates for the size of the likely fall in property values. All we can safely say at this point, I think, is that the number in both cases is large.

The big question for our current concerns is who is exposed to the risk on all this, and the answer to that question is a lot simpler: Spain's already cash-strapped banking system.

One common estimate of the exposure of the banks to the builders would be somthing of the order of 300 billion euros - this is the opinion of Spanish analyst Inigo Vega at Iberian Securities (and it is one I more or less share). So we could say we have something in the region of 20% to 25% (or more) of Spanish annual GDP in play here.

Bank Exposure Through Mortgage Backed Securites

To this second order exposure of the banking system to the construction sector alone (and remember, through the negative impact of all this on the real economy, we should never lose sight of those non-construction corporates, you remember, the ones who had all that indebtedness we saw in the first chart) we need to add the exposure of the banks to the cedulas hipotecarias, which alone run to something in the 250 to 300 billion euro range (to which we need to add, of course, other classes of more conventional mortgage backed-securities ). If we add these two together - the builders and the cedulas - then we are obviously talking about a potential injection into something of over half of one years GDP in Spain.

According to Celine Choulet of PNB Paribas mortgage-backed securities in the broader sense of the term (ie including cedulas and MBS) now add up to around 37% of outstanding mortgage loans in Spain. She also estimates that asset backed securities held by non-residents may amount to as much as 81% of the total securities issued.

Outstanding home loans (for purchases and refis) represent a substantial percentage of the Spanish banking institutions’ balance sheets (21.5% of total assets and 35.6% of total loans to the non-financial private sector in the second quarter of 2007). In the second quarter of 2007, outstanding home loans amounted to 589 billion euros, 56.4% of which were distributed by cajas (29.8% of their assets), 37.2% by commercial banks (15.4%) and 6.4% by mutual institutions (30.9%).

If we add together home loans and the financing of real estate sector (construction and property services), the overall exposure of Spanish credit institutions has increased significantly over the last decade (37% of assets in the second quarter of 2007, 61.5% of total loans to the non-financial private sector). Exposure of Spanish banks to the real estate sector has exceeded, both in level and in growth rate, that of US, Japanese and British banks. In total, in the second quarter of 2007, cajas (49.7% of assets, 70.5% of loans) and mutual institutions (46% and 56.3% respectively) were almost twice as exposed as commercial banks (28% and 55.2% respectively).

According to Choulet - and just to take one example - in 2006 total new funding to the Spanish mortgage market reached 201.3 billion euros, of which 88.3 billion took the form of covered bonds (representing 43.9% of the total of mortgage securities market) and 113 billion was in mortgage-backed securities (56.1%).

And remember the cedulas all need to be "rolled over" in the next few years (with a big chunk coming up between now and 2012). And the problem starts this autumn. According to an article in the Spanish daily El Pais at the end of June the Spanish banking sector needs to raise 62 billion Euros before the end of this year just to rollover what they have coming up on the immediate horizon.

So what does all this add up to? Well, to do some simple rule of thumb arithmetic, just to soak up the builders debts and handle the cedulas mess, we are talking of quantities in the region of 500 to 600 billion euros, or more than half of one years Spanish GDP. Of course, not every builder is going to go bust, and not every cedula cannot be refinanced, but the weight of all this on the Spanish banking system is going to be enormous. Banco Popular is the most visible sign of the pressure, and their shares have already dropped by 44% this year, and by 7.9% on Tuesday alone (they were the listed bank which was most exposed to Mrtinsa Fadesa).

So it is either inject a lot of money now - more than Spain itslelf can afford alone - or have several percentage points of GDP contraction over several years and very large price deflation - ie a rather big slump - in my very humble opinion. And it is just at this point that we hit a major structural, and hitherto I think, unforeseen problem in the eurosystem (although Marty Feldstein was scratching around in the right area from the start). The question really we need an answer to is this one: if there is to be a massive cash injection into Spain's economy, who is going to do the injecting? Spain alone will surely simply crumble under the weight, and it is evident that the problem has arisen not as the result of bad decisions on the part of the Spanish government, but as a result of institutional policies administered in Brussels and monetary policy formulated over at the ECB. And yet, the Commission and the ECB are not the United States Treasury and the Federal Reserve, no amount of talk about European countries being similar to Florida and Nebraska is going to get us out of this one: and it is going to be step up to the plate and put your money where your mouth is time soon enough. Yet, cor blimey, we are still busying ourselves arguing about the small print on the Lisbon Treaty.



Demographics and Construction


The third major area of risk I would like to highlight today relates to the problem of demographics and their impact on the construction outlook. PNB Paribas (see initial link) see demography as one of the principal downside risks to their forecast. They put it like this:

"With United Nations population projections pointing to growth of only 300k per year on a ‘high-population’ variant for 2010-15, housing starts could fall considerably further. Hence the risks to our central forecast of 30% off housing investment by end-2009 are to the downside. The correction could be more rapid than expected. If not, it is likely to persist into 2010. ...........Our forecast has housing investment converging to levels consistent with relatively strong population growth. A weaker population assumption or some undershoot of the ‘equilibrium’ level would lead to a worse outcome."

Basically, I think the big topic in this context is the coming rate of new household formation. And here it is worth remembering that while the countries most affected by the property-driven credit crunch in the EU would appear to be Spain, Ireland and the UK, the UK is rather different from the other two, since while housebuilding grew by 187% in Spain between 1996 and 2006 (and by 177% in Ireland), the equivalent increase in the UK was just 12%. Planning restrictions in Britain meant fewer homes were built and the resulting relative scarcity may provide one part of the explanation for why house prices have almost doubled, in real terms, in the UK since 1999 despite the comparatively low percentage of new builds (this would bring us back to the huge zoned and un-zoned lang overhang in Spain, and what the dynamics are that produced it). That is, while the UK can to some extent offset the impact of the crisis in the longer term by increasing homebuilding (to house, for example, all those extra people from Poland and other parts of Eastern Europe), in Spain and Ireland the problem is going to be very different, since they both have to sharply reduce housebuilding capacity.

So what are the main sources of new household formation in Spain? Well basically they are threefold: natural population development, migration, and second homeowners from the north of Europe. Now if we start with the question of natural population evolution in Spain, ex-migration the Spanish population is virtually stationary at this point - with an average annual increase of a mere 30,000. But what matters in housing terms is not so much the size of the population as its age structure, and here we don't need to go to the level of refinement involved in looking at longer term UN population projections (high, median or otherwise) because in terms of Spanish property from now to 2020 (at least in terms of natural population drift) the deal is now done (or rather the goose is now cooked), and a quick glance at the US Census Bureau IDB population pyramid for 2000 should make this abundantly clear (see below).


What we can effectively see is that in 2000 (and please click on the image if you want a better look) Spain's three historically largest 5 year cohorts constituted the 25 to 40 age group. But if we mentally fast forward as far as 2015 we will see that the aggregate size of the cohorts in this age range is very significantly smaller, and if we fast forward again to 2020, we will see that what we have are the three smallest cohorts in the last forty years. And from here on in we only go down and down - talk about absence of sustainability!

So we are left with North Europeans is search of second homes and migrants to offer some support to Spain's rapidly crumbling housing sector in the coming years. Well on the North Europeans front the picture doesn't look exactly promising either, since the bulk of the buyers in recent years have been British (Britons own an estimated 500,000 to 700,000 properties in Spain), and they are already having their own problems, plus the fact that changes in the value of the GBP and interest rates mean that affordability is becoming an issue, an issue to which you have to add the drop in attraction of properties whose prices may now be set to seriously deflate, and over a significant number of years.

Indeed, according to Manuel Gandarias, president of the ‘Live in Spain’ holiday-home developers’ association, sales of holiday homes in Spain are now down by 50% from the peak “In recent years between 120,000 and 125,000 holiday homes were sold each year, this year it will be half that,” he is quoted as saying. And of course it isn't only the cost of buying the home that has been going up, it is also the cost of servicing the debt that buying the home brings with it. Josep Suárez, director at Solbank in London estimates that the combined impact of rising Euribor rates and the appreciation of the Euro against the pound (15% in the last 9 months) means that mortgage payments for Britons with mortgages in Spain are now 25% higher than they were a year ago.

So the outlook on the North European second home market doesn't exactly look bright either, which leaves us with the migrants. As is now generally well known, Spain's population has increased dramatically in recent years - from around 40 million in 2000 to around 45 million in 2008 - and this increase has been almost exclusively (natural increase is no more than a quarter of a million) the result of huge inward migration.



Basically the future of all these migrants is now deeply uncertain. I would even say that losing the migrants constitutes the most important of all the downside risks to the Spanish economic crisis for the impact it will have on urban rents and mortgage delinquency in the short term (since many of the migrants have bought flats), and for the consequences for Spain's housing market and pensions system in the mid term. Evidently, since most of the migrants are economic migrants the inward flow must surely be about to dry up (since there are few if any jobs for them) and thus our attention should be focused on the need to hold onto those we already have.

Is There A Rescue Plan Available?

Basically, and on the basis of all the above, I would like to now put forward a five point "rescue" plan for the Spanish economy. It would look something like this:

1/ Set up a national land agency, to buy up land and to irrevocably convert it to other uses (agriculture wouldn't be a bad bet where possible given present food prices). This to include the proviso that such land could never again be zoned.
2/ Buy out and close down the bankrupt builders as part of a general restructuring programme such as the one which was developed for the shipyards and the mines.
3/ Buy up and burn immediately ALL outstanding cedulas hipotecarias. Well, I'm exaggerating here, but something very decisive needs to be done to take these things out of circulation in the longer term, or we will never ease Spain out from under this.
4/ Establish a programme to help immigrants in difficult circumstances, and offer training etc to prepare for the future. Abasic focus of policy needs to be on trying to persuade migrants to stay.
5/ Restructure all existing mortgage contracts - which will involve every one paying more - in order to put mortgage financing in Spain back on a sound footing. This will obviously require legislative intervention, and will equally obviously involve breaking the direct tie with one year euribor. It has been following euribor up and down which has gotten the Spanish mortgage market into this mess in the first place.

OK, I warned you. I said none of this was going to be popular. And none of these propsals should be consider as carved in stone. Better ones could well, I am sure, be put forward, but in the absence of anything credible in the way of alternatives I am putting them forward now. As I said at the start, there is no point in agreeing to have your own throat slit just to see people you don't like have their's slit first.

It is very, very important that some form of "corta fuegos" (fire break) is put in place, and put in place now, otherwise the whole of Spain could very easily burn down in just the same way the Liceu opera house did here in Barcelona, simply because some chump decided to do on-stage soldering repairs with the safety curtain up! Risk sir, there's no risk here. It's all as safe as houses.

18 comments:

RealThink said...

Edward, from your description of the Spanish economy's recent history that starts at "So how did Spain get into this rather precarious situation?" it is quite clear that Spain's case is an almost exact scaled-down model of the US case during the same period, with a key difference: the US Federal Reserve can create and lend to American financial institutions as many dollars as they want, while the Bank of Spain cannot do that with euros.

There is a key issue along your post which is only perceived from a Hubbert's Peak-aware perspective: you are dealing in the end with trying to sustain an activity (housebuilding) which, to be sustainable, requires an unsustainable phenomenon to take place (population growth).

Besides that, let me remind you that the way markets realize (and act upon that realization) that a particular economic scenario has become the most likely is highly nonlinear. Remember the level of complacency about Argentina in 2000 and how the movie went on in 2001.

Charles Butler said...

Umm, have you not forgotten the terminal 'raise taxes in a recession to pay for all this' part? Personally, I'll be pretty pissed off if the government bails the lenders out of the incredibly stupid decision to lend the money to buy out Fadesa, creating one insolvent monster out of two functioning, although soon to falter, enterprises with all the net gain to the Spanish economy in Manuel Jove's pockets.

In all regards, builders and promotors have yet to seriously reprice their inventory. I've been through one of these. Southern Ontario saw property prices fall around 50% from 89-95. No amount of government intervention makes the clot start to move until prices get interesting to both buyers and lenders.

CB

Edward Hugh said...

Hi again Charles,

"Umm, have you not forgotten the terminal 'raise taxes in a recession to pay for all this' part? "
No I haven't. But as I say, Spain alone cannot face this. IMHO this - coupled with the Italian Sovereign situation which RealThink keeps drawing attention to - makes this more or less make or break time for the Eurozone. Either French and German taxpayers are ready to stump up the cash to make the dream work, or it is simply all going to fall apart over the next five years. As I say, it is money were your mouth is time.

So in the slitting your own throat analogy, it isn't only the Spanish who are on the line here, but the French and the Germans too. They need to think very carefully indeed before simply sitting back and watching Spain drive straight into the wall.

Basically Charles, I don't think you understand the extent of the distortions which are involved here - I mean basically the whole Harrod-Balassa-Samuelson theoretical model which underpinned much more than Mundell the ECB just went out of the window. We are very much without a figleaf in the conference chamber.

The issue is we need an EU version of the US Treasury, and we need it tomorrow, and if we can't have it, then I think effectively it is "bye-bye" eurozone time.

So my response is this is not Southern Ontario, and it is not 1989. This is Tokyo, and it is 1992, and Spain hasn't got the high tech industrial magnates to restructure around. My god, just look at those levels of non-construction corporate indebtedness. Prisa are still busy struggling away trying to find money I see.

Incidentally, and from the last thread:

"Santander's recent advertising campaign offering Euribor +0.17% for mortgages of more than five years antiquity transferred from other institutions is as close to proof that there is that pressure on the cedula front does not begin to even show itself before 2012."

I don't read this this way. The point about such mortgages is the quantity of equity they carry. What Santander are trying to do is shore up the value of the mortgage pool, by inmproving the quality of their mortagge portfolio.

Basically everyone must be terrified of any big drop in prices (and here I think you have the explanation of why they are still not formally declaring price drops - methinks the likes of S&P and Moody's can find themselves with a huge dose of big trouble in little Spain on this count if they aren't careful), since as prices drop the value of the pools drops, and with it the ratio of the mortgages to the cedula debt, so they will constantly need to keep topping up, which is why they have been so overcollateralised (they claim).

They need to maintain at least 90% coverage of oustanding cedulas in the pool - which in Spain is not discrete blocks but the entire stock of indicated mortgages - ie anyone who had a mortage with Popular could have their home "seized" by international investors (who will of course have first claim on the assets and not BP depositors thus creating another huge headache looming for the Spanish government) if push comes to shove and they fold.

Edward Hugh said...

Hello Again realthink:

"with a key difference: the US Federal Reserve can create and lend to American financial institutions as many dollars as they want, while the Bank of Spain cannot do that with euros."

No. This isn't really the difference. The ECB can more or less do what the Fed does. The Bank of Spain is really irrelevant. They are simply a book-keeping agency at this point.

What the EU lacks is the US Treasury. You see the guarantor of last resort for the Federal Reserve is the US taxpayer - as we are seing now with FannyMae and FreddyMac. But who is the guarantor of last resort of the ECB, not the Spanish raxpayer alone surely. If undemplyment goes up in Southern Ontario - to take Charles's example - benefit payments are not simply funded in Southern Ontario, nor are medicare and pension payments in Florida funded in Florida.

So the eurozone architecture is like a huge tower with one floor of the foundations missing, and this is what people are now discovering. People thought the euro was all about being able to move across frontiers without changing money. Ha ha. I have never heard anything so funny in my life. It was always about the deep structure of financial markets.

"which, to be sustainable, requires an unsustainable phenomenon to take place (population growth)."

Oh I agree entirely. I would make the absolute condition of any rescue plan that the construction be downsized immediately from 12% to 5% of GDP. And during the coming years even 5% may well be optimistic, depending on how much civil engineering you can afford to do.

"Besides that, let me remind you that the way markets realize (and act upon that realization) that a particular economic scenario has become the most likely is highly nonlinear"

Oh, definitely. This is what I am trying to in my debate with Charles, communicate to him that I think people are being far far too compalcent right now, and that when things finally move they will move quickly. Martinsa Fadesa is just a pre quake tremour.

On population, I wouldn't disagree that the planet could well survive better with a reduced population. So the question is not to increase the global population (more than we are already locked into) but to move the pieces around a bit to put some sort of brake on the strong implosion we have set up in some very very low fertility countries. ie along with free capital markets we need free - and I mean really free - labour markets, at least if you are going to argue that the resource constraint is the reason why in the OECD we shouldn't be having more children. It is a question of argument coherence more than anything.

Edward Hugh said...

Just one more time quickly Charles:

"Umm, have you not forgotten the terminal 'raise taxes in a recession to pay for all this' part? "

But the thing is, if you don't do anything and simply watch it all melt down, then you as a taxpayer are going to be hit by all the water that comes on board after they have effectively blown a gaping hole in the side of the national ship.

They of cousre will be gone, but you will be left with one hell of a mess.

There are now no easy solutions here, and with every passing day the issues become more serious.

miguel said...

The fact that espana has a very inexperienced and over simplistic prime minister and a finance minister whose reputation is now shot to pieces is a problem.
Throwing in a wild theory, ---
When do you think the Generals will be talking amongst themselves regarding the specticle that espana is painting of itself on the world stage. Spanish people are very proud and will not want to be portrayed as " STUPID ". Is a "coup" likely? If the financial situation is this serious, then an opportunity for the military must be evident, supported by quite a few of the old Franco henchmen. Just a thought , nothing serious.

Edward Hugh said...

Hi Miguel,

"Is a "coup" likely? If the financial situation is this serious, then an opportunity for the military must be evident, supported by quite a few of the old Franco henchmen. Just a thought , nothing serious."

In a word: NO. I think the most probable outcome is that the other parties refuse collectively to vote the next budget, and then this government will fall - which I think it now has to with Zpt so discredited.

We will then have a very inexperienced leader of the opposition (well not totally) with some discredit due to his tolerance of Acebes and Zaplana, but with a proven capacity to aguantar and estar alli. Maybe this is what the country needs at this point - a dose of true grit, and hold on tight the helicopter just went into tailspin. What was it Borrell said? That's what you get for going to a corrida in a helicopter. The thing is this time its the national helicopter that's in tailspin.

Incidentally, if you want some cultural reflections on this whole situation, then try this piece I just wrote for A Fistful of Euros, which has a pretty cultural orientation.

Charles Butler said...

'Basically Charles, I don't think you understand the extent of the distortions which are involved here - '

Edward, you verge on being condescending here. I'll assume you don't mean to be.

Further, I'm not entirely sure that doubting that your plan is workable or desirable translates into my being complacent. Please advise in that regard.

And I'll gladly debate my take on Santander in the appropriate forum - the blog in which I originally wrote it. We'll leave it up to you put up the link so that others may partake and decide for themselves.

Edward Hugh said...

Hi, Charles,

"Edward, you verge on being condescending here. I'll assume you don't mean to be."

I'm sorry. That certainly wasn't my intention. Please accept my apology.

"Further, I'm not entirely sure that doubting that your plan is workable or desirable translates into my being complacent."

No. Look, if it offends I take the expression right back. What I am getting at, is that this is a question which affects the whole Eurozone, and not simply Spain. As RealThink indicates, the combined weight of Italian sovereign and Spanish banks can simply tear the zone apart.

So we need some kind of major structural level proposals on the table before this deteriorates further.Of course, you are perfectly entitled to doubt mine, I just want to get some debate started, but I'm not clear, which ones are you a advocating? Perhaps you could clarify, then we would both know what we are talking about.

Edward Hugh said...

Also Charles,

"And I'll gladly debate my take on Santander in the appropriate forum - the blog in which I originally wrote it."

I think we are getting our wires crossed a bit here. I have really no idea what you are talking about, or which forum you are talking about. When I quoted this:

"Santander's recent advertising campaign offering Euribor +0.17% for mortgages of more than five years antiquity transferred from other institutions is as close to proof that there is that pressure on the cedula front does not begin to even show itself before 2012."

and said from the last thread, I was talking about the last post on this blog, my Martinsa Fadesa one, which is where I took the quote from. I hope that clarifies things.

MIGUEL said...

Edward,

Thanks for all your writings, you have converted a " no interest in economics person" into some one "hooked on and waiting for your next piece eagerly person ". Up till now information on the economic situation has been pretty hard to get and I have been reading Ambrose Evans Pritchard from the Telegraph.( some one actually wrote in to him asking if he could teach ZPT economics).

Now for the question--- In your considered opinion- Will Espana's best and most politically beneficial route be to adopt the Peseta again? or is this ,as the young say-- a no brainer.

IMHO without the EU backing the country it could be dire,but how long can the spanish financial system withstand the interest rate numbers that are set for deutchland? Could it be that espana's financial cycle is still in it's infancy, ( It's population is still very ignorant of the financial systems, savings and investment market.)I don't mean that to be rude but reflecting on my spanish friends and their children around me.

The future for Espana does not look bright at all at this moment.

Edward Hugh said...

Hello again Miguel,

And thanks for the compliment. Well for someone who claims to know little economics, you certainly know how to put your "dedo en la llaga".

Let me be totally honest, and duxk your question. The answer basically is I don't know. I think at this point leaving the euro is not an option for Spain, as it isn't for Italy, since the quantity of the debts accumulated would just be too great for the countries to shoulder on their own.

This is why I am arguing - although of course at this point on this as on so many other things I am a lone voice, crying, and in the wilderness - that we need to complete all those analogies between the Euro and the US dollar by adding the missing piece of the architecture, an EU equivalent of the US Treasury.

Now without this, and without pretty immediate action to stop the bloodletting in Spain, the end result may well become inevitable, and Spain may well be forced into bankruptcy as a country, and via this route out of the eurozone (though not of course the EU, which is a different institutional level).

The point here is, I think, your debts are in euros, and the euro is, at least at this point in time, a *hard currency*, which doesn't make things easy for Spain at all. If the euro were to fall sharply this would help Spain a lot, becuase the debts it would have to pay off would be much cheaper, effectively, but I don't see much likelihood of that, since here we get into another obscure topic - called the demise of Bretton Woods II - which basically is to do with the now historic decline of the USD, and the fact that with the USD down, the euro is naturally up, and there aren't to many other alternatives at this point.

So not only does the EU need a constitution (this is ultimately what all the wrongling has been about I feel), and an EU Treasury with power to raise taxes, we also need a new global financial architecture.

The problem here is all the timing is off. All of these things could (and possibly will) come in the fulness of time, but what Spain and Italy don't have is time.

Basically I come from the UK, and you will note that my old country (like Sweden) is not in the euro. Perhaps it isn't a mere coincidence that these are the two countries with the strongest tradition in macroeconomics as a science in the EU. In many other countries people imagine that economics can simply be administered politically, which as we are now seeing it can't.

So personally I never thought the euro would work, and to some extent what is happening vindicates this view. However I take no pleasure in this fact. I am a pragmatic person, and prefer to see things work as well as they can rather than see them go up in flames. I thought at one point - for eg - that all the immigration the construction excesses were producing might help level out your ageing population and rickety pension system problems. It still might, again if people act now to ease the extent of the crash.

Nothing here is carved in stone in advance, but "immobilismo" is our worst enemy.

Can I reccomend to you an article on the RGE Europe EconMonitor - "How to prick local housing bubbles in a monetary union: regulation and countercyclical taxes" by Alan Ahearne , Juan Delgado and Jakob von Weizsäcker.

I definitely think this is one interesting policy proposal - which is to use fiscally driven demand management to compensate to some extent for the absence of monetary policy - the problem is it would have been better to have been talking about all this before the horse bolted.

There should also, and obviously, have been much tighter regulation from the Bank of Spain and the lending criteria applied by the banks.

I think the absence of interest rate setting independence may not now be the large disadvantage it once was, simply because of financial globalisation. As we can see, several eastern European countries - the Baltics, Bulgaria, Romania - are now in a "boom, bust" very similar structurally to the Spanish one and they aren't in the euro (and in the Romanian case the lei isn't even pegged).

This would lead us off into another obscure topic called the "carry trade" and the accompanying search for yield, and why Japan has interest rates very near to zero (currently 0.5%) and why it finds it impossible to raise these, but I think for now I have said enough.

Personally I am not a huge admirer of the work of Evans Pritchard (although I am a great fan of his grandfather, the anthropologist) since I think his approach is rather headline grabbing, and at times simplistic. I think probably he, like me, didn't think the eurozone could work right from the start, but I have the nasty feeling that he doesn't really care that much about the suffering which will be produced in the South of Europe (and the use of this ugly expression PIGS for the Mediterranean countries) if the thing finally breaks up.

Also, this north-south stuff is very, very simplistic. Italy is very different from Spain (see my piece on RGE EuroEconmonitor) as is Portugal (see my piece there which is coming next week). While Germany isn't anywhere near as strong economically as they seem to think it is (you just watch what gets to happen next as the rate of export growth tapers off).

Well, as I said, I don't have anything like all the answers to the question you ask. Just questions of my own, and lots of them, but stick around and keep reading, since as we advance maybe many of these points will become clearer.

Edward Hugh said...

Hi again Miguel,

I am just reading Munchau in the FT this morning. Maybe it is rather immodest of me, but I do think my stuff on RGE Monitor gets pretty wide exposure, and Munchau does seem to have adjusted his view slightly over the weekend, and is not, for whatever reason, much nearer to what I am saying. In particular he now recognises:

"Some degree of competitive adjustment is probably needed but the huge scale of the shock that is unfolding in Spain will almost certainly require a macroeconomic response that Spain cannot deliver on its own."

This is the central point I think.

I reproduce below a significant extract from Munchau's piece for those who don't have an FT subscription.


**********************************

But what about intra-eurozone divergences? I was struck the other day by a statistic from the ECB that shows Spain losing competitiveness relative to Germany, even now. We knew this happened during the years of high economic growth in Spain and low growth in Germany. But the trend continued even when the relative positions of the two countries were reversing. One explanation is that Spanish wages are directly linked to inflation, while German real wages are still declining.

Worse, Spain’s slippage comes amid the prospect of a serious downturn in its economy. Last week’s collapse of Martinsa-Fadesa, a large property developer, has been a reminder, if any were needed, of the massive scale of the Spanish property crash. Serious financial and economic distress is almost inevitable. Do not be fooled by the fact that Spanish banks had virtually no exposure to US subprime mortgages. Being exposed to Spanish mortgages is probably worse.

Spain is in a more delicate position than the US or the UK because, as a member of a monetary union, the country has fewer macroeconomic adjustment tools at its disposal. The dollar and the pound have devalued in real effective terms, while Spain has one of the hardest currencies in the world. Spanish interest rates have gone up while US rates have gone down.

The good news is that Spain has some room for manoeuvre in fiscal policy, given its low debt-to-GDP ratio. But the whole structural and legal setup of the eurozone requires that, in any adjustment, most of the heavy lifting is done via the real economy. Spain is thus in danger of entering a decade of misery, with falling real wages.

The problem is that even if Spain were to try to pull itself up through competitive adjustment, it is not at all clear that this would work. I am not even sure whether it works all that well for Germany in the long run, but that is another story. Some degree of competitive adjustment is probably needed but the huge scale of the shock that is unfolding in Spain will almost certainly require a macroeconomic response that Spain cannot deliver on its own.

Yet the eurozone’s system of economic governance is not designed to produce this type of response. There are no cyclical transfer schemes, only structural funds. No common rules exist on bank bail-outs. Small-minded national banking regulators even refuse to countenance the very obvious necessity of a central banking regulator for cross-border banks. The eurozone does not even have single representation at the International Monetary Fund. The economic shocks to be experienced by Spain, and by Ireland, will seriously test the eurozone’s see-no-evil-hear-no-evil approach to economic governance.

I have long thought that the only way the current set-up will be changed is not through debate about future eventualities but as a result of being plunged into crisis. Eurozone finance ministers – the so-called eurogroup – are a complacent bunch. They never do anything until it is absolutely necessary. But they will act eventually. I am relatively optimistic that they will always be able to ward off the worst-case scenario, one that still excites some commentators: the threat of a eurozone break-up.

So what actions would be needed? In the very short run, a transfer mechanism to provide help for countries in severe distress. Of course, any transfers would have to come with IMF-style conditions attached. As a price for an increase in intra-eurozone solidarity, the other member states would almost certainly demand that the beneficiaries end the silly policies that got them into the mess in the first place. Spain, for example, should end the automatic link between inflation and wages. It should also end the monopoly of the one-month euro interbank offered rate mortgage, which has had a hugely pro-cyclical effect on mortgage lending and the housing market.

The one institution that cannot help Spain is the ECB. Its role is to run an optimal policy for the eurozone as a whole. Dealing with this hugely asymmetric shock is primarily a matter for politicians, not central bankers. Anybody who claims to be serious about economic policy co-ordination, such as President Nicolas Sarkozy of France or the European parliament’s economic and monetary affairs committee, should therefore stop bashing the ECB for a few months and focus attention on the storm that is building up on the eurozone’s western front.

Charles Butler said...

Accepted. The forum to which I refer is http://ibexsalad.blogspot.com/2008/07/penny-for-your-thoughts-seor-botn.html. The confusion arises from the lag and the passing of the answer from one post to another. My apologies.

What Spain most urgently needs to do is eliminate the underground economy and the whole administrative and legal infrastructure that supports and encourages it. The effect would be the conversion of some tens of billions of euros of hoarded cash to bank deposits - at no cost to anyone. The hoarding of money is a serious economic problem for Spain and one can imagine a number of combinations of carrots and sticks that might eliminate it.

Second, and intimately tied to the first, in this regard would be the squashing of the unemployment insurance game in this country which, because of near nonexistent vigilance, contributes to the mass of untaxed and underutilized cash, excessive social security costs and etcetera.

One could imagine EU countries coming to the rescue with conditions such as the above attached, sick as they already are with providing subsidies on the basis of false data.

Excess immigrant labour served as a de facto subsidy for the construction industry by flattening wages. Without this effect, house prices may have found themselves peaking considerably earlier in the cycle or, at the very least, would not have run so far ahead of wages. It may be true that there's not enough baby makers in Spain, but the current situation insists on a much shorter term outlook and the unemployment shock absorber is going to foreign labour.

Among the partial solutions available to the problem of the roll of the cedulas would be to make them income tax exempt. That would equate to a 22% increase in their effective interest rate, based merely on the retention tax and thus much higher for many of the interested.

As for investor perception of the prospects for the cajas, CAM's IPO comes to market Wednesday. Early guesses place the price at 5.95, equating to 300 million euros, more or less. If it takes, expect more of the same unprecedented monetizing of value from the rest.

I'm extremely pessimistic, by the way, but tend to be phlegmatic about things beyond my control. In the case of Spain, there also exists the risk that locally applied solutions will not work optimally. Remember that the initial freezing of the world's credit markets was not caused by doubts over the solvency of Caja Duero. It probably won't go away that simply either. If it all drags on for two or three years (as it currently promises to), some of the various countries that funded the disastrous American economic and banking policy that got us here will find themselves forced to enter the fray. The alternative would be a Great March of 100 million Chinese factory workers back to the farm.

As an aside, a serious revision of some of the tenets and data calculations of the economics profession might be in order in light of the gross miscalculations of the current period.

RealThink said...

Miguel asked:

"Will España's best and most politically beneficial route be to adopt the Peseta again?"

Miguel, that's exactly what Argentina did in 2002 to get out of its depression: "pesificación". For España it would be "pesetización".

You should be aware that the move involves redenomination of all debts and bank deposits to pesetas, which are then devalued. So if you had 1000 euros in the bank at day 0, they are converted to 1000 pesetas on the morning of day 1 (which is a bank holiday) and immediately afterwards the peseta is devalued. Bad if you had net savings, good if you had net debt. (Probably the move implies violating property rights protected by laws and the Constitution, but in times of distress any constitution becomes "a damned piece of paper".)

Clearly even talking about the possibility that this measure may be adopted would be enough to initiate a wave of capital flight out of Spain, which would by itself trigger the meltdown, as it happened in Argentina 2001.

And as in the Argentinian case, the pesetization and devaluation path makes it impossible to pay the external debt (which cannot be "pesetized"). Therefore this path implies massive external default.

You might think, "Hey, but in Argentina it led to 5 years of 9% economic growth!". Sure, but Argentina is a big exporter of grains and oilseeds and it happened to catch the price rise of those commodities. So you need to ascertain whether Spain can do something of the kind.

My own thoughts? I wouldn't help someone who does not sell the family jewels. What are the works at El Prado worth?

Edward Hugh said...

Hi again Charles,

"What Spain most urgently needs to do is eliminate the underground economy and the whole administrative and legal infrastructure that supports and encourages it."

Well yes, I think we can all drink to this, but I don't see it happening during the time frame of this crisis. The last serious attempt was Solchaga during the 1990s, or perhaps you could count the various amnesties of migrant labour.

My feeling though is that we are now going in the opposite direction, as people try to cut costs by employing labour on an irregular basis. We will see.

The real place that this is going to hurt in the future is the fiscal base of the pension and health system as Spain ages. This is precisely the problem in Italy. Italy is of coures nowhere near as badly off economically as the official data show, but this won't help them one iota when it comes to the sovereign default issue, since if people don't pay taxes, then they don't pay taxes, and the government's income is reduced accordingly. Add to this people arriving to old age who have never really contributed, and up go the loiabilities, and what do you know, you have a debt of 105% of GDP, under constant upward pressure. There is effectively no way out of this.

Even without the current crisis, I would have been syaing take care with the sustainability of government debt in Spain post 2015. Now it seems the present issues will bring all this hurtling forward. We are already in deficit this year, and it would be a very brave person who offered to tell you when the books are going to balance again.

On a lighter note, an acquaintance of mine was telling me yesterday that Endesa phoned his office yesterday offering his daughter insurance. He said to me, "you can see how bad things have gotten if Endesa are now being forced into the insurance business".

I obviously agreed, but said "look Josep, the best insurance you can take out now is on all those 500 euro notes you have but you don't have". I told him to go home and check the letter code (I have no idea what it is, since I have never seen one of these beasts, but on 20 euro it is a V). This sent him scurrying of to see his agent in La Caixa, to organise changing them over for ones with a French serial number, you know, just in case. That's what insurance is, isn't it. You don't take our flat insurance because you expect to flood your downstair's neighbour's flat, but you do take it out.

Now just imagine what is going to happen when all these people sitting on all those suitcases realise just what riks they are taking should the eurozone one day have problems. You can almost see the stampede now :).

Edward Hugh said...

"One could imagine EU countries coming to the rescue with conditions such as the above attached, sick as they already are with providing subsidies on the basis of false data."

I like you, am not optimistic. I think I know what should be done, but I doubt very much it will be, or at least be done in time to stop the big part of the issue getting out of hand.

In part this is also because I imagine that the package would have to come - as you suggest - with very strict conditions: obviously wages will have to come down (there is just no alternative if you want to stay in the euro and export, increasing productivity alone won't give the competitiveness, and anyway you have to imagine that all your competitors are busy trying to raise their own productivity), and again clearly the mortgage system needs to be restructured in some way, and this will make mortgages more expensive.

Since neither of these are exactly election winners, it is hard to see any local politicians biting the bullet. Which means things are going to get worse, a lot worse, before they get any better.

As you indicate, German and French taxpayers are hardly going to cough up their money just because they are in a good mood.

Edward Hugh said...

"Among the partial solutions available to the problem of the roll of the cedulas would be to make them income tax exempt."

Well as you know, I take the view that in their present form these simply have to go. With house prices falling, and then wages going down, they are simply going to be under constant downward pressure (due to pressure on the underlying asset pool) .

There are also the huge political implications of having problems with the cedulas.

Basically we are going to start seeing these when the first bank goes under. As I understand the situation the holders of cedulas may well have first claim on the banks assets (which will probably mean no bail out of the depositors is possible) and then you could have the highly emotive issue of holders of debt putting luxury property in Madrid on the market and selling for 50% of its notional value, over and above the wishes of the occupants (since they are only mortgage holders, and hence are effectively renting from the cedula holders at the present time).

I mean, the legal status of the cedulas still lacks jurisprudence, but we will get it, and if the people who hold the debt have any sense (and I'm sure they do) they will seek this outside Spain. I mean, why the hell do you think some of the specialists in all this are now busy buying up the debt, simply to do charitable work :).I don't know whether the legal basis exists, but I imagine we could have landmark class actions in somewhere like the US, seizing the assets of Santander (for example, if Santander is in trouble). Basically I don't know where this will end. But I don't imagine anyone else does, which is why we will need to see jurisprudence, but which is also why the problem should be taken out of the ballcourt before any of this truly nightmare scenario can start to happen.

Also, as you point out, CAM mark to market today. It seems they had set a maximum price of 5.95 euros but the final figure seems to be the very bottom of its initial price range of 5.84-7.30 euros.

It will now be interesting to watch what happens.