On Pedro Solbes

Although we could see this explosion coming, I don’t think even the biggest pessimists thought that the crisis would get this bad,” he writes. “But the blame can’t be pinned on the banks and property companies alone. Nor on the different governments that have been in power. At the end of the day we have all helped to created the bubble by paying exorbitant prices for flats and houses, using impossible mortgages, and ignoring our own resources. I remember friends and colleagues saying “property prices have never fallen”, taking it for granted that if they have never fallen in the past, they will never fall in future, and that “there is no safer investment than the real estate sector”. In fact, any time you hear comments like that about any type of investment, you can be sure that a bubble is in preparation.
Anonymous Comment in an El Pais readers forum on the property bubble

It isn't only Artemio Cruz (or if you like José Lluis Rodriguez Zapatero) who needs to get up and take a long hard look at himself in the mirror at the present time. Let each and every Spaniard who said "property prices will never fall" take a good look at themselves too, and before being too free and easy with their criticisms of others say to themselves "there but for the grace of god go I".


Ambrose Evans Pritchard (hello Ambrose, I'm a great fan of your dad's work) had a piece on Spain and on Pedro Solbes this morning. He closes the article as follows:

The vultures are starting to circle around the hapless Mr Solbes. Critics are calling for his head, accusing him of covering up the true scale of the downturn before the re-election of the Socialists in March. This seems unfair. Mr Solbes continued to dismiss warnings of a crisis as "enormously exaggerated" long afterwards. He appears to be genuinely astounded by what has occurred.

Now I think Ambrose, in his way, makes a very valid point here: I am sure that Pedro Solbes is absolutely astounded by what he is seeing in the way of data coming across his desk day-in and day-out at the moment. He could never in his wildest dreams have imagined what he finds in front of him, I think arguably no-one could. I seem to be playing Cassandra here, and while I always imagined we would see some sort of blow-out, it is the magnitude of what is happening that is truly unexpected, and indeed awe inspiring.

Even Ben Bernanke - to take just one example of a macroeconomist who I truly admire for his technical and theoretical skills (I would put him in my global top five) could not be said to have seen it coming, since in his speech - the euro at five - to mark the fifth anniversary of the introduction of the common currency, he simply limits himself to saying that the euro is a great monetary experiment - prudently he doesn't commit himself one way or the other about whether or not the experiment will work - but he certainly doesn't issue any kind of warning either, about the dangers of creating single country property bubbles via the "one size fits all monetary policy". Nor does he discuss what might be done in the event that such bubbles should develop.

Of course, what people are complaining about isn't so much the fact that Solbes couldn't forsee that there might be structural problems managing a common currency regime, but that his short term forecasts since last August haven't been all they might have been. But which national economics minister is getting it right at this point in time? And the point is that back in August 2007 I am sure that Pedro Solbes had no way of knowing that the looming credit crunch was going to give us all the worst set of financial headaches we have seen since 1929.

So what I am saying is that Pedro Solbes is only human, just like the rest of us he is a mere mortal. And he is a mortal who is evidently out of his depth with the problem which is confronting him, but then, I ask you, who isn't at this point. It is time for the fire brigade to go to work, the only problem is we don't have a fire department, because NO ONE saw the need, because NO ONE saw this coming, at least not clearly they didn't.

Now I am saying all this, and in a way writing this blog post, to defend Solbes name and reputation since I think there is a big danger in the way people in Spain are generally reacting to this problem at the present time. I think people here have a tendency to put far too much confidence in the knowledge and abilities of their leaders, and this becomes a problem when such confidence is misplaced, not because these leaders are bad people, but simply because they are, just like everyone else, only human.

I think there is far too great a tendency in Spain to think of politicians as dishonest ("son uns lladres", "no hi ha ni un pam de net") but astute (llestos), and they may be both or neither of these, since this is not my concern, but what they most certainly are not are macroeconomists, and thus they are in no real position to better appreciate the extent of what is happening than is the woman on the proverbial Madrid omnibus (you know, the one at the start of Almodovar's Carne Tremula, "malnacido, y sin padre). They are simply in shock, that is all.

But it is time to come out of shock, and put on our firemen's suits, or the whole house is simply going to burn down around us. We need a plan of action, we need the help of Brussels, and we need it now, and not after everyone comes back from holiday or whenever. If we don't do something soon many of those now idling away their days on the beach may not have a job to come back to when they return.

Now to touch on one or to of the other points which Ambrose raises:

The root cause of the bubble was the extremely lax monetary policy imported by Spain after it joined Europe's monetary union. Interest rates were slashed on EMU entry, and then fell to 2pc until late 2005 - far below Spain's inflation rate.

In other words the whole problem is a result of structural failings in the design of monetary union. This is a real problem, and it is one which needs more or less urgent responses, and not platitudes about Harrod-Samuelson-Balassa effects. These interest rates were "lax" in Spain, but not in Germany, and that is the problem.



Secondly we have the issue of the way in which the Spanish banks are now becoming the centre of global attention. The issue here is a recent report from Morgan Stanley (which I mentioned yesterday) and which Ambrose cites extensively:

"A momentous economic slowdown is now under way. We believe the deterioration in Spain is just in the beginning stages. The bulk of the pain will be suffered in 2009," said the report, by Eva Hernandez and Carlos Caceres. "The probability of a crisis scenario similar to the early 1990s is increasing. If the ERM (Exchange Rate Mechanism) scenario were to become reality the main concern would not be earnings, but capital....We estimate that a non-performing loan ratio of 10pc to 15pc for developers' loans would fully erase earnings in 2009 and would represent between 20pc to 30pc of the current tangible capital base of Banco Popular, Sabadell and Banesto," they said."

This attention is now here, and it is simply not going to go away (and indeed the latest example of such attention is the post "Construction Correction Driving Economy Down" on the Morgan Stanley Global Economic Forum). There is a further point in Ambrose's article which is worthy of comment:

The banks certainly dodged the US sub-prime debacle, thanks to restrictions by Bank of Spain on the use of off-books investment vehicles. Home equity withdrawals and "piggy back loans" are rare. Mortgages were mostly limited to 80pc of house prices, at least in theory.

This is not quite right. The only real sense in which Spain didn't have sub-Prime was in not making use of extensive off-balance-sheet SIVs. In theory this means that banks are inclined to be less risky in their lending, since if things go wrong their own balance sheets are directly affected - or as Morgan Stanley so nicely put it "the main concern becomes not earnings, but capital". So the main issue with the SIVs may well be that the leveraging induced causes everything to fold quickly like a pack of cards, whereas doing effectively the same thing on balance sheet may well prove to be virtually fatal, even if the unwind is a bit slower.

As I argue in my "No sub-Prime in Spain, but is Spain itself sub-Prime" post, bar the SIVs almost every other phenomenon associated with sub-Prime is here. Of course piggy backs and refi's were commonplace, even if the Spanish borrowed not to spend, but to do what they thought was saving, ie modernising and upgrading their home. And with LtV ratios of 110% commonplace for young people (who often didn't even have the savings for notarial fees and furniture - you know, the mil-euristes) there was not so much need for the piggy-back (since you were already up on the shoulders of a giant), but they were certainly there if ever you needed them. Basically, easy lending and over-leveraged households became commonplace here, and now the whole thing is unfolding, and if no one does anything to stop it the whole issue will steadily work its way back upstream to the bank balance sheets.

Which brings me back to Pedro Solbes.

As I say, I wouldn't want to falsely accuse him of attempting to mislead in the past. I have a good deal of respect for him, and for everything he tried to do, almost single handedly, to enforce the Stability and Growth Pact against the mighty forces of the French and German States when he was Economics Commissioner in Brussels. His successor isn't even fit to don the shoes he wore in this area. But that was then, and this is now. And statements like this (given in an interview to El Pais over the weekend) are much harder to forgive and forget:

"Spanish Economy Minister Pedro Solbes on Sunday said in a newspaper interview that he expected the European Central Bank to keep interest rates on hold..... If oil doesn't bring us any more surprises, if there are no other variables with a negative impact, we think there will be very low or flat growth in the coming quarters, but we are not thinking of a recession."

I'm sorry, this is inexcusable. It is clear that Spain is heading rapidly into recession, and the only real issue is how long and how deep it is going to be. So while Pedro Solbes can, for his past "omissions" reasonably take recourse in the defence that he has, like everyone else, simply been overwhelmed by events, this no longer applies to what is happening now, and I would recall here the old Greek adage from Sophocles' Antigone: "call no man happy until the day he dies". Pedro, don't undo a whole life's work for the sake of avoiding conflict and confusion in the short term. The Spanish people have the right to know the full extent of the drama which awaits them, and they have the right to know it now!