Spain Unemployment May 2008 and the Worsening Real Economy

Unemployment rose in Spain last month for the first time in the month of May since 1979. The Spanish newspaper ABC notes in passing that the Spanish Economy Minister Pedro Solbes has finally managed to describe the situation as ‘serious’.

The number of people unemployed in Spain increased by 15,058 in May to a total of 2,353,575, according to the Spanish labour office INEM yesterday. The number of registered unemployed at the end of May was thus up by 0.6% from the previous month.

By sector, unemployment in the services sector was down 0.2% and also dropped 0.1% in agriculture. On the other hand, unemployment in construction was up 4.6% and was also up 0.8% in industry.

Year on year the rate of increase has been rising steadily, and was up 19.38% in May 2008 over May 2007.


OECD Outlook

The OECD also forecast that Spanish growth will more than halve to 1.6 percent this year and fall to 1.1 percent in 2009 as Spaniards cut spending and public accounts fall into deficit, the OECD said on Wednesday. I think from everything we are seeing these numbers are too high, and I think if you look at the very serious outlook for the financial sector in the second half of this year (see this accompanying post here) it is very hard to be so optimistic about short term stabilisation. This is going to get worse, a lot worse, before it starts to get better.


The OECD also forecast that the knock on effects of the abrupt fall in house building will send 2009 unemployment to 10.7 percent from 9.7 in 2008. Again this is begining to look very optimistic from today's data. Unemployment on the EU harmonised methodology is already up around 9.6% and seems set to continue to rise.



Also, perhaps here it is just as important to consider total employment as it is to think about unemployment, since so much of Spain's GDP growth in recent years has been labour input driven and not productivity driven. In fact total employment seems to have peaked in Q3 2007 at 20.511 million. The question is now just how far and just how fast is this going to come down. To get an idea the rate of increase has been dropping by the quarter since the maximum rate of acceleration with seemed to be a year on year 4.91% in Q1 2006. By Q1 2008 we were at a y-o-y increase of 1.66% and we are of course dropping. Since there is very little productivity change going on here the rate of change in the employed population will probably constitute a pretty good proxy for the rate of GDP growth.




The OECD also forecast that Spain's public sector budget will fall into a deficit and be equal to approximately 0.3 percent of GDP in 2009, following five years of surpluses, due to a 10 billion euro economic stimulus package, lower tax receipts and higher infrastructure spending. They anticipate the economy will be sluggish for 18 months (I think we are into something much longer term than this).


Spain's inflation, which is currently among the highest in the euro zone at 4.7 percent, should finish 2008 at 4.6 percent before easing to 3 percent in 2009, the OECD said (this may well be much more realistic).




Credit growth will ease as Spanish banks, especially small savings banks or cajas, struggle to raise external capital. House prices will feel downward pressure as more new homes enter the market with construction firms finishing off the large number of housing projects begun in 2007. Investment in machinery and equipment, one of the most robust areas of the Spanish economy, is expected to contract on weaker demand, waning confidence and more restrictive financial conditions the OECD said.


Spain's current account deficit, the world's second largest (after the US) in absolute terms in 2007, will remain around 10 percent of GDP over the next two years as higher import prices and external debt service payments offset a fall in imports and slightly stronger exports.




Consumer Confidence Hits New Low


Spain's consumer confidence index fell again sharply to 56.4 in May from 63.8 in April, the lowest level since the indicator began in September 2004, the state financing agency Instituto de Credito Official (ICO) said.

The indicator looks at consumer confidence in the current economic situation and future economy in terms of the country, the home and employment.




The index May figure reflects declines in all categories from April, with sentiment on Spain's economy down 6.7 points, on employment down 2.8 points and on household economy down 6.2 points.

Consumer confidence was 39.3 points lower in May from a year earlier, when the consumer sentiment index stood at 93.0.





There is also increasing evidence of a widening divergence between the big four economies in the 15-nation eurozone with Germany and France continuing to prop-up a contracting Italy and a Spain which is in "free fall". This divergence is only going to add to the headaches over at the European Central Bank, which is already pretty worried about the continuing high inflation. After a drop in April, the Business Climate Indicator (BCI) has stabilised in May. The Economic Sentiment Indicator (ESI) remained unchanged in the Eurozone at 97.1.




Car Sales

Spanish car sales fell almost a quarter in May, offering further evidence the Spanish economy is cooling far faster than expected, but French sales were up, bucking weak consumer confidence, and sales in Belgium also rose.

Spanish dealers sold 116,108 units in May, 24.3 percent fewer than a year ago, industry body ANFAC said on Monday.

In the year to date, car sales were down 14.3 percent at 587,407 units, almost 100,000 less than a year ago and the lowest total since at least 2002.

Retail Sales


Spain's retail sales fell 3.4% in April and continue to fall.





Industrial Output


Spanish industrial output adjusted for calendar effects fell 2.6 percent in March from a year earlier, according to the latest data from the National Institute for Statistics (INE). INE also said consumer goods output fell 4.6 percent from a year earlier, while capital goods output was down 0.4 percent. Intermediate goods output fell 6.9 percent, while energy goods output rose 10.2 percent.

Spain Manufacturing PMI May 2008

Spain's manufacturing activity continued to decline in May, and, more importantly, it continued to decline at an ever increasing pace. This is what I mean by problem in the financial sector steadily spilling over into the real economy.

The Spanish manufacturing sector purchasing managers' index (PMI) fell to 43.8 in May from 45.2 in April, the fourth consecutive drop, market research group NTC said. The figure is the lowest in six and a half years, NTC said.

'The Spanish manufacturing sector continues to fall due to the end to the construction boom. May's PMI figures show a record drop in new orders as businesses and Spanish consumers react to the new economic climate,' economist at NTC, Nathan Carroll said.

A reading above 50 indicates that the manufacturing sector is generally expanding, while a reading below 50 suggests it is contracting.

Are Spain's Bank's Facing A Short Term Liquidity Crunch?

Last Monday morning when most of Spain's citizens were busy watch YouTube videos or TV coverage of Rodolfo Chiquilicuatre doing his buffoonery at the Eurovision Song Contest, many readers of the English speaking press were hard at it peering into another video, the one of the FT's Ralph Atkins interviewing Spain's representative on the ECB executive board José Manuel González-Páramo (transcript here, curiously whilst almost everyone in Spain seems to know who Chiquilicuatre is, almost no one has heard of González-Páramo).

The Spanish representative was busy trying to allay fears that European banks have become over-dependent on European Central Bank liquidity injections and in particular trying to deny that the Spanish banks are gearing their operations to take advantage of its extra help.(In other words while good Rodolfo was dando-nos a todos verguenza ajena, González-Páramo was simply doing his job, and dando la cara).

“I don’t think in any way the banking system is becoming addicted,” said José Manuel González-Páramo, ECB executive board member, in an interview with the Financial Times. “They are now behaving a little bit different than they were behaving before August 2007, but the reasons behind that are quite obvious to everyone.”

If González-Páramo was having to work hard to keep the Spanish end up, this was in part a response to the growing concern that Spanish banks are creating ever riskier collateral to swap with the ECB, far riskier collateral than the central bank ever envisaged (see below), that the ECB already holds too much risky collateral, and that the funding was being used to far to great an extent to keep "business as usual" going, rather than bridge finance to enable a sizeable restructuring of the Spanish economy. Just such a view was expressed earlier this month by Yves Mersch, Luxembourg’s central bank governor – who, like Mr González-Páramo, sits on the ECB’s governing council – when he indicated that the type of collateral now being accepted by the ECB was “a matter of high concern”.

Since the global financial market crisis erupted last year, finance houses have been able to fall back on the ECB’s liquidity operations, available to a large number of banks on the basis of a broad range of collateral, including some mortgage-backed securities. To address financial market tensions, the ECB has also altered the way it provides finance.

Slowdown in Bank Lending

Evidence of the difficulties that Spain's banks are having is everywhere. Take bank lending for example. According to the most recent data we have from the Bank of Spain, lending to Spanish households was up by 4.245 billion euros in March when compared with February, and year on year lending to households was up by only 10.6%.

I say "only" here since this rate of increase in lending is only about half what it was at the start of 2007, and as such it is only about half the rate of new mortgage generation that the extensive Spanish construction industry needs simply to keep turning over.



The reason for this decline in the rate of new lending creation is obvious: the liquidity crunch, which is now the principal reason why Spanish banks are steadily lending less and less extra money in new mortgages each month, although evidently since all of this is now producing a substantial slowdown in the real economy, with unemployment rising and take home pay under constant pressure from inflation we are steadily moving from a construction crisis fuelled by a lack of availability of funds for mortgages to one which will be increasingly driven by absence of demand for them as the "affordability" issue steadily locks-in on those who would like to buy their own home.

The fundamental situation is that since the Spanish banks are short of cash they are simply able to lend less. It is this, and not the 4% repo rate set by the ECB, which is the principal reason the value of mortgages created on urban buildings in Spain (at approximately 16,575 million euros) was down in March 2008 by 36.7% over March 2007. In housing, the capital loaned exceeded 9,975 million euros, 41.9% less than in March 2007. 105,608 properties were mortgaged in March 2008, a decrease of 37.77% over March 2007.



The Spanish banks are, of course, able to raise money, but much of this is on a short term basis, and not appropriate for long term lending on products such as mortgages. Moody's recently suggested that Spanish savings banks are trying to attract foreign investors (especially German pension and investment funds) with private placements of tailor-made securities. But such issues are typically in the 30 to 300 million euro range - a far cry from the earlier jumbo cedulas. In addition maturity on these securities is much shorter, typically three years. (To those readers who have no idea at this point what cedulas hipotecarias actually are, I would say fear not, since neither did I when I set out on this venture, but perhaps it is worth reading through my working notes on the topic since they may help you become just a bit more familiar with the meaning of an expression which is - unfortunately - only too likely to become as much a part of the 2008/09 economics lexicon as "sub-prime" was in the 2007 one).

Another strategy the banks have been using has been to issue short term (typically three month) paper, and there was roughly 90 billion euros worth of it outstanding at the end of March. Banks are also trying frantically to attract more deposits, and since the end of last year some 20 billion euros have been transferred out of investment funds into long term deposits. The however do not come cheap, and the price the banks are paying for this money is prohibitively expensive - some of it even pays 7% - for it to be used as a basis for mortgage finance, for mortgage finance since mortagages are still widely on offer for around 0.5% over 1 year euribor (or 5.25% or so).


Thus the problem for the banks is really how to find a stable long term source of finance for their mortgage business given the fact that the wholesale money markets have been virtually closed in their faces. In this connection the Financial Times's Leslie Crawford had a piece in the May Issue of Financial World which examined some of the funding problems the Spanish banks are having. As Crawford says "with every month that the capital markets remain closed to them, the problems of the Spanish banks grow more acute". And since we have no idea at the present time at what level Spanish property prices will finally settle (and thus what the true market value of the pool of mortgages which effectively backs the cedulas actually is) then it would seem that the day the doors will once more open again (at least at prices the Spanish banks would be interested in) is far from being at hand.

Crawford cites the Madrid based consultancy Analystas Financeros Internacionales (AFI) to the effect that during Spanish banks were raising approximately 40% of their funding requirements outside Spain at the height of the boom, as compared with only 15% in 2000-2001.

According to AFI foolowing the August blow-out the Spanish banks and savings banks did continue to issue residential mortgage backed securities (cedulas) in the second half of 2007 (to the tune of an estimated 50 billion euros, although this number seems rather high to me), but none of these were placed with external investors (since there were effectively no takers), but rather they were kept on the books for use in repo facilities with the ECB as needed.

Data from the Bank of Spain show that Spanish banks have doubled their share of the ECB's weekly funding auctions since August 2007 - up to 10% of the total from a previous 5% - and that in February Spanish banks borrowed 44 billion euro out of a total 442 billion euro.


The big issue is of course that there is now no market for the earlier jumbo bond offerings. Worse, many of the original jumbos were offered with maturities of between five and eight years. So these cedulas will effectively soon be coming up for rollover.

I would say that the greatest risk points for the Spanish economy at this stage are:

1/ the potential liquidity crisis which may be constituted by the need to refinance the cedulas.

2/ the potential increase in the quantity of bad debt provision which the Spanish banks may need to set aside as and when the builders themselves start going bankrupt in serious style. With anything up to an estimated 1 million unsold properties on the books in Spain at the moment, and with the banks being de facto owners of these properties through their financing of the builders, this avenue is the most important short term threat of debt delinquency, and not unpaid mortgages (IMHO). And the sums involved are by no means chickenfeed, and could well be very similar in magnitude to the quantities owing on the cedulas. ie the whole problem is very large indeed.

Of course later, as the financial problem ripples its way through the real economy, the ability of individual households to meet their mortgage obligations may well become a problem, but we are a long way from that at this point, and sufficient unto the day is the evil thereof is very much the case here I think.

AFI estimate that around 40 billion euros in cedulas and other bank debt come up for refinancing in the second half of 2008, that in 2009 this number will rise to around 80 billion euros, and that the number will remain high through 2010 and 2011. That is to say my rule of thumb guess that we may be facing around 300 billion euros in rollover issues (or around 25% of Spanish annual GDP) in the coming years does not seem to be too far off the mark. And as I say, we may need to make similar provision for equivalent exposure to bankrupt builders etc.

According to this report in El Economista the President of the Confederación Española de Cajas de Ahorro Juan Ramón Quintás has been in discussions with the Spanish government about the problems the regional savings banks are having and are going to have, and one of the solutions under discussion is that the fondo de Reserva de la Seguridad Social should buy bonos and cedulas to help with liquidity. Help! Well it's not my pension they may be about to start playing with, but still.