Spain Real Time Data Charts

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

Friday, January 09, 2009

Putting Out Fires During Noah's Flood, Or Eyeless In Gaza Part II

Paul Krugman had a short post recently drawing attention to a rather foolish and ill-thought-outstatement originating in the mouth of German Finance Minister Peer Steinbrueck.

Germany’s finance minister told AFP in an interview that cutting interest rates too low in an effort to counter the global recession could create what he called a dangerous “growth bubble.” - "On the one hand we need to boost the economy, on the other hand we must make sure that a policy of cheap money does not lead to a new growth bubble founded on credit, as happened after September 11, 2001," Steinbrueck said."It is therefore important that the focus, at least in Germany, be on sustainable investments in infrastructure and less on consumer spending financed by debt,"

Apart from the point Krugman wants to implicitly make about interest rates, the point about consumer debt in a current account surplus economy like Germany is extraordinarily misplaced. You have about as much chance of fuelling up a property boom in Germany as you have of setting up a ski slope in hell (that is, there is a "ski slope in hells" chance of getting this outcome - or put another way the likelihood is infinitely small). In Spain on the other hand, even while the possibilities of fuelling a further property boom right now are about as close to zero as you can get, the country's leaders waste not a moment in trying to convince people to go out, borrow and buy, even though with a 10% current account deficit to correct, and corporate and household debts which run to over 220% of GDP, what they need to do is start saving, and not borrow more. This very ineptness (and basically I would argue lack of understanding of what monetary policy is all about) was also highlighed recently by statements from the European Union's Economic and Monetary Affairs Commissioner Joaquin Almunia, who said (in an online chat for the Spanish newspaper El Pais) that whille getting financing costs down was necessary and important, interest rates should not be allowed to fall to negative levels in real terms.

"At this moment, it would be good for the cost of financing to go down........We shouldn't go back to a situation in which real interest rates are negative, as we know from experience that this leads to excess indebtedness, low perception of risk and new bubbles which always end by blowing up in our faces."

Essentially two things are being confused here. Negative interest rates (such as those Spain had between 2002 and 2006 - you know, the ones that lead to the current Spanish crisis, see chart below) are highly undesireable during the upswing in a business cycle, when an economy is "overheating", since you are simply giving more stimulus to economies which are already stretched to capacity - and negative rates may thus produce "bubbles", as they obviously did in both Ireland and Spain - but these very same negative rates are obviously highly desireable during a downturn, and especially during recessions of the kind we are seeing at the moment, since they are one of the tools policymakers can use to stimulate slumping economies - all basic Econ 101 really. And of course, we are all currently heading into one of the most important recessions since WWII, or hadn't our "machine-reader" commissioner noticed?

While I'm on this sort of topic, Krugman has a lot of useful and interesting material on the proposed US stimulus plans. The numbers are truly impressive and awe inspiring, with the fiscal deficit set to rise to close to (or even over) 10 per cent of GDP in 2009 according to initial estimates from the Congressional Budget Office.

But even this kind of aggressive fiscal assault may, as Krugman indicates, fall woefully short of what could be needed to stop the US labour market turning really sour, at least in the short term.

The new CBO budget and economic outlook is out. Above is its forecast for the GDP gap — the hole stimulus has to fill. I’d guess that the CBO estimate, which has unemployment averaging 8.3 percent in 2009 and 9 percent in 2010, is actually too optimistic (see 3, below), but even so it puts the Obama plan in perspective: a 3% of GDP plan, with a significant share going to ineffective tax cuts, to fill an 8% or more gap.

A comment which set me thinking about what is actually happening in Spain right now. Unemployment went over the 3 million mark in December, and is now running at something over 13.5% of the economically active population (according to Eurostat estimates). During 2009 this figure is certain to rise further, possibly to 4.5 million, or 20% of the economically active population (my guess, though it is a guess, since there are so many "unknowns" at this point - but we will surely be over the 4 million mark come next December).

Yet Spain's Labour Minister Celestino Corbacho proudly points to a 10 billion euro public works and infrastructure programme which is intended to create 300,000 jobs during 2009 - 300,000 new jobs in an economy losing jobs at the rate over over a million a year, again is like trying to light a damp match during Noah's flood. And obviously Spain's resources are seriously limited in terms of fiscal resources to fight a problem on this scale. My back of the envelope calculations suggest that a capital injection - Japan style - of between 40% and 50% of GDP may be needed to sort out the accumulating pile of non performing corporate loans and grossly over-valued mortgage backed securities. Evidently Spain cannot handle a problem of this magnitude alone. So would those whose monetary policy helped light this bonfire, now like to step forward with the fiscal policy hose to try to help extinguish it? Are you listening Joaquin Almunia?


Anonymous said...

Spanish politicians are simply following up the wrong Keynesian draft to put the millions people pain off till it must be unavoidable once up there, several autonomic elections would have taken place. Within this short-term politicians try to get room for the next trial despite of a huge heap of economic corpses at their feet.

This remembers how the people in the middle age tried to ward off the black death spreading, by smelling scents in the belief it would avoid the airborne infection as a result of the stench of the pile of dead bodies surrounded them. No idea of yersina pestis in the midgut of flees and the rat carrier.

Spanish politicians still remained to find out what the spanish economic yersina pestis really is. We cannot heal the weakened serious-ill patient by inoculating the same evil that caused the illness, but trying to avoid that this spreads further. The reliable information is the first step, we must know which banks are affected by the disease not to support them with public money bail-outs and hide their write-offs and so on.

If not, we will face the worst economic crisis ever. Do the politicians have the guts to admit it and set up the new lines to recover the "old economy" based on savings, hard work and R+D?

Anonymous said...

"... and grossly overvalued mortgage backed securities..."

maybe I am looking at the wrong sources, but MBS prices seem to be hugely depressed...

what do you mean by "grossly overvalued"? it is just a comment or do you have some data?


Edward Hugh said...


"maybe I am looking at the wrong sources, but MBS prices seem to be hugely depressed...what do you mean by "grossly overvalued"? it is just a comment or do you have some data? "

Well it is a comment more than data but I am talking about the new issues the government are buying in the primary market, or the secondaries that the ECB are accepting as security for loans, all of which are still getting some kind of investment grade other other. As I keep saying in various posts, there seem to be something in the region of 300 billion of these to be rolled over in the next five years or so, and I simply don't see how this is going to be done.

Of course, selling anything on the open secondary market already involves a huge write down, but I don't think this has yet been anything like fully reflected in bank balance sheets. In fact the new accounting rules for the bank bailout purchases were specifically framed so that the governments would not have to put mark to market prices (ie reflect the losses in government debt figures) on their acquisitions.

Edward Hugh said...

Incidentally, I am also referring to the fact that the official house prices index which is used to evaluate the quality of these securities grossly overrestimates the value of the underlying assets.

Once we have a much more realistic idea of the real value of the assets which underlie the mortgages pool - in two or three years perhaps - and see the real default rates, then we will have a much clearer idea of what we are talking about, and of what all these bits of paper are actually worth. Or put another way, of just how solvent the Spanish banking system actually is. When Fernandez Ordoñez started talking about the danger of total meltdownjust before xmas I imagine he wasn't doing so just to make a joke.

Anonymous said...


I understand, but it seems to me that you are mixing several concepts:

1.- Discounting paper is not selling paper. Paper is used as collateral with a certain haircut. No doubt he ECB and the Spanish gvt. are way too generous with their haircuts, but this is short term borrowing, no long term.

2.- Ratings. With all this noise people get too easily into a fallacy, which is that of assuming that given the collateral deterioration it is no longer possible to create a AAA security from a mortgage pool. This is just wrong. The credit quality of an asset backed security depends on the quality of the pool, but also (very important) on the cash flow structure of the transaction. All transactions have something called "credit enhancement", which means that senior tranches have priority of claims over pool cash flows (and other features) that can make them very safe investments. For example, you could have 1bnEUR worth of beautiful subprime mortgages (default level 40%) and issue 1 mEUR of a supersenior security, this tranche would get all cashflows from the pool before the other securities get anything; I can tell you, from 1bn of subprime you will get paid back in your 1mEUR. This security will be of very high quality, even when the pool is not. Obviously, you can not have 1bnEUR of AAA from 1bn of trash, but this is not how it works, as I've tried to point out. There were all sort of wrongdoings, but pls, do not fall into oversimplifying.

3.- Spanish bank balance sheets do not have a mark-to-market problem with MBS similar to that of the US and other European banks. They did not invest in these securities, they manufactured them. As you know, Spain was an importer of capital, not an exporter. The problem is on the bank credit assets, not in the investment account. Government purchases in Spain do not solve a mark-to-market problem in the investment account, but a liquidity one (the banks retain the most junior tranches, so the credit risk does not go away when they discount paper).

4.- Potential losses per se, as high as you like, do not make a security grossly overvalued. Excuse me for pointig the obviuous, but you are missing the key variable: the actual price. If you say they are overvalued you need to know the price at which they trade!

5.- Solvency problems in the financial system do not make MBS overvalued, or undervalued for that matter. MBS have an specific collateral that backs them, which is an specific mortage pool. Maybe you have in mind covered bonds, but they are a liablity of the bank, senior and secured, they are typically not considered MBS. Insolvency will affect covered bonds, but if you are concerned about it, you need to first look at senior unsecured debt, then subordinated and then preferreds, covered bond investors are precisely those in the liability structure that are less affected. The comment on valuation also applies here: you need to know the trading prices! maybe you are surprised at how investor are discounting Spanish paper.


JSA said...

Hi Edward

Thanks for you recent updates. We've seen plummeting manufacturing output in Spain (and as per your one of your other blogs in Russia, Germany etc.) since the last quarter of last year.

In Spain we’ve had OEMs simply not ordering anything and running down car stock levels to zero. They have sent their employees home (with temporary EREs), whilst their suppliers have done the same. No one is suggesting that car sales fall to zero. The latest PwC analyst note (Autofacts 9 January 2009) is forecasting annual light vehicle assembly in Spain of 2.1M in 2009 down from 2.5M in 2008. (You can of course argue with this by asking yourself who on earth would set aside discretionary spending to buy a car right now…)

The huge and rapid decrease in manufacturing input is presumably caused by the fact that most car OEMs and their suppliers have been shut for most of the last couple of months. Assuming there is still demand for cars in 2009, the manufacturing out put would have to pick up significantly during the rest of the year. (A drop in production from 2.5M to 2.1M is significant and will mean permanent job losses, but it’s probably a necessary trimming that is needed in the Spanish auto sector).

I wonder about the relationship between speed of the decline in manufacturing out put in a country and the relative importance of the car sector. The car industry is very reliant on lean manufacturing, not holding any stocks etc. I’m not sure how much other types of manufacturers will have taken such drastic measures (smaller discretionary goods less effected etc.). I wonder whether the very large drops we have seen in Russia, Germany or Spain are just a temporal characteristic of the auto sector and not as drastic as they may seem. Forgive me for not researching or looking into this any further – I’m just thinking out loud so feel free to tell me I’m talking nonsense.

Thanks (and Happy New Year)


Edward Hugh said...

Hello JSA,

"I wonder about the relationship between speed of the decline in manufacturing out put in a country and the relative importance of the car sector.....I wonder whether the very large drops we have seen in Russia, Germany or Spain are just a temporal characteristic of the auto sector and not as drastic as they may seem."

I understand what you are arguing, and think you make a valid point, in the sense that people will obviously one day start to buy cars again (although significantly less in Spain than previously - this will be the "correction" - and more will have to be for export) but I am not very optimistic that we will see this sort of recovery very soon.

In other words we should expect things to get a good deal worse before they start to get any better.

Also we need to keep firmly in mind that if output is down this is largely because sales are down - that is this is a problem which operates on two fronts, the demand front, and the company funding front. Sales are down for two basic reasons.

In the first place there is little credit available for consumers due to the crunch, and the need to give priority to company funding. Since cars are largely purchased using credit this means this sector takes a very big hit, possibly second only to the housing sector. I think initially sales started to drop because of the high price of oil, but this is now, to a large extent, history, and things have significantly moved on from the starting point.

Something similar happened with housing, in the sense that the first stage of the housing slowdown was produced by the rise in euribor, but then the credit drought took hold, and we should now expect housing sales to continue fall even as euribor drops simply because the banks don't have sufficient to lend, and are worrried, in addition, about lending to people who are about to lose their jobs. In addition people are not so keen to buy houses whose prices they think might fall.

So in both cases we should only expect sales to pick up again as the credit crunch eases, but in the Spanish case this could be rather a long time, since my impression is that we will see a second wave of the crunch (as large corporate borrowers finally fold and the banks have to straighten out the large and accumulating non performing loans problem) possibly in 2010, but maybe more likely in 2011 (see my post on the proce of a cup of coffee).

Actually, assuming Spain will need help to resolve all this, this is one factor which may help to explain the mystery of government inaction, since the Spanish government may simply want to hang on in there are wait, since the possibility of significant external support is very limited at the moment since given that everyone has their own problems, but presumeably some of these problems will be resolved before others, and then it may be possible to pass round the begging bowl. Actually, this expression may be unfortunate, since what I am arguing in the post is that this enormous Spanish problem is a direct by-product of the way the eurosystem worked, and the Spanish authorities simply followed advice, so when the time comes to pay the bill for the broken plates all of those responible should club together and pay.

But then we have a second mechanism in the car chain, and that is that the industrial contraction feeds on itself. Basically as output falls, then with it job security and earnings fall too. This is the stage we are about to enter now I think. I mean I think job security (in the private sector) and earnings are already down, but as you yourself are indicating, the problem is largely being handled by temporary layoffs. In the next stage we should expect significant permanent corporate downsizeing (and probably bankruptcies), and the insecurity this creates then feeds back directly into people's willingness to borrow and to buy. So at one point we have the banks being unwilling to lend, which produces at the next stage, which is people's unwillingness to borrow.

During 2009 I think across the developed economies we will simply see this negative feedback process at work, with large annual contractions in GDP the norm.

When we get through to 2010 we will be able to see the extent of the mess we have on our hands. In part this is all a big unknown at this stage, since while I imagine that Big Ben's attempts to break the credit crunch by exanding the Feds balance sheet may work, we still don't know whether he will be able to avoid the US falling (at least temporarily) into a liquidity trap (more on this in another post which I will try and write at the weekend).

So really things are very "path dependent" here, in the sense that we really do need to know what happens next before we can get much clearer what the next thing after the next will be.

Also, I would add that it isn't only the car sector you need to think about, in economies like the US, Germany and Japan the investment goods sector (machinery and equipment) is also very important, and this is where the collapse in confidence and orders is also very important, since this leads to a drop in demand for investment goods, and this is really what we are seeing at the moment, and given that the other part of the fixed investment equation - housing - is also running at very low levels, then this picture is rather bleak, and this is pretty important, since it is a key chain in the growth process.

Finally, I would go back to the US Congressional Budget Office forecast I mention in the post itself. They are not only forecasting a US fiscal deficit of 10% of GDP this year, they are also suggesting that the recessionary environment in the US will last to 2010/2011, and that even then the return to normality will be slow, with the US economy returning to trend growth (which is GDP growth of 2% a year or so) only in 2015.

This is a very serious situation, and we can hardly imagine Spain will be any better served. The reasoning behind the slow recovery part of the forecast is evident (and more or less valid) it seems to me. The very high leveraging of the US population - both households and corporates. Again Spain is hardly different.

US policy, like Spain's, will thus be focused on increasing domestic saving, and on expanding exports as the debt is worked down. During the crisis years of 2008 - 2011 the leveraging in the private sector will to some extent simply be transferred to the public sector as the authorities struggle to keep the ship "easyside up", so the paydown process will only really begin when the short term crisis is over, and thus the recovery will naturally be slow.

In the Spanish case we also have the little issue of what long term trend growth will be even when we get back there. Will it be in the 0% to 0.5% annual rate we have been seeing in Italy since the start of the century? There are reasons for thinking it might be, since at least half of Spanish growth has been "excess" since 2001 as part of the boom bust dynamic, and much of the growth has come - not from productivity - but from "piling on labour inputs" via immigration.

Spain's working population is ageing and this will inevitably make productivity gains more difficult to achieve, so this is why I think Italy may be a better guide for what is in store for Spain than the US is. Certainly, if post 2015 we have tred growth of 1% of GDP a year I would consider this an achievement.

Charles Butler said...


I don't have that much trouble accepting the IPV as indicative because the pricing of real estate in Spain in times of low demand defies economic logic. Categorically, in a crash a fair liquid price does not immediately get set at the bid as it does in the United States, for example. Certainly, if you are in a forced sale position, you are going to have to take your lumps. But if you are forced to buy by, say, a change of job, you might not find yourself benefited as much as you would have thought.

A reasonable example would be yourself having to move to Madrid. You'll be force to accept the bid on your place in Barcelona and, if you're at all picky, pay the offer in the capitol. Your contribution to a mark to market price will be the average, which might not be far off the 8% drop in second-hand dwellings that many claim to be fictitiously high.

Further muddying the issue would be the cultural tendency to cling to property, rather than money, in times of financial crisis. It may be the absolute wrong strategy in circumstances of deflation, but (just as Germany's experience with hyperinflation is skewing their policy choices) the Spanish experience of crises has always been one of devaluation of the currency.

Unless a financial institution has to sell assets to ensure liquidity, there is no reason to make fire sale assumptions when marking properties to market.

The statistic that is not worthy of believing is the unemployment rate, however. Currently at a depression-era 20% for Andalucía, my regular drives around the back roads reveal that the proportion of foreign labourers picking olives this year is higher than ever. Also, keep in mind that at the height of the boom, when I can assure you that there was zero surplus labour, the UR never dropped below 14% for the province of Jaén. That statistic is purely the rate of claiming of unemployment benefits and not that of being out of work.

Considering that even in the good times many commentators assume the black economy in Spain to be 25% of the official, this national custom also does a not inconsiderable disservice to figures that are measured as percentages of GDP.

All this to say that the inferno to which Spain might be heading is might not be all that distinguishable from that of its neighbours.


Edward Hugh said...

Hi Charles,

"All this to say that the inferno to which Spain might be heading is might not be all that distinguishable from that of its neighbours."

Well, you're hoping aren't you, and where there is hope there is life, as they say. I too would like it to be this way, but I just don't see it.

You are pointing to the informal economy, and I think you are right, this will grow again during the crisis.

But there is a problem with that, since much of this money does not end up in banks, and even more to the point the government does not earn tax revenue on it. So, if you take the view, as I do, that the core of this problem is now in the banking system and in funding the government debt, this expansion in informal activity not only won't help, it will probably make matters worse.

On the unemployment in Southern Spain issue, it is purely anecdotal I know, but I was talking to a young girl I know yesterday, and she had spent the new year with her boyfriend in a village in Murcia - where undemployment is up if my memory does not fail me by 79% y-o-y.

She told me all the young people in her boyfriends village were very nervous since while many of them (whose families were traditionally involved in agriculture) had lost their jobs in construction related activity they had not gone back to work in agriculture because they were not willing to accept the very low wages migrants were prepared to work for.

So the "insider-outsider" thing works in two directions. The big problems will come for the native Spanish population as the INEM entitlement runs out.

Happy New Year,


Edward Hugh said...

Hi again,

"I understand, but it seems to me that you are mixing several concepts:"

Possibly I am, as possibly I was being overly loose in talking about "overvalued paper". Thank you for drawing this to my attention, since I think it never harms to tighten up what you are saying. Also thanks for all the expert knowledge you have put into your comment.

"Paper is used as collateral with a certain haircut. No doubt he ECB and the Spanish gvt. are way too generous with their haircuts, but this is short term borrowing, no long term."

Yep. Well - having admitted I was possibly playing fast and lose with my original expression, do let me try - at least for the sake a dialectic finesse - to sort of rescue myself here, since I think I can mount a first line of defence by simply saying that these pieces of paper are being grossly over-valued by the ECB and the Spanish government at the present time. I don't (incidentally) accept that the liquidity/solvency thing here is as straightforward as you are trying to maintain, since arguably the Spanish banking system is trying to resolve a longer term solvency problem by recourse to short term liquidity measures (certainly they have been widely criticised by ECB watchers for this - including Gonzalez Paramo and Yves Mersch), but that is another issue.

Also, as far as I can see, these two institutions are the only major entities willing to buy Spanish mortgage backed securities in the primary market at the moment, so this is hardly a triviality.

Basically the banks need money they get from the ECB and the government to be able to lend (due to the blood -letting going on as a result of the need to finance the current account deficit), and in these kind of straits no source of cash/capital however humble or inappropriate is to be turned down.
But under the spirit rather than the letter of the law you are right, since I do want to argue something rather more than simply that the ECB and the Spanish government are being over generous in their pricing.

I think your point (2) is very helpful, because it is very clear.

"For example, you could have 1bnEUR worth of beautiful subprime mortgages (default level 40%) and issue 1 mEUR of a supersenior security, this tranche would get all cashflows from the pool before the other securities get anything;"

I take this completely, but my issue is - what happens if between now and 2015 (see my last comment) the cash flow deteriorates sufficiently to be unable to cover the payments on all the senior debt? (We will come to the cedulas later, but my understanding is that in this sense they are all equivalent to secured senior, ie they all have priority over all the rest, not only on cash flow, but in the case of institutional failure on the reimbursement front, they are thus "enhanced" in that sense).

Put another way, you cannot issue new senior debt if your income stream is insufficient to guaranteeing existing senior secured debt and covered bonds etc, which is why I presume the collateralisation issue is so important.

Obviously arriving at a situation where your total income stream is insufficient is only a theoretical limit case, since if you were having to divert all your income from car loans and personal loans etc to pay secured senior and cedulas, well you would be structurally broke long before you reached that point. But maybe thinking about this possibility helps to see the extent to which things can go wrong. I mean Sacyr Vallehermosa, to take a commercial example is having to use the whole income stream from its Testa subsidiary just to cover the liquidity enhancement shortfall on its loan to buy Repsol shares (now that these shares are down), and if they stay down of course Sacyr gets steadily pushed towrads insolvency simply by the need to divert income streams.

And the nearer any entity gets to insolvency the less its paper - whether CP or RMBS - becomes worth.

Basically, the question is, for some of the institutions involved, just how quickly is the degree of "overcollateralisation" - or safety margin - they have (which was previously substantial) going to get ground down?

The point is - and this really goes back to a much earlier point in an earlier post - everything depends on the default rate, and this is where I think the macro view you take IS crucial, since obviously if unemployment peaks in 2010, and then starts to fall, then the level of default will be much lower, since most of the unemployed will have INEM cover to see them through.

If, on the other hand, unemployment peaks, not at 5 million in 2010, but at some rather higher number in (say) 2012, then the level of defaults will be much higher, and the level of dislocation to the banking system much greater.

Obviously all the banks in the system are not going to fail, but if you get a significant fraction in serious trouble (and I think we will see this) then you can even have defaults on a portion of the conventional RMBS's I think. Simply because full recourse, and selling the properies off in a market where there are already over a million unsold homes isn't going to raise anything like the market value of the property.

But again the position does seem to me to be more complicated, since there are conventional RMBSs on the one hand, and "more modern" conduit-driven forms on the other - like Santander's Hipotecario 4, and Caja Madrid's RMBS III FTA, which I have mentioned previously. I have no idea how many conduits like this exist, since the banks are hardly coming forward spelling this out, and there seems to be relatively little research into the topic, but the issue is there, and the ratings agencies are hard at work downgrading a lot of this paper, which is presumebaly a recognition that the earlier rating overvauled them.

"Solvency problems in the financial system do not make MBS overvalued, or undervalued for that matter."

Well, I'm not sure about this, since doesn't this operate through the mechanism of the credit rating. I mean if an institution has investment grade rating, then doesn't that influence the price at which securities which represent a claim on an income stream generated by that organisation trade in the market. I mean, if the rating on some institutions (as on some governments) were reduced to junk, wouldn't that drop the price at which their securities traded in the market (or the cost of insuring them against default), and if it is my view that some of these financial institutions should be downgraded (Caja Madrid, Bancaja and CAM aready are alreadt in the works on this it seems) couldn't I as an analyst (which I freely admit I am not, but I am just sorting out the semantics here) claim that these securities were currently being over valued by the market (ie couldn't I attach a "sell" sticker to them)?

"Government purchases in Spain do not solve a mark-to-market problem"
Sorry, just to clarify what I am saying. I am talking about a mark to market problem for the government here. The government is going to buy securities (which I am arguing are overvalued, since they are carrying investment grade supported by an investment grade from a bank which may well not itelf merit investment grade) and then they are not fully recognising their true debt liabilities in their debt to GDP estimates (as they are allowed not to do by Eurostat rules) because they do not have to ascribe a current market value to them at this point. What I AM saying is that at some stage this paper will need to be "written down" (or given a haircut if you prefer) and then government debt will have to be raised accordingly. For this year we are talking about a "mere" 50 billion euros, but this can become a lot more between now and 2015.
"Spain was an importer of capital, not an exporter. .....Maybe you have in mind covered bonds, but they are a liablity of the bank, senior and secured, they are typically not considered MBS."

Well this is the meat of the whole problem, isn't it, and it is precisely why there is a solvency issue not for the banking system, but for the whole of "Spain incorporated", IMHO (worst case scenario). In fact I was indeed talking about covered bonds - or cedulas hipotecarias - when I mentioned the extent of the problem (which I conservatively put at 40% to 50% of GDP - it is probably higher) which exists between the combination of potential non-performing loans from the builders and developers (which I am calling 300 billion euros - which is an understatement of the problem because while not ALL loans to this sector will become non performing there are loans to other sectors which will). and the other 300 billion euros (which may be rather high, perhaps 275 billion euros would be more accurate) for the cedulas, which although not being at risk as such at the present time, do need refinancing, and the people who bought the original cedulas will want repaying in full on the capital value, and so the government will have to buy these cedulas on a one for one basis (that is why I am saying "overvalued") or else the liquidity issues involved can become solvency ones. But the real problem here is that all this capital then leaves Spain, and either internal investors buy the bonos de tresoro which finance the cedulas, or these bonos have to be sold to external investors and the yield spread with the German bund rises and a meltdown of Spanish government finance begins. So I think here there are no very easy options. Which is why, quite franky, I think we are in a mess.

Charles Butler said...

Happy New Year to you, too..

As for whether the money gets in the bank, or not, the unemployment payments are made by transfer and if someone is working on the side, there isn't that much reason for it to come out unless it's paying off a car loan. It's true that cash doesn't count as savings rate as far as banks are concerned, but it sure does in terms of present or future consumption. Proof of that was the buying spree of big ticket items the country went on just prior to the introduction of the euro, more than slightly attributable to the rumour that changing of cash to pesetas was going to require a declaration as to the source of the money.

The point is that it is easy to find statistical proof of Spain's more dire straits, but those numbers are frankly not believable. 'Unemployed' and 'working' are not antonyms en castellano.


Edward Hugh said...

Hi Everyone,

Just one briefish last point. Talking to a friend of mine today he raised the inevitble issue of my "back of the envelope" 50% to 60% of GDP for a cash injection.

I want to try and make clear that I am not saying that the extent of DEFAULT in Spain will be to the tune of 50% to 60% of GDP, but that the size of the government cash injection needed to break the back of the credit crunch cam e be of this order.

If we look at one of the most publicised recent defaults in Spain - Martinsa Fadesa - the NPL was something in the order of 6 billion euros. So in a way this is a 6 billion euro default.

But of course not all the 6 billion euros is lost, since the administration process will recover something from the assets which are still to be disposed of.

So even if the Spanish state has to fund in some way or another some 300 billion euros in non performing loans, this doesn't mean that net government debt needs to rise long term to pay for them, since in the end something can be recovered.

The same thing goes for the cedulas. In my opinion the Spanish state will have to buy out all the cedulas which need refinancing over the next 5 years, and they will need to fund this. I estimate between 250 and 300 billion euros involved here.

So someone has to raise this money, and I am saying the Spanish state cannot do this alone, or the yield spread will go through the roof.

EU bonds to expand the ECB balance sheet in the way that Paulson has done for Bernanke could be one way, but this raises a structural question, since non eurozone countries like the UK and Sweden would be being ask to underwrite eurozone debt, and this may lead to political issues.

Basically my view is that our architecture is a mess here, simply because not enough thought was given to all this when the eurozone was set up - in the same way as how to avoid the kind of bubble Spain has been subjected to by single size interest rate policy didn't have enough thought given to it. The problem is there is no eurozone specific equivalent of the EU commission which could issue bonds and regulate fiscal policy.

Having said that all this doesn't need to go straight onto the debt to GDP figure, however, isn't exactly the same thing as saying it doesn't matter, as we can see in the Japanese case.

The true level of Japan debt to GDP is still a hugely controversial issue. The OECD insists on using the gross figure 182% - due to their unwillingness to put a value on assets (like land) still held by the government, and for which no one really knows the mark to market prices.

Other agencies quote the much lower net debt to GDP - which is still near 100% - and until someone actually disposes of the assets the Japan government holds post the credit crunch bailout no one will really know what the true level of Japan sovereign debt is. In Japan's case this doesn't matter so much, since most of the people buying the debt are themselves Japanese (home bias) and Japan is a current account surplus country. This is not Spain's case, and Spain will need non Spaniards to buy some significant part of this extra debt, hence the problem.