My Name Is Edward Hugh, And I Am Here To Recruit You....

The above quote is, of course, a straight parody of Harvey Milk, the businessman based in the Castro district of San Francisco. Now, the point is, Spain is living a lie. Everything is being "massaged" in a way that those of us who have lived here long enough had grown used to, but had hoped now belonged to the past.

Some of us are trying to put together a detailed, but non sensationalist, account of the actual state of play in the Spanish banking system. I think we owe this to our families, our friends, and our loved ones. So....

So, if you work in the Spanish banking system, and have valid knowledge of current practices and accounting positions, please get in touch with me. Insiders have to explode this, before "this" explodes all of us. With unforseeable consequences, not only for the Eurozone, but for the whole global financial system.

One example of what can be done is show in this presentation from José Contreras, which you should all read.






I might differ on some of the details, but José gets right through to the core points, which are:

i) the significance of the foreign debt
ii) the importance of rising unemployment
iii) the impact of price deflation

More examples of what needs to be said can be seen in this interesting exchange in Afoe comments.

José

Edward, thanks for your comments. I am more inclined to believe that if banks sell a particular product strongly enough, clients end up buying it. In this particular example, in my view, the burden of gilt is more with banks than with clients. I am a spanish citizen with a mortgage and have I worked in a spanish Caja, so I can claim to have seen both sides of the picture. My general impression is that financial ignorance by clients has been used by banks to make money, which obviously is not illegal but certainly questionable.

Mark:

That is a great summary! Re Spanish banks dubious advising of clients (= out and out selling), the latest scam has been to sell prefeence shares as to retail clients as if they were deposits. Someone (the OCU?) should be taking out legal action about this.

José

Thanks Mark. By the way those preference shares are a perfect example of what I am talking about. Round about the time the banks were selling them (Jan 09-Jun09), the institutional market was pricing identical transactions by the same issuers in the secondary market at 25%-40% of nominal value. The preference shares being sold in the retail branches were sold at 100% of nominal value (as you would expect with any normal fixed income product). As I said before, it is not illegal but clearly questionable.

Also, this comment from the thread in Expansion on the recent Variant Perception report.

1. broker (Autor sin e-mail publico) el 23 de Agosto de 2009 a las 10:50

Trabajo en un Banco, en uno de los Grandes, en junio se nos dio oreden con prioridad absoluta de refinanciar todos los préstamos impagados, esta semana le di un vistazo a las primeras refinanciaciones y vuelven a estar la mayoria de ellas en situación crítica. Estamos aplazando el problema y esta Bola de Nieve pronto rompera. La mora real bancaria sin trucos, esta por el 10%, OJO QUE ESTO ES SERIO.

He is saying that distressed loans are already more like 10%, and that in June (when Salgado raised another 90 billion in debt, and just before the ECB "wheelbarrow") bank staff were advised to refinance all loans, whatever.

Basically, in the face of so much official silence and hypocracy, my feeling is all of this is going to fall apart when people who have been working on the inside finally come out in the open and admit the reality. They two have childre, loved ones and elderly parents. No family will remain untouched.

Finally, this comment from José, which is 100% to the point as to where we are now.

Edward, my reading of Blanco´s comments regarding higher future taxes is that the EU has privately held talks with the govt. and announced to them the maximum level of deficit that they are prepared to tolerate. Since Maastricht no longer applies and deficits have theoretically no limits in the EU, these issues are being held case by case behind closed doors. Spain is clearly the most worrying partner for its size and problems. My open question is simply; What is the limit that the EU has informally impossed the Spanish govt. regarding the public deficit? Once we have an answer to that question we can make our own calculations as to how long the govt. can sustain the financial system, new unemployment benefits and public works (among others).

Absolutely. The game is over. The future is already being decided behind closed doors, and once we know what next years spending limit will be we can start to calibrate.

Crickey, Harvey Milk ended up badly, didn't he. I certainly hope nothing like that happens to me :).

Raising Taxes In Spain Is Not A Solution!

Victor Mallet had a piece on public works minister José Blanco's Thursday speech in the FT yesterday. My feeling is that the Spain of Zapatero looks more and more like the Hungary of Gyurcsany with every passing day, and I say this more from the point of view of the twin deficit problem, and the impression the administration gives of things being totally out of control and no one knowing what to do, than anything else.

I am not at all party political, and my observation should in no way be read in that sense. The situation has only deteriorated since Solbes and Vergara were ousted, and the only mystery for me is why exactly they were replaced with a team who have no understanding of macro economics whatsoever. For the record, I predict the IMF will have a permanent delegation in Madrid before 2011 is out. My long promised piece on the current situation will finally appear this weekend and will attempt to justify this view.

As the following chart - from Dominic Bryant at PNB Paribas - makes clear, while Spain's households and corporates are busily deleveraging, government finances are deteriorating in a totally unsustainable fashion.



On the details of Blanco's statement, I would simply make three points.

Firstly, it is far from clear that this is a serious proposal. There must be a battle royal going on inside the PSOE even as I write, and this proposal may well have more to do with internal party debates than anything more substantial. Economy Minister Elena Salgado has been notably silent, so one possibility is that Blanco made the speech simply to "test the ground".

Basically, the current Spanish administration want to hear nothing of internal devaluation, and will try anything to avoid that going down road. The biggest issue they have is growing deflation, and falling revenue as prices drop. This has been a common picture across Eastern Europe, it is just that the states in the South of Europe are rather richer, so there was more flesh on the bone when the crisis broke. They have a salary increase for public servants pencilled in for next year, and this, of course, is a commitment which it will be impossible to honour in the present climate.

Secondly, the biggest unspoken issue we are seeing in one economy after another is the retreat of a lot of activity back into the informal sector. So called economic "greying". Just look what is happening to revenue in Italy. Again, we have seen this happening throughout the East. The contractions in the Baltics are nowhere near 20% in my view (although they are, of course, very large), people simply are declaring less and less. This is a problem the IMF are struggling with day in and day out in Latvia. But this whole process makes things very difficult for government finances, as we are seeing. More tax increases on the very rich and professional middle classes will be entirely unproductive as they will only accelerate this process.

Lastly, increases in VAT. These are again very counterproductive, since they hit consumption directly, at a time when consumption is declining anyway. All such increases do is accelerate the contraction (IMHO the IMF is wrong to be advocating this in the East, but undoubtedly they feel they have little alternative if they wish to preserve some minimal semblance of social services, which they need to do to get the population to agree to their packages in the first place). I wouldn't even mind betting that a VAT hike would be nearly revenue negative, for the consumption drop it would produce and the retreat into the informal economy it would accelerate.

Twenty Percent of Spanish Mortgages Now Considered To Be High Risk

Hello, and sorry I have been away for so long. Basically I have been busy with holidays, and economic problems out in the Baltics and across Eastern Europe. I have however been posting regularly in Facebook, and basically those of you who haven't taken advantage of my offer to join my friends don't know what you have been missing.

I break radio silence this morning to cover a story which appeared today in the Spanish newspaper Expansion. According to that article, one in five Spanish mortgages is now considered as being high risk and liable to become "non performing".

The mortgages at greatest risk are naturally those contracted after 2005 where the loan to valuation was over 80% of the total. In 2006 and 2007, according to data from the bank of Spain, LtVs were over 80% in 17.7% of the mortgages granted.

Prior to 2006, the main source of data comes from a study by Genworth Financial, who show that loans with +80% LtV rose from 12.2% in 1996 to 26.4% in 2005 (see chart below which comes from Expansion). These loans were especially popular between 2003 and 2006, but then started to decline as the decision of the ECB to raise interest rates made the likelihood of a price correction rise sharply.



The other key indicator for risk of mortgage default is, of course, the proportion of income devoted to servicing the loan. This has risen, according to Bank of Spain data for the second quarter of 2009 to an average of 38.6% of disposable income.

This figure is down sharply from the 46% reached between 2006 and 2008 largely as a result of the drop in interest rates. This is the plus side of over 90% of Spanish mortgages being variable interest. The boost to families with mortgages has been significant, and this is evident in the consumer confidence surveys.

But there is a downside here. Spanish households are now extraordinarily vulnerable to any rise in interest rates.

Secondly, people feel better because of the improved cash flow situation, but are probably not looking at the capital account side of their personal balance sheet. People with large mortgages and very high LtVs may well be better off by a few hundred euros a month, but the capital value of their investment may be sinking like a stone. In other words they are bleeding out money through the rear window. One day they will wake up to this, and find they are paying interest on a loan which is worth far more than the property they hold. Then, if there is no change in the bankruptcy law it is off to Australia, Canada or Brazil for many highly educated but heaviliy indebted young people, since as the Spanish law stands there is simply no way out from underneath this for them, ever. That is what those awkward little words "full recovery" mean.

Thirdly, Spain is now in deflation. This means that incomes will go down (over several year probably, if there is not one dramatic year of fall), and property values (which will remember correct against the general price index, that is they will also be further sucked down by the general level of prices) will also continue to fall. So the LtV will rise even as the proportion of income which needs to be paid to service a debt of which so many people were once so proud, but which they now find the be a millstone round their necks, will go up and up an up.


Meanwhile Bad loans as a proportion of total credit at Spanish lenders fell the first time in two years in June as savings banks reported a decline in defaults. The ratio fell to 4.6 percent from 4.66 percent in May and compared with a rate of 1.7 percent a year ago, the Bank of Spain said today on its Web site. Bad loans at Spain's banks slipped to 85.6 billion euros in June from 86.7 billion euros in May and 31.2 billion euros a year earlier.

But to put this in perspective, the ratio of bad loans to the total has still tripled to 4.6% over the past 12 months. And the situation is worse than it seems, since according to a study by UBS Spanish commercial banks have clawed back about €10 billion in debt-for-property swaps. And this number does not include Spain’s savings banks who do not disclose the relevant figure. If the position is similar to their commercial peers and we reclassify all these property purchases as bad loans, then the non-performing loan ratio would be 5.7% (before making any further adjustments for the loan restructuring which has been going on thanks to the availability of generous government and ECB funding).

In addition the central bank recently circulated new guidance relaxing the provisioning rules on risky mortgages. Until now, banks had to make provision for the full value of high-risk loans - those above 80% of the property’s value—after two years of arrears. That was obviously far too demanding, since property values rarely fall to zero. However the timing of the change was far from inpeccable, and the new rules, which mean banks only have to allow for the difference between the value of the loan and 70% of the property’s market value, give the impression of massaging rend results.

Iñigo Vega, an analyst at Iberian Equities, estimates that the new rules would relieve banks of the need to make provisions of about €22 billion in coming months (assuming non-performing loans only reach 8% by the end of 2010). To put that into context, Spain’s savings banks, which are heavily exposed to developers, are expected to make profits of only €16 billion before provisions this year.

As the Economist said, deferring losses to mañana doesn't change the extent of the difficulties facing Spain’s financial system.

And just to confirm that Spain really is different, surreal almost, this article (in Catalan) explains that the majority of the long term unemployed who have gone to the employment offices to claim the 420 euro monthly payment they thought they had been promised have discovered ...... that they are not in fact entitled. Apparently, according to the small print, you need to have run out of benefit and been declared unemployed AFTER 1 August 2009. This is Monty Python stuff, isn't it?

Incidentally, I have a much longer and more thorough post now in the works, sometime tomorrow for publication probably.