A hearty 'que te recuperes' to Spain


It has long been an open secret that Spain's banking system is in trouble – or to be more precise, in deep trouble. It's an 'open secret' because it isn't much talked about, usually. Now and then however, some news snippet comes to light as a reminder. Back in March of 2009, shortly after global stock markets had found a durable post crash low, the Caja Castilla La Mancha was identified as 'Spain's answer to Northern Rock' (link broke on August 5th 2010), requiring a 9 billion €uro bail-out.


That  was clearly only the tip of the iceberg. In the course of the 2002-2007 inflationary boom, real estate development took off in Spain. The housing bubble in Spain was a good size larger relative to the size of the total economy than the one in e.g. the US, with prices first rising, and then falling rather dramatically. Not officially, as it were, because the official price statistics are widely ridiculed as a bad joke (see 'Official Spanish house price index invites ridicule'). The official price chart is luckily not the only one available. Closer to reality we find the TINSA (Tasaciones Inmobiliarias SA, Spain's largest property appraiser) index.


TINSA price index: the dizzying rise…..



… and the stomach-churning fall.



Unfortunately we couldn't find two similarly designed charts showing both the rise and fall, but these two should get the idea across. Why did the government come up with an evidently flawed price index that understates the price declines so flagrantly that it has left all expert observers incredulous, even inviting comparisons to the statistical shenanigans of Greece? Our guess is that this is just another example of a government trying to make things look better than they are.

There are essentially three major reasons for keeping official economic statistics:

  • 1. to give the government ammunition to intervene in the economy
  • 2. to make the economy look better than it is, which reflects well on the government's policy decisions.
  • 3. to hide the price effects of inflation, so as to keep inflation-indexed spending down and be able to pretend that the 'inflation tax' is lower than it really is.

The liberty minded financial secretary of of Hong-Kong from 1961 to 1971, Sir John James Cowperthwaite, who is widely credited for introducing the free market oriented policies to Hong Kong that have served it so well over the decades, collected and published almost no economic statistics. He refused to release GDP statistics, and famously sent a UK delegation of bureaucrats that had come to inquire about the unemployment rate packing without the desired information (he simply didn't have it).

Cowperthwaite opined that keeping such statistics would only encourage central planners to, well, centrally plan. He kept personal taxes at a maximum of 15 percent, there was no government borrowing at all, there were no tariffs, no subsidies, and so little red tape that company registration could be done with a single page form. The result: in 1960, the per capita income in Hong Kong was estimated to be 28% of the UK's. By 1996, the year of the handover, it had risen to 137% – in an overcrowded city state with practically zero natural resources – oh, and very little by way of economic statistics. A non-interventionist government doesn't need them.

Spain's government is not a laissez-faire minded organization, so it does keep plenty of such statistics. In the case of the house price index, the motto seems to be: let's pretend that there is less damage than there actually is. The reason are Spain's banks and cajas (thrifts). As recounted in 'Government Actions in Times of Emergency' (see also this table), Spains largest banks hold an inordinate percentage (between about 550%  – 1,400% of their tangible equity capital) in PIIGS debt, presumably mostly debt issued by Spain itself.

However, the Spanish banks and cajas were allowed to largely keep the extent of the damage suffered through the property price implosion swept under the rug by all sorts of accounting tricks. The Bank of Spain, normally known as prudent, has changed the provisioning rules for mortgages, keeping write-offs artificially low. The banks have not marked their loans to market, and moreover conveniently control about 50% of all real estate appraisers in the country. Loans to long de facto bankrupt property developers are not foreclosed upon, but are instead rolled over.

They offer 100% LTV (loan to value), 40-year mortgages to get rid of their REO (real estate owned), as they have, naturally, become the biggest residential property owners of the country. So it's

  • a) let's lie
  • b) let's lie some more
  • c) pretend and extent
  • d) more pretend and extend

Admittedly, these methods are now practiced practically the world over, but we can take a bow in Japan's direction for originally coming up with these great ideas, which have left the country in an economic funk lasting two decades (and ongoing).

Given that these facts sort of simmered quietly in the background, the latest reminder from the news wires is very interesting. 'Bank of Spain takes control of Caja Sur', Reuters reports. This is only a small bank, which will now have access to Spain's 'FROB' (Fund for Orderly Bank Restructuring). Several items stand out. It is mentioned, en passant, that:


“Spanish banks have overall weathered the global financial crisis well thanks to strict regulatory oversight, but the bursting of a decade-long housing bubble has left them with a more than 300 billion euros debt hangover.”


Weathered well? A 300 billion €uro (about $400 billion) debt 'hangover' in a country the size of Spain? And that, let us not forget, is the 'official' figure, the one they admit to. The 'weathered well' part presumably comes mainly from a),  b), c) and d) listed above. The other interesting thing is, as the article further states:


“The Bank of Spain said on Saturday it had taken over the running of Spanish savings bank CajaSur after its planned merger with another of the country's small lenders failed.” [….] “ The country's largely unlisted savings banks — accounting for about half of the financial system — are most exposed to struggling property developers and have seen their capital eroded by soaring bad loans. About one third of the regionally-controlled savings banks have merged, with another third in the process of merging.”


Well, this is so … 1931, really. The seminal 'trigger event' that preceded the deepening of the depression in the early 1930's was the insolvency of Austria's Creditanstalt. And why did it fail? It had taken over an ailing competing bank, Bodenkreditanstalt, a year earlier, to keep it from failing. Merging failing banks with healthy ones often doesn't result in the creation of a 'so-so average' bank.

Often it merely creates an even bigger failing bank. There's always FROB of course, and the fact that the official housing statistics confirm that things are not as bad as everybody says. Oh, and by the way, Spain's foreign-held debt is the fifth largest in the world. Only Germany, France, the UK and the US have issued more debt held by foreign investors (absolute amounts, mind).

During the boom, Spain's current account deficit shot up to 10% of GDP and was by 2007 the second largest in absolute terms, right behind the US. I mention this mainly as a further illustration of how extraordinarily large Spain's bubble was. Clearly Spain is the real problem for the Euro-area, and ultimately the lynch-pin on which 'success' (as defined by the bureaucrats and politicians arranging the wealth transfer) or failure of the recent bail-out hinges.

If Spain can not manage to get through the grinding process of wage and price deflation and austerity (its unemployment rate is already over 20%), then the remaining Euro-area members may well be faced with a 'too big to bail' situation at some point down the road.


Charts by TINSA




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