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How it all went wrong for Spain
Spain may soon require a massive aid package. How did Europe's fifth largest economy end up here?
by Chris Marshall on Jul 27, 2012 at 08:31Follow @cmarshallCW
Spanish economic miracle!
It’s the start of 2005 and over the next 12 months more houses will be built in Spain than in Italy, Germany and France combined.
The unemployment rate will also fall to a record low this year.
There are construction jobs aplenty. This is the engine of Spain’s economic boom, one that is sucking up all of the country’s resources including spending by the central government and the 17 autonomous regions to which it cedes so much control.
Housing is one super-safe investment that everyone wants in these early-noughties boom years, not least foreign speculators who see Spain as less risky since it ditched the peseta and joined the euro.
A population swollen by a baby boom and huge inflow of foreign workers, which can easily get hold of mortgages at low interest rates, is on its way to tripling house prices in just 11 years. The only way is up. And companies are getting in on the action too, surfing on a wave of easy money and pushing up the price of commercial real estate.
Debt fuels growth, fuels wealth…
It’s now 2006 and interest rates have started rising. But still it goes on: debt creates growth, which creates wealth.
Two years later and ‘España va bien’ continues the chant from presiding politicians – Spain is doing well – even as the US credit crunch pitilessly shuts the door on bank lending around the world.
Then recession. Bereft of its former growth engine, economic growth stalls at the end of 2008, and workers – particularly those in a rapidly downsizing construction sector – are the victims. So are homeowners, who see the value of their homes do the unthinkable: go down.
The lid is lifted
Suddenly, with the bursting of the housing bubble, everyone realises just how outrageous it has all been. Absurd! An oversupply of up to a million homes has since been exposed.
Half of Spain’s under-25s are eventually to become unemployed. Public debt will rise as the government splashes out to help the economy and as taxes from construction activity vanish. In the words of economists, as some imbalances started to correct, others simply take their place.
March 2009, five months after the British government announced it was bailing out its banks, and the Spanish president who presided over much of the long housing boom, José Luis Rodríguez Zapatero, announces a government rescue of Caja Castilla la Mancha, a big regional bank.
Zapatero follows up with severe economic reforms to clean up the country’s public finances, overhauling the pensions system and labour laws even after demonstrators hold their first general strike for eight years.
It all falls apart
It’s November 2011 and with investors increasingly pressuring Spain into more reforms, an election hands power to centre-right president Mariano Rajoy who proceeds to dismantle social rights accumulated over decades in a desperate bid for financial stability.
But it can’t be done quickly enough. Like here in the UK, Spain needs to unblock its banking system, which still carries the burden of loans secured during the good years. They can’t lend as they need to shed their debt, plus they can’t get funding. Without banks the wider economy is stuck on pause.
The most needy of these is Bankia, a patchwork of seven troubled banks, rife with bad loans from the burst bubble. In May 2012 a nascent run on the bank prompts the authorities to rescue the bank. Just two weeks later, though, the bank’s bosses provoke fury when they reveal that the multimillion-euro profit Bankia previously announced for 2011 was really a stonking €2.98 billion (£2.33 billion) loss. More money will be needed; money that Spain’s ‘Frob’ bailout fund just doesn’t have – and which could push Spain’s worsening finances deeper into the red.
So Spain, like Greece, Ireland and Portugal before it – though desperate to stress it is getting a loan, not a ‘rescue’ – seeks €100 billion (£78.3 billion) from eurozone funds, which after much political toing and froing, it gets.
‘More!’ shout investors
But by now, investors in government bonds are sending a strong message to Spain: it’s not just your banks that need saving, it’s your whole financial system, government n’all. The country’s economy isn’t growing enough amid the austerity measures. And the banking loan isn’t the ‘circuit breaker’ between the banking system and government that the City had been hoping for – it keeps them connected in a perilous loop of growing debt.
The government relies on these powerful bond investors to fund its budget, but they are selling the bonds, pushing up the amount they expect back from the government in exchange for holding its ‘debt’.
‘Naughty students’ of austerity
All the while, Spain’s government tries to rein in its autonomous regions, which have real power over big issues such as health and education. Described in the Spanish press as the 'naughty students' of austerity, the regions haven’t cut spending to match the decline in money coming in that resulted from the housing bust and downturn. Nor has their accounting been up to scratch.
The regions have missed their budget targets, in part because of their discretion over increasingly squeezed welfare programmes, which are politically tricky to downsize.
Central government efforts to corral the regions into improving their behaviour comes too late, and Valencia – just last Friday – becomes the first region to call for aid from a €18 billion (£14.1 billion) government fund. Catalonia – Spain’s richest but most indebted region – says it will decide later on whether to tap the fund, which comes with strings attached.
The reaction from bond investors is unsurprising; they push up the government’s borrowing costs even higher – and even closer to a bailout.
Rajoy and friends in denial
How can Spain get out of this? As it stands, Europe’s bailout pot isn’t really big enough – not to sustain Spain’s funding needs and then provide for the bailout for Italy that could follow (Spain is no special case here, it’s merely on bond investors’ menu del día).
The Spanish government, attempting to avoid the market stigma of such a clearly defined ‘bailout’, wants Europe’s policymaking central bank, the ECB, to help. The ECB could reactivate a scheme to buy Spanish government bonds, pushing against the pressure exerted by hard-selling bond investors. The ECB though isn’t in the game of bailing out governments, its chief Mario Draghi keeps on saying. And besides, this would only be a temporary solution, which could lead ratings agencies – organisations that decide how investable companies, governments etc are – to downgrade Spain’s status.
This could mean some investment funds are no longer to invest in the bonds, adding the pressure on Spain.
Spain can’t hold out. The bond market is signalling the final act in an all-too-familiar story of boom and bust.
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