Thursday, June 26, 2008

Spanish Housing Crisis Update (1)

According to the most recent data from the Spanish Ministry of Housing house sales fell 30 per cent year on year in the first quarter. On the other hand the Finance Ministry have revealed that the budget surplus was down to €2.72bn at the end of May from €13.6bn a year ago. Buying by non-residents, which previously helped fuel Spain’s 10-year construction boom, also fell in the first quarter, by 26 per cent year on year, and by nearly 50 per cent from the previous quarter.

According to a recent article in El Periodico - "The British Fall Out of Love with Spain" - “The British are starting to sweat in Spain, and not because of the heat....Mortgages payments for their properties on the Mediterranean coast have shot up...and the numbers no longer add up. Some are returning the keys to the bank, others are being evicted, and many are abandoning the dream of living in villas and apartments in Andalucia”.

The appreciation of the Euro against the pound (15% in the last 9 months), and the rise in the one year euribor means that mortgage payments for Britons with mortgages in Spain are now 25% higher than they were in August last year.

The web portal are reporting that average asking prices for resale properties in Spain’s biggest cities fell by between 2% and 4% in the second quarter of the year over the previous quarter. We should note that these are asking and not selling prices. Selling prices are undoubtedly down rather more, although this is all really early days at this point. The cululative drop over the next 3 to 5 years is obviously going to be much larger, and the only real question is whether prices fall in one foul swoop, or drift steadily downwards.

Also El Pais reported this week that the Spanish banking sector needs to raise 62 billion Euros before the end of the year just to rollover the accumulated cedulas debt due 2008. This is no mean sum, and as the Spanish banking association says the liquidity crunch is a much more serious problem than the rising rate of mortgage delinquencies at this point in time. Up to then end of May the banks had raised some 20 billion euros, with 17 billlion of that coming from May alone. Just how much they are having to pay for this funding is not clear however, and over half the 20 billion has come from the Spanish banks buying their own cedulas.

El Pais scratches its head and asks just how the Spanish banks are going to "refinance" all the money which is coming due if the wholesale money markets remain closed to them. One interesting option they speculate on is offering better returns to lenders. But this would obviously mean Spanish banks and savings banks would need to raise the interest rates they charge their own clients. I find it interesting that people are already begining to speculate about the need for people to pay higher interest rates on their mortgages (remember we are talking about refunding the existing mortgages here, not new finance), since personally I imagine this is going to be an important ingredient in any longer term "rescue package". But redefining en-masse existing mortgage contracts would presumeably need legislation (I am no expert on Spanish law), and would obviously be far from popular with voters. But then, precious little of what the Spanish government is going to be forced to do from here on in is likely to be popular with voters.

Wealth Effect

According to the latest estimate from the Bank of Spain, for every 10,000 Euros fall in property prices, there is a corresponding fall in average household spending of 300 Euros per year. When the head of the household is in the 35 to 44 years bracket, the fall in spending is 600 Euros per year.

This is basically the well known transmission effect from property prices to private consumption known as the "wealth effect". Properties are the main form of collateral for household borrowing, so falling property prices reduce the ability of households to borrow and spend. The Bank estimates that for every 1% fall in property prices, household consumption is liable to fall by over 0.1%.

Land Prices

One of the big problems here in Spain is likely to revolve about what happens to the price of land. According to the latest data from the Ministry of Housing, land for building fell to 251 Euros/m2 in March, a 7.7% drop when compared with March 2007. Land prices have now fallen for 3 consecutive months, and at least as far as the official statistics are concerned, are currently falling faster than house prices. The average cost of land in Spain is now back to where it was at the end of 2004. Along with falling prices, the market for land has also been shrinking. Thn number of land transactions in the first quarter of the year was down by 31% compared to Q1 2007.

Spanish borrowing at the ECB

Returning to the theme of borrowing by Spanish banks at the ECB for a moment, and that notorius €208 billion ($320 billion) of eligible securities which have been created by eurozone banks since last August largely (everything but 5.8 billion euros according to JP Morgan) for use at the ECB, I have been noting how the Spanish banks are not standing out especially for their use of this facility, and have mainly drawn according to the weight of their share in the eurozone itself. One explanation for this may be found in the most recent appearance of Bank of Spain governor, Miguel A. Fernandez Ordoñez, before the Economy and Taxation Commission of the Spanish Congress. There he stated (June 24, p9) that Spanish banks have increased their participation in eurosystem fundings, "without going far beyond the equivalent participation in the key of Bank of Spain in BCE´s capital".

Las entidades españolas mantenían así una liquidez razonable y una amplia diversificación de plazos y segmentos de financiación cuando los mercados mayoristas en los que venían captando una parte notable de sus recursos colapsaron. Su capacidad de respuesta en este entorno de dificultad ha quedado patente en la adaptación que han llevado a cabo de sus fuentes de financiación, pugnando por captar pasivos tradicionales, desplazándose hacia plazos más cortos y, en el tramo final del pasado ejercicio, elevando su recurso al Eurosistema, aunque a partir de un nivel limitado y sin alejarse de la participación equivalente a la “clave” del Banco de España en el capital del BCE.

The Spanish banks low (although increasing)share on the ECB's weekly funding auctions (around 10%) may well be some kind of explicit or implicit limitation imposed by the ECB authorities themselves. Perhaps the rule is not to go much beyond the key suscription of the BDE on the ECB capital (it is 7.55%). This is the "clave" referred to by Ordoñez in the paragraph I quote in Spanish above.

José Luis Rodríguez Zapatero is finally due to appear before the Spanish parliament next week to offer his account of what is happening. It will be interesting to see just what exactly he has to say.

A fuller analysis of the whole structural problem in Spain can be found in this post here.

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