There’s Pain in Spain as Banks Go Down the Drain… Let Me Explain

Please don’t assume that this article is only about Spain, and therefore not one you should read.


A little over a week ago, Jose´María Roldán, the Bank of Spain’s Director General of Banking Regulation, gave a presentation in London to investors that the New York Times described as “surprisingly frank.”  Apparently, Spain’s banks are not doing very well at all, and Roldán was there to tell those in attendance that the country’s central bank forecasts that the situation is going to worsen going forward.

It’s interesting because, according to Roldán, the cause of the pain in Spain, has nothing to do with Greek or Irish bonds, as one might have guessed, rather it’s because “with Spain’s economy weak, and home prices falling, bad loans are growing,” explains Floyd Norris of the Times.

I don’t want to get too far off track here, but that sounds eerily familiar to me… it’s spooky.  Where the heck have I heard of that same sort of thing going on… a weak economy and falling home prices causing more loans to default… and the country’s banks going under as a result?  Let me just think for a moment…

Nope… can’t place it, especially that last part about banks getting in trouble as a result.  I seem to recall something about a weak economy, falling home prices and increasing loan defaults, but banks getting in trouble as a result… why, that doesn’t seem to fit in at all.  Oh well, maybe it was the plot of a movie I watched recently, or something like that.  Let’s get back to Spain…

Roldán told investors that land prices in his country, adjusted for inflation, have now fallen 30 percent, and Spanish home prices have dropped roughly 22 percent, since their high water mark back in 2007.  He also said that Spain’s central bank expects further declines in the years ahead.

The Central Bank’s “baseline scenario” shows that land prices will ultimately fall to about half of their peak in 2007, but the bank’s “adverse scenario” shows that the decline in process could be a whole lot worse.

I have to tell you that I like how Spain operates in terms of its economic forecasting.  They’ve got a “baseline scenario,” which shows that things are going to get worse, but they also have an “adverse scenario,” which shows that the baseline might paint too optimistic a picture of what’s to come.  On the other hand, here in the U.S. it seems that we only put out a “baseless scenario,” which never comes close to materializing, and we don’t even consider anything more “adverse.”

Maybe people in Spain are more mature than we are in America and therefore Spain’s government feels they can be told the truth.  It’s fascinating though, don’t you think?  Okay, sorry… let’s get back to our story…

The reason the New York Times called Roldán’s latest presentation to investors “surprisingly frank,” is that last February, when he gave a similar presentation, home prices in Spain were down by about 18 percent from their 2007 peak, and yet he argued that the declines were merely “cyclical downturns,” as had occurred in the past, and that prices would soon be rising once again.

Here’s another aspect of Spain’s banking crisis that I found remarkable to say the least.

According to the story in the Times, Spain doesn’t have “irresponsible homeowners” that are causing the residential mortgage loans to default, like we do here in the good old U.S.A.  In Spain, lending to homeowners was far more prudent, so the story goes, and as a result, Spanish banks are not being left holding large amounts of bad loans as the country’s residential mortgages increasingly go into default.

(Look, if that last paragraph is making you feel a little lightheaded, or you’re starting to break out in hives, just let it go, okay?  Of course, it makes no sense whatsoever, but who am I to question the venerable New York Times.  Just take a deep breath and lets press on…)

In Spain, it’s not the “irresponsible borrowers” that are causing the problem, instead it’s Spain’s “irresponsible real estate developers and construction companies” that are at the root of all economic evil.  Sí, es verdad.

Apparently, as land prices went higher and higher between 2003 and 2007, Spain’s banks became more and more eager to push out loans to developers and construction companies, and as of the middle of this year, 17 percent of the loans made to Spanish real estate developers and construction companies were considered “doubtful,” which is the term favored by the country’s central bank.  And not only that, but the percentage of doubtful loans has been increasing fast, which coincides with the declining residential real estate values.

I still can’t get over how familiar the facts of this story sound to me… why is that darn it… it’s driving me crazy, like when I can’t remember who played the Professor on Gilligan’s Island, or something like that.  (It’s Russell Johnson, by the way… that useless fact I have no trouble remembering.  Where I’m supposed to be this afternoon at three, I have no idea.)  Okay, sorry… it’s just that it’s nagging at me… never mind… let’s get back to it…

The story in the Times went on to explain that when the financial crisis hit in 2008, it seemed that Spanish banks were in better shape than most, primarily because of stricter regulations that prevented them from making the same mistakes that other banks had made, but as it turns out, Spain’s banks were heavily exposed to the real estate market, and now they’ve got trouble… with a capital ‘T’ and that rhymes with ‘P’ and that stands for “pool de hipotecas,” which is Spanish for “mortgage pool.”

So far, the Bank of Spain has forced the country’s troubled banks to merge, brought in new and improved management, and as of the end of this month, will have put in about 26 billion euros to recapitalize the banks, although the chief Southern European economist at Barclay’s Capital says that Spain’s banks will need closer to $50 billion before they are on solid ground again.

Of course, Spain’s banks are still sailing around in a boat with a hole in its bottom, so it’s hard to say how much they will ultimately need to remain afloat.  Loans secured by raw land and by construction that were made during the real estate bubble continue to default and as they do the losses are destroying the balance sheets of Spanish banks.

It seems that real estate developers took out the loans to build offices, stores and new homes, and now that the economic situation has worsened, demand has evaporated and Spain’s irresponsible developers are finding themselves unable to repay their loans.  And not only that, but with unemployment in Spain now above 20 percent, there are other corporate loans that are also showing signs of “doubtfulness,” I suppose the Spaniards might say, and wouldn’t you know it, car loans and other loans made to individuals aren’t doing all that well either.

Why, who would have ever thunk it?  Go figure.

Spain is still taking some misplaced comfort in the fact that only 2.5 percent of its mortgage loans appear to be in danger of default… today.  That’s about where we were in 2008, so I see no reason to worry about that statistic becoming more of a problem, especially when you consider that all mortgages in Spain are variable rate loans… we might call them ARMs… so, as long as interest rates never go up, there’ll be no need for refinancing and everything should be muy bueno.

It is worth noting that Spain does have a couple of advantages not shared by the U.S. as related to the mortgage markets.  For one thing, Spain has almost no home equity loans so most people still have equity… today at least.  When someone loses his or her job, they can still sell their home, assuming the new buyer can get a loan from one of Spain’s troubled banks, that is.

I wonder what will happen in the next few years as more loans default and the condition of Spain’s banks deteriorates further.  You don’t suppose that will mean fewer loans and tighter credit, which will reduce the demand for residential property, and which in turn will put downward pressure on housing prices thus forcing more and more Spaniards underwater as far as their mortgages are concerned?

And once underwater, is it possible that when someone in Spain loses a job, they could find themselves unable to sell and in foreclosure?  And do you think that foreclosures will put even more downward pressure on housing prices, thus forcing even more homeowners in Spain underwater?

Nah, none of that will happen.  Geeze, Mandelman… where do you get this stuff?  You’re such a downer.

The other positive difference Spain has in its corner is that its banks didn’t engage in the securitization schemes our Wall Street bankers did.  Spanish banks didn’t just originate the loans in order to bundle them up to be sold as AAA rated bonds to investors.  So, when the loans go bad, Spain’s banks take the losses, but at least they don’t have to worry about having leveraged themselves 30 or 40 to one.  If a bank in Spain looses $100k, at least all they loose is the $100k, instead of the three or four million that U.S. banks lose when they have a $100k loan go bad.
Norris’ wrapped up his story in the Times with the following paragraphs, which I think are worth reprinting word for word:

“The Bank of Spain has said it is emphasizing transparency in seeking to fix the banking system, and that it is willing to be flexible as conditions change. Its openness may be winning over investors. No one likes to hear bad news, but it is reassuring to believe that the news is accurate, rather than sugar-coated.

Here, here!  Here’s to accurate news.  May we one day experience some here in the United States.

I have not seen other banking regulators distributing charts forecasting the biggest problem facing their banks was likely to get significantly worse, as the Bank of Spain did this week.

No, you have not, Mr. Norris.  And you know why that is, right?  Because U.S. Treasury Secretary Tim Geithner prefers a slightly different strategy than the one being implemented here… he believes that in light of the worst financial crisis since the Great Depression, the only decent thing to do is to deceive us.

It has been more common for regulators to seek to weaken accounting rules, on the theory that it will help confidence if banks seem to be strong, regardless of the facts. That is an attitude that has backfired, particularly after the European stress tests chose to assume that all sovereign debt was safe.

Yes, and it does cause one to ponder where else such a strategy has been employed… on steroids… and is therefore highly likely to soon backfire, doesn’t it?  I mean, here’s some key learning to hang onto for life… when you hear that a plan being implemented is being referred to as “extend and pretend,” unless it involves only five year-olds… hit the pause button and see if things shouldn’t be reconsidered.  I’m just thinking out loud over here…

Rather than denigrate markets as being foolishly negative — as some other European officials have done recently — Mr. Roldán cited market trends, including the rising cost of credit-default swaps on the banks, as evidence of the problems confronting them.


All hail the honest banker!  Yes, last February he was every bit as full of beans as the rest of them, but as of a couple weeks back, the man who regulates Spain’s banking system has broken with the pack.  All hail the honest banker!

It is a refreshing attitude in a bank regulator. When, and if, Mr. Roldán ever starts to say the worst is over, it will be a lot easier to believe him.”


Funny how that works, isn’t it?  Perhaps Tim Geithner’s mom never read him the story of “The Boy Who Cried Wolf.”  I know it made a big impression on me as a child.  Geithner, on the other hand, if he was in fact read the story, seems to have entirely missed its point.

Okay, so now that we’ve covered what’s happening in Spain… I have a minute to try to remember why this story sounds so darn familiar to me.  Let’s see… here’s a recap of what’s going on in Spain…

There was a real estate bubble between 2003 and 2007… check.

It popped in 2008, when the financial crisis began in earnest… check.

Unemployment started rising, and is now over 20%… check.

Land has fallen in value by 30 percent, homes by 22 percent… and it is acknowledged by Spain’s central bank that both have farther to fall… check.

Only 2.5 percent of residential mortgages are currently in default, but as credit constricts and home prices continue their descent, more and more homeowners will find themselves underwater… foreclosures will begin… check.

The banks made loans to “irresponsible real estate developers and construction companies” that now cannot be repaid, and the number of such loans in default is growing, as are defaults on car and other consumer loans… check.

The government is forcing some bank mergers, and pumping funds into the troubled banks to recapitalize them.  Oh yeah, they’re also replacing bank management at the same time, although that’s not something I’ve seen done in our country… check.

Wait… I’ve got it.  It is a movie I saw recently.  No, I’m kidding…. I’m a kidder… I kid.

It’s a mirror image of us, but as seen though a country that is choosing not to extend and pretend… not to fabricate a recovery out of thin air, the same way the Fed generates our GDP of late.

So, what about the discrepancies… answer me this:

How come as Spain’s economy worsens, unemployment rises, property values fall, and “irresponsible developers,” among others, cause loan defaults to steadily increase… those same things have a negative impact on the country’s banks.

But when the very same things happen in the United States, our banks appear impervious to such forces… they don’t lend, but they still only thrive… becoming more profitable and awarding larger bonuses year after year, while they ignore entirely a generation that will never trust them again?

The answer is… someone is not telling us the truth about our financial institutions, because the same forces in play must have a similar impact.  The fundamental tenets of economics don’t know from geopolitical borders.

There are two obvious differences between our handling of the crisis and Spain’s.  One is that when they recapitalized their banks, they replaced bank management.  We did nothing of the kind.  I wonder if that could be playing a role in how well we’re not doing in the United States.

Ya’ think?

The other difference is that Spain is hanging the irresponsible jacket, not on homeowners, but on real estate developers, so if they do punish one group at all, they’ll be punishing a much smaller group than that of the American homeowner.

We, on the other hand, are continuing to blame and therefore punish the very people we need to transform our recession into recovery… the American homeowner… the millions of consumers whose spending has always been something like 70 percent of our economic growth… and yet we continue to bankrupt our middle class by the hundreds of thousands, under the guise that their irresponsible behavior is what caused our economic collapse.

Spain is facing essentially the same economic conditions that we are, albeit on a smaller scale, and with certain advantages, and disadvantages… but it’s a similar situation, as I hope you now see.  So, maybe we should start blaming “irresponsible real estate developers,” instead of our homeowners, whose crime at most… if there is one at all… was wanting a nice place to live.

Isn’t it time we stopped blaming our neighbors for a crisis that continues to destroy the world’s economy, or if we’re going to continue blaming our homeowners, shouldn’t we at least start blaming them for what’s wrong with Spain too?

Mandelman out.

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