New dangers lurk for rudderless Spain

MADRID Thu Jun 21, 2012 6:29am EDT

A trader points out a screen showing the results of Spain's bonds auction in a broker's office in Madrid June 21, 2012. REUTERS/Sergio Perez

A trader points out a screen showing the results of Spain's bonds auction in a broker's office in Madrid June 21, 2012.

Credit: Reuters/Sergio Perez

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MADRID (Reuters) - Spain seems trapped on a conveyor belt carrying it toward a furnace - an international rescue of the euro zone's fourth biggest economy.

Bad commercial loans, economic decline and sliding real estate prices are all aggravating problems at Spain's over-extended banks, which lent too much too freely during a credit fuelled property boom that lasted almost a decade.

Madrid's euro zone partners are making available up to 100 billion euros to clean up the banks and, they hope, shield Spain from a debt crisis that has engulfed Greece, Ireland and Portugal and now threatens the single currency project itself.

But grave risks remain as the economy succumbs to a cycle of budget cuts destroying economic growth, leading to more cuts. Many in the bond market don't believe Spain can save itself - more evidence of that came on Thursday when Madrid's 5-year borrowing costs hit a 15-year high above six percent.

"Spain is getting too close to a point of no return when it comes to public debt," said Alejandro Ruyra financial analyst with Kepler Research in Madrid.

Signs of the spending spree that began when Spain joined the euro on 1999 are everywhere - empty apartment blocks, unused airports, grandiose cultural centers and highways to nowhere. The house of cards collapsed in 2007-2008 leaving banks with 300 billion euros - equivalent to almost one third of annual economic output - of exposure to the property sector.

The banks, and Spain's indebted regions have been economists' main focus in trying to fix the Spanish problem.

The International Monetary Fund's worst-case scenario forecasts Spanish housing prices falling 20 percent this year - they have already fallen as much as 30 percent since 2007. A Reuters poll assuming no worsening in economic conditions - an optimistic scenario - sees prices dropping by 10 percent.

The IMF says Spain's financial system would need at least 40 billion euros to weather a serious economic storm and recommends a figure far in excess of that.

In theory, the bank bailout agreed earlier this month should banish doubts over whether lenders can handle the fallout from economic recession. Added to that the property market is beginning to move finally as sellers start to cut the asking price for homes that on average are taking in excess of a year to sell.

But beyond the property market, the construction firms and other businesses most exposed to the price crash, there are other dangers. A detailed independent audit of the banks by four major global accounting firms - due by September - may show companies from other business sectors have also been pushed to the brink of default. Banks are already seeing rising mortgage defaults and bad loans in non-property sectors.

Time is also of the essence.

One banker who says the audit should find the banking system mostly sound still doubts it will come on time.

"What I'm not sure is whether it will be enough to recover market confidence, that it is not going to make things worse," he said, speaking on condition of anonymity because of the business sensitivity.

Centre-right Prime Minister Mariano Rajoy, who pledged to restore investor confidence in Spain only to see the crisis deepen during six months in office, is pressing for outside help rather than enacting convincing new measures at home.

Investors have steadily lost trust in Spain.

Moody's credit rating agency downgraded Spanish sovereign bonds to just one notch above junk level, which means only investors with a high tolerance for risk will touch them. Tracking the bond market has become a national obsession.

Public outrage is growing that every euro cut from spending on schools and hospital is going to pay higher financing costs on the national debt or to rescue banks.

Unemployment is the highest in the European Union - 24.4 percent. Banks have gone from lending too much to not lending at all, and families and companies nervous about the future have stopped buying. Economic activity risks grinding to a halt.


After taking office in December Rajoy thought he would forge an alliance with Germany's Angela Merkel, a fellow conservative, and quickly win back the confidence of financial markets with belt-tightening measures.

With his People's Party's enjoying an absolute majority in parliament he easily passed an austere budget that slashed spending on international aid and job training schemes, and introduced laws to make the economy more competitive, by reducing labor unions' pay bargaining power, for example.

He also cracked down on Spain's 17 autonomous regions, which were meeting bond payments by delaying paychecks for health workers and street sweepers.

But Rajoy was undermined by his own limited experience on the international stage. He tried too fast to win more leeway on deficit cutting from European partners and soon got frustrated with Merkel's perceived inflexibility. His European strategy has now become a major risk for Spain.

Rajoy has clung to the argument that he has done enough and it is now up to the European Central Bank or the European bailout mechanisms to step in with emergency action to bolster Spanish debt prices while his reforms take effect.

"How far does Europe have to go to the edge before the ECB steps in," asked one high-level Spanish official.

This game of chicken - basically a Spanish threat to take the euro currency to the brink of disaster unless it gets aid with minimal strings attached - will be hard to sustain. European leaders are pushing Rajoy to raise sales tax, further cut public sector wages and speed up plans to raise the retirement age.

"Rajoy has lost too much credibility over the last few months to just appeal for the ECB to intervene and for Europe to continue to support him. He's unrealistic if he thinks Europe is going to help him without getting something in exchange and they've been unimpressed recently by what he's done here," said David Bach, political analyst at IE business school in Madrid.

(editing by Janet McBride)

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Comments (3)
scythe wrote:
rajoy’s incompetence is in the furnace (toilet, dog box …. whatever)

the rest is hyperbole to meet the web page word count

Jun 21, 2012 10:06am EDT  --  Report as abuse
Eric93 wrote:
Another bony hand reaching out from the Euro-Crypt for German wallets. As the song goes, “when will they ever learn?” If the Germans had any sense they would convert back to the DeutschMark this weekend, before it’s too late.

Jun 21, 2012 12:30pm EDT  --  Report as abuse
usagadfly wrote:
Imagine Spain with a proportionately worse real estate bubble, banks “in need” of another trillion or so (so they do not lose money or dissolve from stupid loans and speculations), but with a political system that holds “elections” where meaningful change is not a choice (no socialist parties at all allowed), and you have discovered America. Oh yes, with comparable earned income taxes on the lower 3/4 of the population, much lower social services and tax rates on the very rich which are obscene. And no choices for change.

Throw in 1 1/2 decade long wars which cost the entire national deficit, of course hidden and disguised in a hundred open budget categories and a huge “classified” secret budget perhaps 1/3 the size of the admitted budget. And no option on the ballot to stop this waste of money and lives either. Land of the free. Sure.

Jun 21, 2012 1:17pm EDT  --  Report as abuse
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