As Greece prepares for a June 17 election that may determine whether it exits the euro, the attention has shifted to Spain, where the problems are different—and much larger. Greece’s troubles stem from excessive government borrowing; Spain suffers from a property bust and its banks remain crippled by an estimated €184 billion ($230 billion) in troubled real estate assets. The government is struggling to devise a rescue plan as the country grapples with a deepening recession and 24 percent unemployment.
Prime Minister Mariano Rajoy insists his country doesn’t need a bailout, though investors say otherwise. The cost of insuring Spanish sovereign debt rose to a record high on May 30, and yields on Spain’s 10-year bonds climbed close to the 7 percent level that led Greece, Ireland, and Portugal to seek bailouts from the European Union and the International Monetary Fund. Considering that Spain’s economy is almost twice as big as those of Greece, Portugal, and Ireland combined, the country poses the biggest test for European authorities yet. “It’s getting increasingly ugly,” says Georg Grodzki, who helps oversee $515 billion at Legal & General Investment Management in London.
Spain’s bank woes currently center on BFA-Bankia (BKIA:SM), formed in 2010 by the merger of seven troubled savings banks. Its assets are equal to a third of the entire Spanish economy. After Bankia’s share price plummeted 43 percent in less than a year, Spain nationalized the bank on May 9. Bankia then asked for €19 billion of government funding to clean up bad loans. The bank has begun offering Spiderman beach towels to customers between 14 and 25 years old who add €300 to their accounts in a month. On May 30, Bank of Spain Governor Miguel Ángel Fernández Ordóñez, who has faced criticism over the handling of the crisis, resigned a month before his term was to expire.
Spain has only about €5.3 billion left in the bank bailout fund it set up in 2009, but with its borrowing costs rising, the government wanted to avoid raising the cash in the markets. So Spanish officials got creative. On May 28, Spain signaled that it was considering giving banks government bonds that they could use as collateral to borrow fresh money from the European Central Bank. The government soon backed away from that plan, with Economy Minister Luis de Guindos saying its bank bailout fund would turn to the public markets to raise money for Bankia after all. At the same time the European Commission, the European Union’s central regulator, proposed that the euro-area permanent bailout fund inject cash directly into banks instead of channeling the money via national governments.
As the debate continues, Spain’s real estate problems are festering. For years the country relied on home and office building activity as a source of growth. At the height of the boom, construction accounted for more than 20 percent of Spanish gross domestic product. That’s the same level it reached in Ireland. While both countries experienced similar real estate booms and busts, their actions post-crash have been strikingly different. Ireland worked quickly to address the solvency of its banks—nationalizing them and removing billions of euros worth of toxic debt from their balance sheets by transferring it to a so-called bad bank.
Photograph by Angel Navarrete/Bloomberg
Spanish leaders shunned proposals to create a bad bank like Ireland’s. Instead, they pushed banks to absorb weaker lenders. “In Spain, there seemed to be an effort to smooth out the pace of activity rather than face the shock, as Ireland did,” says Cinzia Alcidi, an analyst at the Center for European Policy Studies in Brussels. “There was kind of a denial of the scale of the problem.”
In Ireland, new building came to a halt in 2008, and property values there have crashed about 60 percent since their peak in 2007. Spain has done everything it can to support property values. To help unload the 329,000 foreclosed homes they own without slashing prices, Spanish banks provide 100 percent financing on easy terms including interest-only payments. No such deals are available to buyers of nonbank-owned properties.
“Banks are employing financing like a weapon of mass destruction to sell their stock and keep prices artificially high,” says Mikel Echavarren, chief executive officer of Irea, a corporate finance company in Madrid that specializes in the real estate industry. Spanish banks report that property values have fallen by only 22 percent, according to Jesús Encinar, CEO of Idealista.com, a Spanish property website. Encinar estimates the decline without supports would be at least twice that.
Inflated real estate prices have also helped prop up Spanish developers, many of which are still building despite a glut of vacant homes. Rather than marking their loans as being in default, Spanish banks give developers new loans to pay off the old ones, says Ruben Manso, an economist at consulting firm Mansolivar & IAX and a former Bank of Spain inspector. “There has been a lot of cheating going on where banks have lent developers new money, classed as new lending, so they can pay off their original loans,” he says.
Whatever the government comes up with to address Bankia’s immediate cash needs, it will still have the larger real estate problem to deal with. “Spain has engaged in a policy of delay and pray,” says Echavarren. “The problem hasn’t been quantified by anyone because there is huge pressure not to tell the truth.”