The Pain in Spain is Mainly from the Plain

While Greeks accelerated their standard of living and social programs across the board with debt, the Spanish debacle is much more focused on the “plain” – the real estate sector. Sunny Mediterranean (a sea that seems to like to depress European economies) hugging Spain, Europe’s captive playground and vacation paradise. What’s not to speculate? Housing, commercial real estate… a developer’s dream. According to a report from the London School of Economics, Spain accounted for 2/3 of Europe’s new housing from 1999 through 2007, and loans to build these properties consumed as much as half of the nation’s GDP. This market collapsed (beginning in April of 2007) in a massive crush that applied brakes to growth and took the economy with it… the fall screeched unemployment numbers upwards to 20%. Local real estate lenders, Spain ’s equivalent of savings and loans, were threatening to go down like a small seaside village facing a giant tsunami. The world has moved its focus from Greece to Spain as the next of the PIIGS to require a massive fix.

And the crisis in Spain is so terrible with an obvious central cause that the unheard of occurred: the prime minister and the leading opposition leader met face-to-face to discuss what to do next. That would be like Republican Mitch McConnell sidling up to President Obama to plot strategy. I’ve already blogged how regional politics generally trumps national policies in this sun-drenched but troubled democracy, but at some level the solutions still reside at the national level. What did these two boychicks decide was necessary for the country? “They didn't fashion emergency spending cuts to counter negative impressions of bloated budget dyspepsia or make an impassioned plea for European monetary security. Instead, they pushed for quick mergers of Spain's troubled savings and loans so these banks, known as cajas de ahorros, can better hand le bad real estate loans that threaten to bury them.” TheDeal.com, May 14^th.

To compound the problem, Spain’s legal system has been struggling with a series of reforms aimed at upgrading its bankruptcy and insolvency laws. Insolvency is also a huge cultural stigma and clearly not viewed as a business tool in impaired times. Unfortunately, Spain’s antiquated legal system does have such obvious tools that – for example – reorganization under Chapter 11 of U.S. bankruptcy statutes would permit. Effectively, American laws allow bankrupt companies with some viability going forward to restructure and continue operations. Instead, 95% of all bankruptcies in Spain wind up in complete liquidation.

TheDeal.com explains: “ ‘No specific measures have yet been developed which truly work when it comes to restructuring companies under distress, before they file for bankruptcy protection,’ write Angel Martin, head of restructuring at KPMG Europe LLP in Spain, and Mikel Ortega, KPMG Spain's senior manager of restructuring, in a joint e-mail. ‘Once these proceedings begin, the company's image deteriorates, key management leaves, no refinancing is available, and a high percentage of cases are eventually wound up.’… Among other limitations, there are no provisions for prepackaged bankruptcy, debtor-in-possession financing or superpriority new money. Even if there is no fraudulent intent, anything done by the debtor up to two years before filing that somehow jeopardized asset structures can be unwound. Tough employment retention provisions supersede insolvency laws. It's a time-consuming, cumbersome process. The default response is to avoid insolvency at all costs, or at least until finances have deteriorated so badly that there's no other choice.”

The government is applying austerity measures within its own budget as well; Prime Minister José Luis Rodríguez Zapatero has cut civil service pay, reduced public sector investments and has indicated that Spain’s foreign aid packages will be contracted. The economy has at least stopped falling of late, although a .1% rate of growth can hardly be deemed significantly positive. But because development and real estate are such a huge part of the entire Spanish economy, failing to fix this sector means that Spain will remain “broken” for some time. Property developers, construction and financial lending – and the jobs that go with each of these elements – are, to put it mildly, moribund. Banks are playing games – gee, we don’t have that in this country, do we? – and they have simply been unwilling to write down their real estat e loan assets by much more than a meager 15%, while actual values would mandate a 20%-50% reduction. Think the same banks would lend money to potential homebuyers at these inflated values? Precisely!

The assumption underlying this folly is that sometime in the foreseeable future, the sunny Spanish marketplace will rebound, and all those underperforming housing values will turn out to be gold. Unfortunately, there isn’t a shred of tangible evidence that such a recovery is anywhere in that “foreseeable future” and it would seem that some realistic bank consolidation, improved bankruptcy laws and some money from the European Central Bank are needed… er… now. Also, perhaps, some major brain transplants in a number of senior bankers.

I’m Peter Dekom, and if you’ve got some cash, there’s this lovely house I’d like you to see in a Madrid suburb.