2012-04-16

Spanish financial system about to supernova?

Back when Greece was just starting to heat up in early 2010, I wrote Greece is yesterday's news, Spain is tomorrow's. The major problem in Spain back then was real estate on the bank's balance sheets carried at full valuation. Bad debts were effectively hidden and Spain looked as though it would have a real estate/banking led financial crisis that would require a bailout. I did not expect Spain would have a sovereign debt crisis; I though it would have a financial crisis that maybe led to a sovereign debt crisis.

Instead, this has metastasized into a monster because Spain's government is leading the crisis. Instead of a bank bailout potentially causing a government debt crisis down the line, the government is going first and will take the financial system down with it. This is why we are now seeing real estate prices tumble in Spain, not as the precursor, but as a result of sovereign default risk. However, that's not to say this is the end—what it signifies is that Spain, and by extension Europe, may be about to lose control of the situation as both the Spanish government and the banking system require simultaneous bailouts.

Spain’s real estate crash gathering speed
House prices are down between 22 and 29 per cent from the 2007 peak, according to various indexes, against roughly 50 per cent in Ireland. But there was an 11.5-per-cent year-on-year fall in March, according to Tinsa, the surveyors. And the trough probably still hasn’t been reached.

...Banks might give house prices another downward nudge this year. Lenders own nearly 20 per cent of the country’s estimated one million empty homes, according to Cheuvreux estimates. They have been understandably weary of selling houses and crystallizing losses. But they effectively have little choice. The government is demanding haircuts on foreclosed properties of 35 per cent on average.

Once banks start to write down the value of the properties, the theory is that they will be more willing to sell at large discounts. And anecdotally, banks are already flooding the market with cheap property.
There is one entity that can absorb the blow of a double default in Spain, it is the same entity that absorbed the default in Greece: the European Central Bank. By extension, this entity directs the force of the blow into the euro. The collateral damage from a falling euro will be a relatively stronger U.S. dollar and higher gold prices.

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