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Spain: The balance sheets are beyond repair

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession  (McGraw-Hill, 2009) and “The Coming Collapse of the Municipal Bond Market” (Aucontrarian.com, 2009)

Spain is beyond repair. This is also true of the United States. Following is a bottom-up view of the insatiable parasites clinging to the rump of the Spanish economy and how such gruesome imagery applies elsewhere.

A Bloomberg story on September 27, 2012, resembled many others since the mid-’oughts: “Spain’s Boom-Era Building Gear Sold as Developers Cut Off.” This does not need much explanation but a connection is offered: though QE3 is designed, and will (in cases) lift asset prices, gravity rather than levitation is the natural direction of assets.

Construction equipment manufactured during the Spanish housing boom now lounges and pouts, or jets to countries where housing bubbles still offer a thrill. For the connoisseur of booms-and-busts, Berlin, Oslo, and Hong Kong may be peaking. None are likely to match the sheer weight the defunct construction industry loads on the Spanish economy. Bloomberg described its proportions: “The property bonanza that ended in 2008 has left around 2 million unsold homes in Spain, representing supply that will take a decade to absorb…. Spain’s construction and real estate industry, which represented 18 percent of gross domestic product before the financial crisis, now accounts for 11 percent and building permits plummeted 87 percent last year from the 2004 peak.” [That it has only shrunk from 18% to 11% means the state is spending madly to keep it, and the banks, operating. - FJS] “Work started on fewer than 4,500 houses in February this year, a 94 percent decline from the October 2006 peak.”

Towards the bottom of the article, a modern financing mechanism was advanced: “Almost half of Spain’s 67,000 developers are insolvent but not bankrupt after getting additional financing from banks, according to R.R. de Acuna & Asociados, a property consulting firm. Extending the lives of companies is becoming harder for banks after Prime Minister Mariano Rajoy’s government demanded they set more money aside to cover losses on real estate loans.” [My italics. - FJS] That the fantastically over-occupied development sector “is insolvent but not bankrupt” should not be a surprise, at least to Americans, where the same has been true of money-center banks, General Electric and General Motors.

The question arises how the encumbered Spanish banks are extending the lives of the developers. Rifling the archives, Bloomberg also met with Fernando Rodriguez de Acuna, president of R.R. de Acuna & Asociados on July 22, 2009. At that earlier meeting, Sharon Smythe (the author of both articles) learned: “The nation’s banks lent about 318 billion euros to domestic real estate companies and also were forced to accept billions of euros of real estate assets in exchange for canceling debt with insolvent developers.” The banks accepted the property back from the developers in lieu of payment for the loans.

Fernando Rodriguez de Acuna went on to say (in 2009): “Those assets are sterile, or constantly falling in value, so the banks have to get them off of their books or else they will damage their balance sheets in coming years.” One could sigh at Mr. Rodriquez’ innocence, but he was not alone in thinking the banks could not indefinitely pretend they held real assets.

The banks are slowly admitting losses, but Bloomberg’s summary is of a slow recognition. Even so, writedowns have left the banks stranded: unable to make loans. Up until now, it appears, the banks and the government were able to carry the building gear manufacturers.

We know bank writedowns in Europe have been limited to window dressing. We may presume the assets that were “sterile, or constantly falling in value,” are worth a nominal amount today. Referring to the September 27, 2012, Bloomberg brief in which “Prime Minister Mariano Rajoy’s government demanded [banks] set more money aside to cover losses on real estate loans”: Money from where? Who would invest in an insolvent bank that is pretending its capital is not impaired? An unaccountable international organization is the best bet.

Let’s suppose, first, the ECB is allowed to capitalize banks. We will skip over (second) the Spanish government’s “bad bank” plan, and assume it takes wing. Even so, in this most optimistic of scenarios, the revived lending capacity will fund, not strong and growing businesses, but: the Spanish government.

The government’s deficit gap is growing fast. On September 25, 2012, Spain reported the January through August deficit rose from 3.81% of GDP in 2011 to 4.77% GDP in 2012. The Spanish government – in the second or third year of “austerity” – has spent 8.9% more euros in 2012 than in 2011. Tax revenues have fallen by 4.6% in 2012.

The ECB needs to distribute euros at an extraordinary pace to retain the façade of a continent that is not bankrupt.

Of the many reasons the deficit is getting worse, coddling the insolvent but not bankrupt building industry is one. A total of 4,500 houses were built in February. Not all the developers build houses but, when it takes five or ten companies to build one house each month, tax revenues will fall. Living as if this is 2006 will push Spain back to 1492. It is interesting that economists, who sold the world on “GDP” and “productivity,” have trapped workers of the world in the most unproductive jail cell imaginable.

Across the ocean, Washington runs business in the United States. This is why employment gains have been in government jobs. This is why the favored financial industry is still far too large for a functioning economy. This is why the capital-equipment industries that invest after projecting demand over the next 10 years are not investing at all. These companies have historically produced most of the high-paying jobs; their absence is the reason new jobs are in the worst paying fields (except for government, which pays a solid, middle-class wage: None of that hedonically-adjusted, ex-food, ex-gas, pay-plan at the BLS.)

Federal Reserve policy props up dead and malignant businesses. Its no-interest-rate gambit is manna for bad companies that contaminate good companies. Good businesses do not hire. They do not invest. In past times, they only had a vague notion of the Federal Reserve chairman since they had business to conduct. Now, they are no less dependent on the ministrations of Bernanke than the Soviet steel industry was to KGB requests. They sit around wondering what Bernanke will do to them next and what this all means. Introspective CEOs are un-American (if not un-Spanish.) The economies run by Rajoy and Bernanke are headed down the same path as the failed enterprises that hopped to the orders of Beria and Malenkov.

Frederick Sheehan

About 

Frederick Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession. He is the co-author of Greenspan's Bubbles: The Age of Ignorance at the Federal Reserve. Mr. Sheehan was Director of Asset Allocation Services at John Hancock Financial Services in Boston. For more than a decade, Mr. Sheehan wrote the monthly "Market Outlook" and quarterly "Market Review" for clients. He is a frequent contributor to Marc Faber's "Gloom, Boom & Doom Report." He also has written articles for "Whiskey & Gunpowder" and the Prudent Bear website, among others. He currently serves as an advisor to an investment firm and a non-profit foundation. A Chartered Financial Analyst, Mr. Sheehan is a graduate of Columbia Business School.

1 Comment

  1. David_Lazarus says:

    What everyone should be looking at is how they clean up the banks. If these toxic worthless debts are transferred onto the tax payer as in the US the prospects for this ending nicely evaporate. The sovereign balance sheet will be crippled by such transfers. So watch who asks for them to be made. If Spain had followed the Icelandic model they could be in a much better situation now. Same economists learn the wrong lessons from crises.