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The Pain in Spain

As its economy goes down the drain

Apr 5, 2010, Vol. 15, No. 28 • By CHRISTOPHER CALDWELL
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Spain is by some measures the country most dangerous to the Western economic system. Unemployment has doubled (to 19 percent) in the past 18 months. Spain is one of the so-called PIIGS (Portugal, Italy, Ireland, Greece, Spain), the European countries running an elevated risk of falling out of the common currency or into sovereign default. Spain is not as bad off as Greece, which was given a credit lifeline at a European Community summit in Brussels last week. But, since Spain’s economy is about four times as large, making up 9 percent of the Eurozone, most of the stopgap solutions that fixed the Greek economy cannot be applied to it. Its problems are like those of the two other countries where a housing bubble fed into a financial crisis that threatened to take down the entire economy. One of them, Ireland, appeared to be in desperate straits a year ago, but has since mustered the will to shrink its government 8 percent. It has slashed benefits, and cut public employee salaries by 14 percent. As a result, despite going through a period of austerity, it is on track to bring its economy back into balance. Spain’s problems, alas, run deeper. They go back decades. A combination of partisan animosity and unreasonably high expectations of government may make it impossible for the country to right its fiscal ship. In this, Spain has less in common with Ireland than with the second of the two real-estate-boom countries, the United States. 

Housing, banks, and government

When GDP in Spain was growing by 6 percent a year, the construction industry was growing by 30 percent a year. At the height of the boom in 2007, construction made up 13 percent of GDP and about 10 percent of employment. As a result, there are now around a million homes in Spain with no one to live in them. There are entire subdivisions in the deserts outside Madrid—including one notorious boondoggle in the town of Seseña with 13,000 housing units—that are standing empty because financing ran out before the infrastructure was quite complete.

Since Spain’s native population was shrinking as all this housing was being built, it might seem obvious now that what was going on was a bubble. But it was less obvious at the time. Several factors were driving the housing boom. First, the market for second homes among Northern Europeans took off. Second, 4.5 million immigrants arrived, mostly from North Africa and Latin America, in the decade after 1999, many of them to work in construction. (In a funny way, they were brought over to build houses for themselves.) They quickly transformed Spain from a zero-immigration country into one in which more than a tenth of residents were foreign-born. Finally, divorce boomed, particularly after the passage of Zapatero’s reforms in the middle of the decade, and this caused the demand for housing to increase by mitosis. Prosperity accelerated the trend. Whereas a young man in his twenties during the dictatorship of Francisco Franco would live in his parents’ house until he married, a “modern” young man in a rich democracy wants—and feels he deserves—a place of his own. 

It is in the financing for all this construction that the Spanish crisis differs from the American. Under the circumstances of Spain’s entry into the common European currency, its lending market could not help but overheat. Spain’s interest rates were around 15 percent in the years leading up to its euro membership—and then overnight interest rates fell to levels that were suited to the sluggish economies of Germany and France. These eventually fell into the low single digits, and Spain had negative real interest rates for the whole half-decade after 2002. The banks were paying their customers to borrow money. 

That being the case, Spain behaved relatively responsibly. It had neither subprime loans, nor a mortgage market heated to the boiling point by Fannie Mae, nor offshore “special investment vehicles” that permitted banks to take a lot of their mortgage exposure off their books. In fact, it had one of the toughest and most responsible systems in the world for making sure that banks’ loan portfolios were adequately capitalized. Under a system of “dynamic provisioning” introduced in 2000, Spanish banks had to keep reserves of roughly 10 percent of the value of every housing loan they made. That seemed onerous when the default rate of mortgages was 1 percent, as it was 18 months ago, but now that about 7 percent of mortgages are defaulting, it provides a nice cushion.

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