ECB Buys into Spanish Property
May 19th, 2009
Last week, the ECB announced the purchase of 60 billion euros of covered bonds or cédulas hipotecarias. In doing so, the ECB is effectively buying into the Spanish property market.
This is obviously very good news from a Spanish point of view. The Spanish economy is in the throes of a major correction which will involve moving from a construction and consumer debt driven economy to an export driven growth model.
But in the path of this correction lie three very strong impediments.
1) The need to refinance the cédulas (estimated cost 250 to 300 billion euros)
2) The need to resolve the issue of the growing volume of builder and developer non-performing loans or the million plus empty houses – estimated bank expoure 470 billion euros.
3) The complete lack of competitiveness of Spanish wages and prices.
Basically, we can see a solution in three parts here. The ECB will refinance the cedulas as we move forward. This will not only help the banks, it will take some pressure off government finances, and it will effectively give support to the last-man-standing in the Spanish real world economic arena, Bank of Spain Governor Miguel Angel Fernandez Ordoñez.
Regarding the housing overhang, and the bad loans that go with it, I fully expect Spain to follow in some shape or form the “Irish solution” of either buying the houses direct, or buying the loans which go with them – with or without the creation of a bad bank. However, neither Spain nor Ireland will be able to sustain the volume of public borrowing necessary to finance this move unaided. I therefore fully expect the issue of EU Bonds to raise its head again.
The third point, the correction in wages and prices will likely result in “the budget from hell”. The Spanish economy will likely contract between 5 and 7 percent this year, and will continue to do so next year, and the government fiscal deficit will likely run at over 9%. Clearly, Spanish public finances are headed for an acute crisis, and the “budget from hell” will be imposed, whatever José Luis Zapatero think he wants.
EU bonds can and will be created. These will effectively give Europe a fiscal capacity that is equivalent to that of the U.S. Treasury. Second, given the deflation problem, the European Central Bank can now follow the Bank of England and the Swiss National Bank by entering the next tier of quantitative easing, expanding its balance sheet and starting to buy those crisp new EU bonds in the primary market.
Quantitative easing, which is simply a generic way of referring to all the recent attempts to boost money supply when interest rates fall close to zero, becomes in this particular case a euphemism for “printing money,” with the unusual characteristic that this time, inflation is exactly what we are looking for. And if we don’t get it, we run the risk of ending up with a European economy that is depressed and tending toward deflation for years to come.
The most important thing to realize is that the arrival of deflation is not only a threat; it is also an opportunity. Having the power to print money should give Europe’s central administration extra clout should it need to use it, and it will.
While the first argument in favor of buying cédulas hiptecarias and issuing EU bonds might be an entirely pragmatic one, the longer-term argument is that the ability to make such purchases and issue such bonds might well enable the EC and ECB to become something they have long dreamed of becoming: an internal credit rating agency for EU national debt.
Story from Spain Economy Watch
