Spain:Navigating through an Economic Crisis

Case Code: ECON043
Case Length: 19 Pages
Period: -
Pub Date: 2013
Teaching Note: Not Available

Price: Rs.500
Organization : -
Industry : -
Countries : Spain
Themes: Economic Downturn

Excerpts

The Origins

The 1990s saw a spree of house buying among Spaniards due to various favorable economic conditions. Two events that triggered the housing boom were the Maastricht Treaty and a law passed by the government that increased the extent of land allotted for development.

In 1992, a treaty was signed in Maastricht in the Netherlands, called the Maastricht Treaty. The Treaty laid out plans to establish a monetary union and prescribed five important criteria that European countries had to meet to become a member of the Economic and Monetary Union (EMU). (Refer to Exhibit I for the 5 criteria to be met under the Treaty of Maastricht). This called for Spain to lower its long-term interest rates. The lowered interest rates provided easy accessibility to low-interest housing loans; and thus the housing sector became more attractive to both businesses and individuals. The countries of north Europe started buying up land in Spain and thus foreign investment in the housing sector also increased.

In 1998, the government of Spain passed a law to increase the extent of land allotted for development. The developers sold the idea that owning a house was a good proposition as housing prices would see a consistent escalation. With the introduction of the euro and adoption of the common currency in 1999 , Spain was able to provide loans at lower interest rates. The mortgage interest rates that were at 15% in 1991, fell to 10-12% in 1995-96 and further dropped to around 3.5% by 2003. The ‘cajas’ or local banks of Spain and commercial banks made funds easily available to the public at low interest rates.

With the encouragement of the government, the banks offered and issued significant mortgages and long-term loans to the public. Government policies and tax incentives on interest payments encouraged more people to pay even 20% more than the actual home prices to buy houses. Encouraged by government initiatives, the banks also offered long-term mortgages of 40 years and more. After 2004, the house prices were at a peak and hit record levels relative to the income in Spain...

The Crisis

Spain’s financial crisis was triggered by a decade long real estate boom and the subsequent collapse of the sector. Once the funds inflow into the housing market stopped, the housing bubble burst, unemployment soared, and the economy was impacted. After Spain joined the Eurozone in 1999, the interest rates fell. For many years, the interest rates were less than the inflation rate in the country. The value of property began to increase. Construction activity also witnessed a boom. The government encouraged people to buy houses and own property. In 2005, several local governments reclassified land from rural to urban, making large tracts of land available for real estate development...

The Aftermath

"In 2009, RR de Acuna y Asociados, a Madrid-based consultancy, reported that Spain had 565,000 completed, unsold housing units, and 358,000 abandoned units. It also estimated that around 1.3 million housing units were up for sale......"

Collapse Of The Spanish Banking system

"The Spanish regional savings and loan banks, called cajas, contributed to 50% of the country’s banking system. They were relatively unregulated and were not required to disclose information like collateral on loans, repayment history, etc. The cajas were not traded publicly and were controlled by regional politicians instead of shareholders. The depth of the cajas’ involvement in the real estate market could not be gauged by the government due to non-disclosure of the information. Before 2007, there was a huge inflow of credit into Spanish banks and cajas from northern Europe, particularly German banks, and it flowed into the housing sector......"

Growing Unemployment

"When the housing bubble was growing bigger before 2007, the construction sector was booming, providing employment to thousands of youth. The construction industry was considered neither efficient nor technically advanced. Still, it managed to contribute a major chunk of the GDP of the country by providing employment to high school and college dropouts. The youth preferred to take a decent-paying temporary construction job to studying for a university degree. At the end of 2007, the builders of the country employed 13% of the Spanish workforce. The booming housing sector lowered unemployment in the country and also attracted migrant workers. Between 1996 and 2007, 4.2 million migrants came to Spain to work in the construction industry......"

Austerity Measures

"In order to revive people’s confidence in the government and cover up the public deficit, the then Prime Minister of Spain, José Luis Rodríguez Zapatero, approved a €15 billion austerity arrangement in May 2010. This austerity program was projected as capable of reducing the public deficit from 11% of GDP to 6% by 2011; however, it also involved a 5% cut in salaries in the public sector. The Spanish government opted for the cost-cutting plan which involved suspension of automatic inflation adjustment for pensions, cutting the payout to parents for birth of children, and reducing the funding of regional governments by €1.2 billion. In the first quarter of 2010, the country moved out of a two-year recession....."

On Road Recovery

Exhibits

Exhibit I: The Maastricht Treaty Criteria
Exhibit II: The Impact of Eurozone Debt Crisis on Spain
Exhibit III: Unemployment Rate* (Percentage)
Exhibit IV: GDP Growth Rate*
Exhibit V: Spain’s Gross Debt as percent of GDP*
Exhibit VI: Credit Rating Agencies - Rating scale

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