Saturday, May 12, 2012

Collective Debt Burden ... The Spanish Example

Let's look at the developing story in Spain to see why it may become the world's next potential catastrophe after Greece. Greece is small, but Spain is Europe's fourth largest country in terms of GDP.  That alone makes its financial problems big ones.

Spain's financial dilemma is a somewhat unique story, since its financial problems weren't fundamentally attributable to excessive government borrowing. In fact, real estate related issues are what brought Spain to its knees.

In brief, the total accumulated debt of a society, both public and private, is the only realistic way to view the composite financial health and prospects for a sovereign nation.

Stated simply, we're all interconnected. As a result, our various and cumulative debt obligations make the only realistic financial story a holistic one. In other words, we're all in this together, since the various financial systems of the world are interrelated.

So let's look at Spain specifically to gain a more complete picture of this worldwide practice of spending and borrowing our way into a seemingly insoluble financial dilemma.

Example #1 ... Spain Takes Control of Its Top Real Estate Lender says this about Spanish banking issues and the billions in dollars in real estate bad debt still sitting on banks' books:

"Spain has seized control of Bankia, the country’s largest real estate lender, as a first step toward recapitalizing the company and before ordering other banks to add billions of euros in provisions for bad debt.
Under the plan announced late Wednesday, a state-run bailout fund, known as Frob, will convert a previous €4.5 billion emergency loan into equity and thereby take full control of BFA, Bankia’s parent company, and obtain a 45 percent stake in Bankia as well.
The Economics Ministry described the Bankia intervention as “a first step to guarantee its solvency,” suggesting that it was preparing the ground for a capital injection, expected to amount to between €7 billion and €10 billion, or $9 billion to $13 billion. . . . Analysts are anticipating that banks will be required to set aside at least €30 billion more in provisions against bad loans, on top of the €50 billion of provisions already ordered in February . . . .

Spanish banks are sitting on a combined €180 billion of troubled assets, about a third of which has been provisioned so far. The savings banks . . . have been particularly hit by the downturn, having funded much of the decade-long property boom that came to an abrupt halt once the world financial crisis started. . . .

“Right now, Spain is sliding down a very slippery slope,” said Nicholas Spiro, managing director of Spiro Sovereign Strategy, a consulting firm in London that specializes in sovereign credit risk. “The economy is now officially back in recession . . . unemployment is skyrocketing and, perhaps most worryingly, it is difficult to see what can be done in the near term — domestically and abroad — to stop the rot.”"

That's pretty bad. But that's not all that's pretty bad in Spain. 

Example #2 ... Now let's turn to the problems in one huge Spanish company's real estate portfolio. 

In Spain, a Debt Crisis  Built on Corporate Borrowing puts the Spanish private sector debt debacle in perspective by highlighting the problems faced by Grupo A.C.S., a giant global construction company:

"Saddled with a 9 billion euro ($11.7 billion) debt pile that is twice the size of the company’s shrinking market value, A.C.S. is in the midst of a frantic campaign to sell off assets, pay down debt and further distance itself from a Spanish economy caught in a spiral of austerity and deflation. . . . economists now say that one of the greatest threats to Spain could well be the snarl of debt choking off the growth prospects of A.C.S. and other highly indebted Spanish corporations. And they warn that as these companies cut back on investments and shed assets as well as jobs, the result could be a Japan-style lost decade of stagnation.

An important metric in the euro zone debt crisis has been government debt as a percentage of the total economic output, and Spain has a relatively low ratio of 70 percent, compared with 165 percent for Greece and 120 percent for Italy.

But according to a recent report by McKinsey on global debt, Spain’s nonfinancial private sector debt is 134 percent of gross domestic product, higher than any major economy in the world with the exception of Ireland, where the figures are skewed by the outsize presence of foreign multinationals. 

Factoring in bank, household and government obligations, the total figure rises to 363 percent of G.D.P., trailing only Japan at 512 percent and Britain at 507 percent.

“The problem in Spain is not government debt, it’s private sector debt,” said Jonathan Tepper of Variant Perception, a London-based research boutique with a specialty in Spain. “A.C.S. perfectly captures this problem.”. . .

 “It is a really bad time for these companies,” said Mauro Guillen, an expert on Spanish multinational companies at the Wharton School of the University of Pennsylvania. “The government is no longer investing in infrastructure, the municipalities are no longer paying their bills and the companies are in constant need of refinancing from their banks. So they have to unload their positions to raise cash.” . . .

“The debt of this company has gone out of control,” said Javier Suarez, a utilities analysts at Nomura in Madrid."

Summing Up

Government debt in Spain isn't that country's biggest problem. That honor goes to the real estate related debt. Assets on the books of Spanish banks aren't worth anywhere near their carrying value. Something has to give and soon.

Spanish banks loaned money so people could buy real estate, both residential and commercial.

Then when the world's financial crisis hit, the Spanish real estate bubble burst. Assets are now worth a great deal less than they were when loans were made initially.

 Accordingly, now the banks don't have nearly enough reserves on hand to sell their "underwater" assets and come out whole.

But neither do the real estate developers, such as Grupo A.C. S. described above.

Along with individual home owners, companies heavily involved in real estate investing/speculating will undoubtedly represent the biggest debtors of the banks.To repeat, something has to give.

To better make the point of global interconnectedness, many of the A.C.S. assets are located in the U.S. and elsewhere beyond Spanish borders.

Thus, what happens in Spain won't necessarily stay in Spain, as the story goes.

That's the potential "contagion" effect of these seemingly isolated European problems, presenting policy makers with a worldwide problem to tackle.

Massive accumulated debt everywhere is a pervasive worldwide problem, including the U.S.

We can't ignore it.  Neither can anybody else.

That said, I'd rather be us and definitely prefer our dilemma to that of Greece, Spain and the other European nations.

Things will be a whole lot better for us if they don't get a whole lot worse for them.

Thanks. Bob.