Spain’s woes stem from the bursting of a property bubble during the global financial crisis which left banks with huge piles of bad debts; properties which were worth a fraction of the book price; stalled building projects and constipation in the housing sector. Spain had a balanced budget with no deficit prior to the global financial crisis, but Spaniards took advantage of cheap loans which became available when Spain joined the Euro. The upshot of this was that between 2004 and 2008, property prices spiked 44%. In the aftermath of the bubble bursting, prices have slumped by 25% generating lots of bad debts.
Spain has far and away the worst unemployment situation in the EU with almost a quarter of the workforce idle. This has meant that Spain has had to borrow to cover social security costs against a backdrop of falling tax revenues. This leaves the country highly exposed to changes in yield on its bonds – a dangerous situation when markets are anticipating that Europe’s fifth largest economy could be the fourth nation requiring a bailout: a proposition strenuously denied by the government of course.
At the weekend, Bankia had to ask the state for €19 billion. The bank was formed through a merger of troubled banks and has seen its share value fall by a third this week, but struggled back to a loss of 17%. The premium on Spanish 10 year bonds compared to their German counterparts now stands at a record 5.05%.
With uncertainty over the future of Greece in the Euro, leaders need to make a clear and unambiguous move to support reasonable borrowing costs at the state level in Europe. This could be achieved by making Eurobonds a reality which would be a high quality, low yield investment vehicle, but Germany is opposed to such a move. Alternatively, the ECB may need to intercede in the sovereign bond markets to ensure demand is sufficiently high to moderate yields. However, until the uncertainty about the Greek situation is resolved, any initiative is likely to be ineffective.