Pension Funds and Real Estate
We are already aware that pension funds control a significant amount of investment funds across the world. The total amount of money controlled by pension funds runs into trillions of dollars. However, historically pension funds have shied away from investing in real estate. Pension funds are generally invested in asset classes such as equity or […]
Income Approach to Valuation of Sports Franchises
From the previous articles, we now know that sports franchises across the world are now being viewed as commercial entities. Hence, it is vital to derive the correct valuation for them in order to ensure that buy and sell as well as restructuring transactions can take place at the correct valuation. However, we also know […]
Multi Bank Cash Concentration
In the previous article, we studied about the concept of sweeping. We are now aware that commercial banks provide their clients with the facility to sweep additional balances into a centralized account. However, we are also aware that such facilities are generally provided to corporations that use the commercial bank as their main or primary […]
Conflict of Interest in Investment Banking
Investment banking institutions are engaged in multimillion-dollar transactions. This means that if an investment bank is perceived to be operating in a conflict of interest situation, it could severely damage the reputation of the bank. This lost reputation could end up becoming a financial loss is no time. There have been several instances where conflict […]
Introduction to Turnover Ratios
Turnover ratios (also known as efficiency ratios) are a very important class of ratios. These ratios are not only used by financial personnel but also by the people in charge of operations. However, we are going to consider these ratios from the point of view of outside investors. This is because judgments have to be […]
Spain’s economy has been in an unprecedented decline since 2008. The average Spaniard found himself unemployed and had a huge mortgage bill to pay. An entire country has been bankrupted by the seemingly insatiable lust to acquire increasing quantities of real estate which drove the prices higher. This article will trace the beginning of this bubble from 1990’s to its present day situation wherein it has left the Spanish economy in shambles.
The Spanish miracle started in the 1990s and intensified around the turn of the century. Real estate prices had really started heating up in Spain. Between 1990 and 2006, the prices increased by a factor of 3. This was incredible given Spain’s dismal economic growth in the recent past. Many onlookers started praising the Spanish economic system. However, very few were actually aware that the entire economy stood on shaky grounds and the fall was yet to come.
The Euro membership in 1999 gave a significant impetus to the Spanish property market. Spaniards were used to high interest rates being set by their central bank. However, when the European Central Bank took over, the interest rates were comparatively quite low. In fact, there was at least a 4% drop in the percentage points at which banks were willing to lend.
Also, Spanish banks started offering mortgages of longer duration. Thus, even though the price of the house was high, the monthly payment could be kept low. All this combined to create immense demand for housing in Spain. The real estate market was witnessing a sudden and unprecedented boom.
The Spanish miracle was further supplemented by large scale immigration to Spain. The Mediterranean climate and the beautiful landscape of Spain had always made it a preferred destination amongst retirees. The retirees from all over Europe started flocking to Spain as the property boom came into existence. They could now combine a retirement home with a smart financial strategy if they purchased property in Spain!
Also, the illusion of rising economic growth encouraged a lot of immigrants from developing countries to make their way into Spain. Spain witnessed its largest immigration during 1990’s and the early 2000’s. This immigration and the resultant demand for housing gave a further boost to the already rising housing sector.
The Spanish banks were creating more and more money as they made housing loans. This reflected in the macro-economic statistics of Spain during the period. Spanish banks witnessed an unparalleled credit expansion during the 1990’s. The newly created money found its way into the real estate market further increasing its price and creating a self-reinforcing feedback loop of rising prices and increasing money supply.
An important fact regarding the Spanish real estate bubble is the fact that about 98% of the loans that were taken out during the bubble period were adjustable rate mortgages. These mortgages combine to form over 60% of the value of the Spanish GDP. This should give an indication that a lot of people owe a lot of money on their mortgages in Spain.
To compound the problem, as the crisis has erupted after 2008, people find that their interest rates have risen and so have their mortgage payments. However, rising interest rates are also contracting the economy and causing unemployment. Hence, a lot of Spaniards are defaulting on their mortgage loans, ending up losing their life’s savings in the process.
Another astounding feature of the Spanish bubble was that housing supply and prices both grew at an unprecedented rate during the 1990’s and the 2000’s. Usually, in a bubble scenario, the supply remains constant or drops. At best, there is a moderate increase in the supply. This helps create the image of scarcity which leads to price rise.
However, the Spanish case was markedly different with the number of housing units in Spain growing more than Germany, Italy, France and United Kingdom combined during that period. Spain virtually built itself many times over during that 15 year period. The seemingly insatiable desire for real estate caused prices to continue rising threefold even as supply was flooding the market.
To top it up, the fundamentals of the Spanish economy had not changed. Most of the Spaniards were involved in low skilled jobs which paid a mediocre wage. The huge tracts of real estate that were being developed found no buyers! This is because most of the employment in Spain was in the form of menial employment provided by the real estate sector itself. Real estate contributed to over 25% of the GDP and was the largest employer. However, it certainly was not capable of creating a class of consumers who could afford to buy the end product that was being produced.
Post 2008, the Spanish bubble burst. This burst happened as a result of the shocks received from the American subprime mortgage. However, the Spanish fall has been slow and less dramatic. Since 2008, real estate prices have been steadily dropping. Today the market finds itself 40% below the peak value that was quoted during the 2008 period. Some analysts believe that the fall has been much steeper and that there are areas within the country where prices have fallen by as much as 70%
To compound the problems, Spanish banks had securitized a lot of this real estate debt and sold it to pension funds, mutual funds and such other funds in the securities markets. Thus as defaults are happening, the Spanish banks are not the only ones that suffer. The life savings and pensions of people are being wiped out.
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