wsj-madrid

Spanish Banks

2010-06-13T07:43:00.000-07:00

Well, we have had some unwelcome excitment over the last few weeks with the focus on the Cajas which are now scrambling to re-organize to take advantage of the capital available through FROB. Unfortunately, many of these arrangements will allow a strong element of local political control to remain and, as we all know, this has been at the heart of many of the problems at the Cajas. What we are conveniently forgetting is that the capital injection from FROB will have to be repaid. Where will that money come from? We are applying band aids to situations where major surgery is required and these actions will not fully solve the problem. With this government it is always too little, too late.

EU Commissioner, Joaquín Almunia, has warned that problems in the Cajas could easily spill over into the main banking sector, which has a few of its own problems. This was demonstrated in recent excessive movements in the Ibex 35, with particular emphasis on the banking sector. Also, the inter-bank lending market is practically dead so it would seem that the European Central Bank will have to continue its funding programme beyond September.

With the deteriorating external view of the Spanish economy as encapsulated in a recent web article entitled The Spanish Economy is about to get Gored..., we need a strong banking sector, with the ability to lend to businesses, as an important element of any recovery. Check out this link for some background information on the problem, and this link for information on the current debt situation of Spain and the other important European countries, a recent Banco de España presentation about the banking situation, and why a lower value Euro won't help our exports in any material way as most of our exports are destined for Euro countries.

A Greek Tragedy - Part 2

2010-04-25T12:17:00.000-07:00

As expected, Greece's problems have resulted in uncertainty about its ability to raise finance to repay maturing debt and they will now avail of a EU / IMF rescue package - Euro 30 billion from the EU and Euro 15 billion from the IMF. This should please those clever people who have been buying Greek and Portuguese debt at very nice prices indeed.

The situation is extremely difficult as Greece will inevitably require substantially more over the coming years. After all, their national debt stands at Euro 300 billion with much of it maturing over the next year or so.

Germany will likely provide the bulk of the Euro 30 billion thereby causing Frau Merkel some political difficulties - the German people do not want to lend (maybe they will end up giving) their hard-earned money to the Greeks. Whilst Merkel may ride this one out, what will happen if Portugal or another Euro country gets into the same difficulty?

What is wrong with the IMF handling the situation directly with support, if necessary, from the major Euro economies? With Eurozone countries that have some difficulties, such as Ireland and Spain, providing up to Euro 500 million and Euro 2 billion respectively, I would prefer to see the IMF taking charge, expecially if we consider the possibility that other countries may end up in the same boat as Greece.

What do you think?

IMF in Euroland

2010-03-25T23:58:00.000-07:00

Last year, Ireland raised the prospect of seeking IMF help. It is highly likely that the Irish government was voicing this prospect as a means of frightening the public sector unions into accepting necessary wage reductions and possible job losses. The reaction of the market and the unions was not good and reminds us of the risks of playing this type of poker. Hollow treats are never a good idea.

A recent article entitled "Germany will stand by Greece, says Merkel" clearly indicated that Germany did not intend, at least at that moment, to provide Greece with any financial support. Mr. Papandreou, the Greek Prime Minister, has indicated that Greece may seek IMF support. Déjà vu!! Once again, the prospect of IMF involvement has been raised. Another hollow treat?

Is it so unrealistic to consider IMF help for eurozone economies in difficulties? I am not so sure that it would be such a problem. IMF help would entail adhering to very strict budgets to endure that the country being helped returned to good health in a timely manner. The patient, in these situations, is the sole concern of the IMF. Would that be the same if Europe were to provide the support or would European considerations be more important?

In the case of Ireland, French support for any European initiative would certainly require that Ireland "adjust" their corporation tax rate which the French object to but any change would not be in Ireland's interest. Fortunately, Ireland seems to be turning the corner although we can expect a long convalescence.

Another consideration is that the current head of the IMF, Dominique Strauss-Kahn, could be an opponent for President Sarkozy at the next French presidential elections. For this reason Sarkozy would prefer not to see any IMF involvement (particularly successful) in euroland. A recent article on the onĺine New York Times entitled "IMF Help for Greece is a Risky Prospect" is interesting.

Now an agreement has been reached by the 16 eurozone members on a rescue package for Greece should it be needed (Greece has welcomed it but hasn't actually asked for it!!). This decision requires the 27 EU countries to ratify this agreement. It would seem that, once again, the spectre of the IMF has been raised in order to progress matters here in Euroland.

As an aside, Spain currently holds the presidency of the EU so, where was Zapatero, who values his role on the European/world stage, when all these decisions were being made? Apart from the usual suspects, we have had commentaries from the President of the European Council and the European Commission President but not so much from our man.

In my view, given the current stage of the development of the EU, where we have partial monetary union without adequate political union, we would we be better off with an IMF involvement to avoid internal politics and squabbling and allow us to concentrate fully on resolving our problems.

What do you think?

The Spanish Economy

2010-03-03T11:55:00.000-08:00

The Spanish economy remains in recession according to a recent article on the BBC web site. It is a fairly balanced article which looks at the current situation in Spain, backed up by INE statistics. Another BBC article of interest could be PIGS - Portugal, Ireland (or perhaps now Italy), Greece and Spain - which provides statistical information for Eurozone countries worst affected by the recession.

There is no doubt that the situation in Spain is bad. However, every bad situation provides an opportunity. Now could be the time to make fundamental changes to re-shape our economy in order to take advantage of opportunities when things start to improve.

In order to correct a situation, it is necessary to accept that a problem actually exists. None of us is very good at accepting our faults or shortcomings and some people feel that this is especially true here in Spain.

These and other points are raised in an article (English translation of the original Spanish article) about the Spanish economy which I have just read by a Spanish journalist, Ricardo Angoso García. The article, written towards the end of 2008, seems rather hard-hitting to me although it is hard not to agree with many of his contentions.

Check out the articles and let me have your views.

The Economic situation in Ireland

2010-02-17T02:30:00.000-08:00

I have to thank my sister in Ireland for sending me two excellent books that are very revealing about the current situation in Ireland and the events over the last few years which led up to our current economic plight.

The books are:

"The Bankers" by Shane Ross with the sub-heading "How the banks brought Ireland to its knees" - Penguin ISBN 978-1-844-88216-8

Review "The Bankers"
Author's Blog Shane Ross

"Follow the Money" by David McWIlliams - Gill & MacMillan ISBN 978-0-7171-4254-5

Review "Follow the Money"
Author's Blog David McWilliams

Both books are excellent and I would strongly recommend anyone who is interested in Ireland and/or economics to read them. I have included links to the authors' blogs as well as to some reviews.

I wonder if there are any lessons to be learned here in Spain. For example, can countries on the periphery of the EU continue to be members of the Euro, particularly as some economic commentators feel that countries such as Spain need to devalue?

What are your thoughts on these issues?

La Crisis

2010-01-31T05:47:00.000-08:00

Everybody seems to be getting bored with our current economic problems. However, it is important to recognize the reasons for the crisis and also the realities of our situation in order to take action to correct it. At present, at least in public, we are in denial, and many think that the problem will resolve itself with time. That may be true but at what cost?

Apart from the obvious problem of overvalued real estate, too much emphasis on short-term profit, over-reliance by local government on property taxes, etc., I see interest rate policy as being at the heart of the problem. How so?

In my view, nobody benefits from low interest rates in the longer term for the following reasons.

Savers:
In times of low interest rates, savers invariably receive interest lower than the average inflation rate (3%). In addition, they have to pay tax on this unearned income. So, without spending any of their income, their capital is eroding at an alarming rate.

Personal Borrowers:

Low interest rates make property ownership more affordable in the short term. Very quickly, prices start to increase forcing new entrants to borrow larger amounts of money to fund their purchase. This means that they are spending a larger percentage of their income on their homes and, when interest rates rise, their situation becomes perilous.

Corporate Borrowers:

It is hard not to understand corporate borrowers taking advantage of low interest rates. If their borrowing costs are 5% (cost of funds plus lender's margin), their net interest cost, after tax, is equal to average inflation therefore, they are paying zero or negative interest on an inflation adjusted basis. The problem is that this situation encourages companies to borrow too much. The companies that are doing well even during these times are mainly those who do not rely on the banks for funding or have not over borrowed.

Banks:

Low interest rates are bad for banks. Commercial banks make their money in three ways. Interest margin on loans, fee/transaction income and interest margin on resources. If the margin on resource income is lower (as at present due to a lower return on "free" deposits), then the bank must improve its return in the other areas to maintain profitability and keep shareholders satisfied.

Banks have been increasing their charges, both normal and penalty, at an alarming rate.

On the lending side, banks also need to improve their income. With margins being squeezed due to competition, banks have been gearing up significantly and utilizing the markets to source funding. This is invariable a disastrous strategy. Although they are not mis-matched on an interest basis, they are funding very long-term mortgages (up to 40 years in some cases) on a short-term basis. In such a situation, there is always the potential of a liquidity crisis.

And, let's not forget the potential for bad debts. Perhaps the Banco de España needs to start fulfilling its role properly as the overseer of the banking sector. It is worth investigating the rather large property portfolios acquired by the banks from their clients and which are not being released onto the market thereby creating an artificial shortage of housing and the consequent effect on property values. The absence of control of interest rate policy makes things difficult for the Banco de España in helping to control the situation, but not impossible.

Banks are funded by their clients and the inter-bank market, not in any meaningful way by their shareholders. When banks lend to companies, they are not too worried about those companies' shareholders - they put themselves first in line when things go wrong. Perhaps they should also put us first when we lend to them (by way of credit balances in our accounts) rather than their own shareholders. A nice thought!!

Interest Rate Policy:

Some years ago, we were told that low interest rates were desirable to encourage investment in the production process, especially in Germany. This in turn would stimulate economic growth in Germany which would pull us all along to a more prosperous future. Actually, Germany has never been an engine of growth for the rest of us (that's the USA) rather, they have been a significant exporter of inflation over the years.

My view is that this idea was a great lie. Low interest rates were desirable to stimulate spending (usually on products from the Far East) as a means to fund (via taxation) European expansion to the east. Not necessarily a bad idea but why the rush?

Low interest rates have been the basis of the problems in Ireland and Spain. I have no doubt that, should the ECB decide to raise interest rates in the future (probably this year to stop inflation in Germany and France), not too much consideration will be given to the effects on the economies on the periphery of Europe so, in this scenario, I can see our problems here in Spain getting worse, not better, over the next few years. Perhaps interest rates will not rise while Zapatero holds the European presidency.

Summary:

The question of interest rates is only one of the problems. There is a need to address many issues such as the high cost of moving home here in Spain due to taxes and the ridiculous situation where a Notary is required (at enormous cost) to witness signatures for these transactions. Only when action is taken on such fundamental issues will our economy move forward.