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Home > Blogs > Ian Fraser > As Portugal succumbs to an EU bailout, Spain could be next in line

As Portugal succumbs to an EU bailout, Spain could be next in line

PIIGS | As Portugal succumbs to an EU bailout, Spain could be next in line Ian Fraser

When prime minister Jose Socrates formally requested a bailout for Portugal on April 6, it left just two of the five PIIGS countries standing.

While the details of Portugal's expected €80bn facility from the EFSF have yet to be hammered out, it left only Italy and Spain still able to refinance their sovereign debt - albeit with significant support from the ECB - from the markets without external assistance. So which of these two Mediterranean countries is likely to be the next domino to fall?

The smart money is on Spain.

The Madrid government is adamant its economy is competitive and that a bailout won't be required. Dominique Strauss-Kahn, managing director of the IMF, gave the Spanish economy a vote of confidence on the day of Portugal's bailout announcement. However it must be remembered that we've heard this sort of thing before, with Portugal insisting it wouldn't need a bailout for months before Wednesday's U-turn.

The biggest single problem faced by Spain is the capital shortfall of its banks. There is widespread suspicion that this is even greater than my colleague Anthony Harrington suggested in his recent gloomy prognosis. The country also has a public debt of €638.8bn, or 60.1% of GDP, and unemployment remains stubbornly high at 20.5%.

On March 10, Fitch Ratings put the black hole in Spain's banks at €38 billion (under Fitch's base case scenario), and at €96.7 billion under its "extreme stressed" scenario. Yet Spanish banks - the largest of which are Santander, BVCA and La Caixa - and the Spanish government seem to be in denial about this.

The Bank of Spain also has its head in the sand, claiming that Spanish property prices have fallen by just 17% since 2007. The banks also take a quixotically rose-tinted view of Iberian property prices.

In an article published on Friday April 1, the Economist suggested that “worries about land” would be pivotal to any future Spanish crisis. For land in Spain became a bit like tulips in 17th century Holland - its valuation became divorced from reality. Yet it still hasn't been permitted to fall to earth. The Economist said:

“How bad things get for Spanish banks depends largely on the country’s unfolding property bust. Nestling at the heart of these worries is land. Land was the hot commodity in the decade-long Spanish property boom. Local councils allowed ever more plots to be zoned for urban development, issuing building permits with abandon and receiving fees or a percentage of the land. The scale of the boom is only now apparent, following requests from the Bank of Spain for details of lenders’ exposures."

To me it seems astonishing that, despite the bank "stress tests" last year, the central bank has not yet got to the bottom of the banks' exposure to what remains a hugely overvalued asset class on their balance sheets.

The magazine added that one-quarter of the €320bn that Spanish banks lent to property developers duiring the bubble was lent against land. Land also represents nearly half of the €70bn of  Spanish banks' real-estate assets. The Economist said the nation's banks are also sitting on €100bn worth of exposure to empty plots, either as lenders or owners.

The trouble is these vacant plots probably are not worth anywhere near what maxed-out borrowers paid for them in Spain's extraordinary boom. An 'overhang' of 1.5m unsold homes in Spain, a legacy of the country's manic building spree in 2000-08, doesn't help matters. The “delay and pray” approach widely adopted by UK banks to their underwater commercial property loans also seems to be prevalent in Spain:

“Banks are carrying the land on their books at higher prices and are reluctant to sell at a big loss. Even those lenders that have braced for big losses—Spain’s biggest bank, Santander, has provisioned 35-40% of its acquired land, for instance—may need to set aside more. Just how much more is a question with ramifications well beyond those empty tracts of Iberia."

I'll explore the chances that Italy will be the next PIIGS country to fall in a future blog post. But rest assured; for now, Spain is looking a whole lot more vulnerable.

Amid these dark clouds, at least EFSF president Klaus Regling has managed to find a silver lining. In an interview he said there is no longer a widespread assumption that the euro is doomed as a currency. He told Reuters:

"We are going through a particularly difficult period, especially for three countries Greece, Ireland and Portugal. But if you take the euro zone as a whole, we have passed a certain mark... The euro as such is no longer being put into question."

Well, I suppose that's something.

Further reading on the Spanish economy, the PIIGS, and Europe's unfolding sovereign debt crisis:

Tags: banking , EU , European Monetary Union , eurozone , financial crisis , Portugal , sovereign debt , Spain
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