Spain Following in Ireland’s Footsteps

Watching developments in Spain since the beginning of April has been source of non-stop déjà vu for anyone who spent 2010 watching events unfold in Ireland. There are a number of striking similarities between the position in which the Spanish government now finds itself and the Irish government’s situation in November 2010, just before it was forced into an EU/IMF bailout programme. Based on Ireland’s experience, a bailout for Spain seems inevitable.

The trifecta of problems
While many have deemed the eurozone (EZ) crisis to be fiscal in nature, it has never been that simple. It is true that neither Ireland nor Spain were as fiscally healthy as the headline numbers they were posting may have suggested. But that fiscal vulnerability was largely a reflection of other problems in the two economies. Both Ireland and Spain had allowed their public finances to become reliant on property bubbles that had also seen the countries’ banks over-extend themselves and their construction sectors grow unsustainably large.

When the property bubbles burst, this house of cards fell in on itself. Banks in the two countries faced massive losses and in some cases were pushed to insolvency, while in the real economy unemployment spiked as construction activity ground to a halt. The Irish and Spanish governments were left to pick up the tab, just as government revenues started to slump.

With debt and deficit levels soaring, the Spanish and Irish governments were forced to retrench, adding yet more pressure to their economies. What started out as a property bubble underpinned by cheap cross-border credit quickly turned into a trifecta of inter-related problems in both Ireland and Spain: banks needing government recapitalisation, ever-greater demands for austerity to bring the public finances back under control, and the drag of austerity on economic growth.

This trifecta brought Ireland to its knees in late November 2010 when it was forced into an EU/IMF bailout programme. Irish residential property prices had fallen 36.3% from peak to trough by that time (and have since fallen a further 20.5%), but it was disastrous commercial-property lending that had made the Irish banking sector a black hole for recapitalization.

Eye-watering losses on banks’ commercial property loans were crystallized over the course of 2010 as they were transferred to NAMA, the bad bank for Ireland’s worst non-performing loans. To prevent these losses collapsing Ireland’s banking sector and undermining the wider EZ financial system, the Irish government was forced into a series of recapitalizations totaling €46bn by early 2011, including €31bn in promissory notes provided to Ireland’s zombie banks Anglo Irish Bank and the Irish Nationwide Building Society (now merged as the Irish Bank Resolution Corporation).

With each bank bailout, the Irish government promised in vain that this would be the last. Credibility was only restored when the EU/IMF bailout programme was put in place and Blackrock was brought in to run independent stress tests on Ireland’s banks. These tests identified the need for up to €24bn in further capital, leading to the effective nationalization of all but one of Ireland’s banks.

Spain’s residential property market has only collapsed around 22% from its peak in 2007 to the end of 2011 and will probably fall an additional 15-20%. The more gradual fall in Spanish property prices (relative to the collapse of those in Ireland) means that the Spanish government has not poured as much into its banking system as Ireland has. Spain’s bank recapitalization costs have also been smaller as a percentage of GDP than those in Ireland because Spain’s bank resolution institution, FROB, does not force banks to crystallise bank losses up front.

This unfortunately does not mean Spanish banks are any healthier today than Irish banks were back in late 2010. As Spanish property prices fall further and unemployment continues to soar—Spanish unemployment reached 23.6% in February, with youth unemployment exceeding 50%)—mortgage defaults will rise. Spanish banks will almost certainly require further recapitalization from the government.

As was the case in Ireland, it is extremely difficult to estimate the size of the hole in the Spanish banking sector, and this uncertainty is deeply corrosive of investor confidence. As long as the health of Spain’s banks remains a huge source of doubt, investors will shun Spanish sovereign debt and borrowing costs for Spain will remain elevated.

Austerity vs growth
Throughout the EZ crisis, the first response demanded of countries in difficulty has been austerity. But this has caused more problems than it has solved. While fiscal adjustment is undoubtedly necessary in the medium term, on the scale and at the pace that we have seen it implemented during this crisis, it has choked off growth.

The Irish government has used successive budgets to announce a steady stream of draconian austerity measures with a view to reining in its budget deficit—a key requirement of the EU/IMF bailout agreement. Coming at the same time that banks, companies and households have been forced to rebuild their balance sheets, the government’s severe fiscal squeeze has served to deepen and prolong the economy’s slump.

A similar dynamic is playing out in Spain. Its budget deficit ballooned to 8.5% of GDP in 2011, and the Spanish government has agreed with the European Commission to cut it back to 5.3% of GDP in 2012 and 3% of GDP in 2013. But we have already witnessed in Ireland what happens to GDP when the government is forced to retrench alongside every other level of society. There is no reason to expect a different result in Spain, and indeed the country slipped back into recession in the second half of 2011.

The government can’t win
In late 2010, Ireland had reached a point at which nothing it could do would shift market sentiment in its favour. The combination of uncertainty in the banking sector, an increasingly unsustainable fiscal dynamic, and ongoing economic contraction was more than a match for the beleaguered Irish government’s attempts to reassure investors.

In early November 2010, the Irish government announced the size and pace of its planned fiscal adjustment over the next four years. It had little chance of pleasing the markets with this announcement.

A small fiscal adjustment would have been perceived as a lack of seriousness about the need for fiscal sustainability. A big fiscal adjustment, on the other hand, would raise concerns about the impact of retrenchment on growth.

The Irish government opted for the latter strategy, front-loading its fiscal plan with a €6bn adjustment in 2011, out of a four-year total of €15bn. Investors were not impressed. Bond yields rose further after the announcement and within weeks Ireland was forced to enter its bailout programme.

Spain’s current trajectory looks eerily similar. In early April this year, Spanish bond yields started to creep upwards to unsustainable levels once again. In an effort to reassure investors, the Spanish government announced an additional EUR10bn in savings. But the news of a bigger Spanish fiscal adjustment only served to unnerve investors, who fretted about the implications for economic growth. Consequently Spanish government bond yields edged upwards even further.

Does Ireland offer a sneak preview for Spain?
If the Spanish government cannot regain market confidence, it will be forced to request access to official funding. This may initially come in the form of support for Spanish banks, but recapitalizing the banks only addresses one piece of the puzzle. In the absence of economic growth, the Spanish sovereign will need a bailout too.

Given the similarities between the Irish and Spanish cases so far, one has to wonder if the success of the Irish bailout programme could be a sneak preview of things to come in Spain.

Let’s hope not.

Ireland has been held up as a success story by the European Commission, the ECB and the IMF (the so-called troika). This is true in a relative sense—conditions in Ireland are better than those in the other two bailout countries, Greece and Portugal. But Ireland dipped back into recession in the second half of 2011, and with domestic demand set to contract further and foreign demand weakening, it is unlikely the country will find sustainable growth in the next few years. Consequently, Ireland will almost certainly require a second bailout programme when its first programme expires.

This highlights a crucial difference between the Irish and Spanish cases: size.

Ireland is small enough for a second round of EU/IMF funding to be affordable if it is needed. Spain is not.

There is only enough money in the EU/IMF arsenal to bail Spain out once. If Spain were to fail to find sustainable growth during the course of a first bailout, it would get no second roll of the dice. Instead, we would face a debt restructuring in one of the EZ’s largest economies, with detrimental effects on global growth.

This post originally appeared at Economist Meg and is posted with permission.

14 Responses to "Spain Following in Ireland’s Footsteps"

  1. steviefinn   April 23, 2012 at 6:27 pm

    The sooner the lot collapses the better & then hopefully there will be some kind of reckoning. It would be preferable than this death of a 1000 cuts & an eventual collapse anyway. Greece has been bled dry to bailout mainly German banks & Ireland is on the same trajectory & both peoples have been declared as unter menschen by the Germans. I hope that the 64/1 leveraged Deutsche bank shows the world the hypocrisy of Merkel, Schauble by going bang in front of their faces.
    It's simply an exercise in the banks trying to pull in as much as possible before it goes bang, aided by their gimps in governments & a lapdog media who are complicit in their attacks on democracy & liberty, not to mention corrupt. There is a moral black hole here & it's based on the premise that it is OK for corrupt insolvent bankrupt banks to be bailed out at any price, even if because of mark to myth nobody knows what that amount is, at the expense of ordinary people. But I suppose who cares if someone you don't know blows their brains out or somebody dies because their medication is unavailable, empathy has no stock market value.
    We have " Too big to fail " gigantic fat corrupt parasites that are sucking the life blood out of everything, they are corrupt as are those who should prosecute them. Capitalism warped into a crony version where if you are big, fat, greedy & crooked you will be bailed out, unlike any normal company in a so called free enterprise system, all the fine words only veil this truth, that despite the suits the Wall st. philosophy is that of predation.
    We perhaps deserve it anyway, hardly anybody gives a damn unless it affects them directly, empathy is in short supply & people are aided in their lack of interest by a media & governments that deals in disinformation or wishful ignorance coupled with " bread & circuses".
    If the world becomes a ground zero, there will be an almighty audit of the complicit in this race to commodify humanity.

    " Animals feel for their own, it takes a mensch to feel for others "

    • Phil Rourk   April 24, 2012 at 2:01 am

      Well said. It is all a manifestation of deep corruption and a perversion of fundamental human values. Until we get that right again — if that is still possible — anything else we do, whether in Spain, Ireland, Germany or the US, will just be more can-kicking. The repressive apparatus that has been set up all over the so-called democratic Western world is huge and very frightening, but we must somehow find a way to take control again without providing an excuse for another world war. Thanks for your clarity and your courage.

    • AlxndrJcbs   April 24, 2012 at 9:10 am

      nice touché !!!

    • Mantenidis Kostas   April 24, 2012 at 9:50 am

      Very well said! Greece's corrupted so called white colars "nomenclatura" (Banksters, politicians, state's businessmen, MME propaganda's personel) brought the citizens to a no way of exit new era's tragic humanitarian drama in slow motion.
      Troica could "follow the money" and put most of them in jail for State's Treason and organized crime of extreme poverty of the population!

    • geospyro   April 25, 2012 at 2:38 pm

      well, steviefinn has it!!! we will see how far the germans can go. history repeats itself in a different way. Aristoteles said '' To dis eksamartein ouk andros sofou'' . amateuer translation-''To fall into the same sinn twice is not for wise men''. To fall for a third time is …….??????.

  2. anna-marina   April 24, 2012 at 1:11 am

    These giant squids owe the governments.
    Take a note at the speed with which multiple antidemocratic laws are coming into effect in the US. The single goal of this assault on democracy is to prevent meritocracy and save privileges of the financial-military elites, which are "elites" in name only. They are, in essence, the scum of the earth. Dishonorable, banal, psychopathic, they cannot stand the real competition and recognize only one method of winning – theft.

    • Aegean1972   April 24, 2012 at 5:52 am

      very good points Marina

  3. Aegean1972   April 24, 2012 at 6:12 am

    the european debt/political crisis is about to blow in the face of the corrupt elites. What started in Greece WAS NOT a Greek problem but a Pan-european one. But euro-leaders stuck their heads in the sand like an ostrich and instead of giving a european solution to it, they decided to choke the Greek economy with the hardest austerity measures ever enforced to a nation. The consequences to Greece were tragic. People are blowing up their brains on high street. But Merkel and the rest of the gang want to enforce this disastrous recipe to the rest of the eurozone.

    I expected the euro-crisis to unfold over the next 2-3 years in a controlled way. But it turns out that it will blow in their hands at any moment. Coalition gvmnts are falling like autumn leafs. Italian and spanish yeilds soon will be at 7-10%. France is kicking Sarcozy away, Holland (a major supporter of austerity measures in the past) doesnt have a gvmnt anymore. The crisis unfolds around Europe like a forest fire. And Germany is trying to put it out with garden hoses.

    A major "earthquake" is about to hit the Euro-continent but the corrupt elites pretend that it is not happening.

  4. Aegean1972   April 24, 2012 at 6:16 am

    A political crisis (on top of the financial one) is about to blow the lid all around europe.
    and the US is next. The longer they kick the can, the more pressure will accumulate in the steam cooker and the harder the lid will blow.

  5. "Honest Money"   April 24, 2012 at 9:12 am

    Sad but true – only way out is with honest money – protect your assets with gold and silver. It has woeked for 6,000 years!

    • Aegean1972   April 24, 2012 at 12:31 pm

      i think so too HM.

      After the lid blows in europe (in 2012) and the crisis spreads to the US, gold will be the only "safe haven". If there was light at the end of the tunnel, i would sell my gold right now, since i believe it is already overpriced. But not only theres is no light at the end of the tunnel, its gonna get worse. so keep your gold.

      Its only a matter of time till the euro-fire spreads to the US and America is at its most vulnerable position in decades. Enromous debts, out of control spending and budgets, unemployment, 99% vs the 1%.

      We re going for a bumpy ride. Unless they find the golden-balance between growth and austerity. Its gonna take years to solve this mess.

  6. geospyro   April 25, 2012 at 2:37 pm

    well, steviefinn has it!!! we will see how far the germans can go. history repeats itself in a different way. Aristoteles said '' To dis eksamartein ouk andros sofou'' . amateuer translation-''To fall into the same sinn twice is not for wise men''. To fall for a third time is …….??????.

  7. barf   April 28, 2012 at 2:15 am

    Germany is in a debt bubble. Once Hollande is elected President it will be "ola to Hollande" as well. Austerity is OVER. This "180 degree turn" will be dramatic when it occurs…with major consequences that cannot be foreseen once it is begun…something that could happen within just a few weeks.

  8. Bobito   May 10, 2012 at 9:14 am

    Europe can't face that it is no longer Europe, colonial master of the world, and is now just a second tier economy in decline.