Spanish Financial Crisis

Philo and Soc Sci Essays

 

 

 

 

What factors and processes best explain the Spanish financial crisis in 2007?


Introduction

In this essay, I am going to analyze the factors and processes that could best explain the Spanish financial crisis in 2007.

The financial crisis that hit the world in 2007 has been considered by many economists as the worst financial crisis since the Great Depression of the 1930s. As is well-known it began with the mortgage crisis in the United States, which resulted in the collapse of key investment banks, such as the Lehman Brothers. The crisis developed into a full-blown international financial crisis resulting in a debt crisis in almost all countries in Europe, most particularly in the Eurozone.

Spain was one of the countries in the Eurozone that was deeply affected by the crisis. In fact, since 2008, Spain has been experiencing a sharp fall in GDP which leads to a property collapse and eventually to a deep recession. By this time, the Spanish economy was paralyzed and, according to the BBC News website, ‘worries are increasing that Spain may become the fourth Eurozone country to require a full bailout.’[1] This prompted the new Spanish government which came to office in December 2011 to initiate various strategic reforms in order to address the crisis.[2]

This essay will briefly describe and explain the evolution of the Spanish financial crisis. Although I agree with Mirasol García’s contention that the crisis in Spain has been characterized by the dynamic interplay between the globalizing forces and internal cultural traits,[3] this essay will specifically focus only on two key factors that played a major role in the rise and development of the crisis, namely, the real estate sector and the banking sector. The essay concludes with a brief discussion on the impact of the crisis on the Spanish society, especially on the issue on unemployment.

Spanish financial crisis: The real estate sector

In order to fully understand the specificity of the Spanish financial crisis, let me briefly describe the situation of the Spanish economy during the pre-crisis period. According to Francisco Carballo-Cruz, Spain experienced a rapid economic growth and expansion during the 1990s to the early 2000s.[4] As a matter of fact, during this time, Spain was considered as the 5th largest economy in the Eurozone. One of the reasons for this is that Spain greatly benefited from the policies set by the European Central Bank (ECB), which allowed Spain to enjoy a significant lower interest rates. This fueled an unprecedented demand for consumer good as well as houses bought on credit leading to a boom in housing, construction, and mortgage lending industries. For many economists, this phenomenon has resulted in one of the most overheated housing markets in the history of Europe. For instance, in 2006, Spain started to build 800, 000 new houses, which is more than the combined total houses built in the United Kingdom, Germany, France and Italy.[5] Thus, by the late 2007, the construction sector concentrated almost 14% of the employment and 16% of the Spanish GDP.[6]

In addition to the strong economic expansion and reduced interest rates on housing loans as the primary factor for the growth in the real sector, Carballo-Cruz also mentioned three more factors, namely, 1) greater competition in the banking sector, 2) growth in the number of households due largely to the massive influx of immigrants, especially from Mexico which amounted to 4.5 million between 1997 and 2007, and 3) the housing purchase by non-residents as second homes.[7]

The implication of this phenomenon in the Spanish housing sector and the economy in general was profound and far-reaching.  As the data show, there were over 4.3 million houses built between 2001 and 2008, which leads to an unprecedented increase in housing investment. In fact, by this time, Spain’s housing investment’s share in the GDP had increased form 4.7% in 1997 to 9.7% in 2007.[8] The massive acquisition stimulated by the reduction of interest rates on housing loans has spurred an extraordinary demand for credit. For example, between 1997 and 2007, the housing loan’s percentage share in the Spanish GDP had increased from 28.4% to 102.1%.[9] With this, households’ private debt in Spain had increased as well, which rose from 52.7% of the disposable income in 1997 to a maximum of 132.1 % in 2007.[10]

As expected, the massive increase in household debts necessarily resulted in a decrease in the prices of houses, which, as a consequence, leads to a significant loss of the investors’ money. This is clearly proven by the fact that the construction of houses in Spain at the height of the financial crisis had been reduced significantly. If we recall, Spain started to build 800, 000 houses in 2006, but two years later, in 2008, Spain built only around a third of the total new houses built in the preceding two years. Worse still, in 2010, the number of new houses built in Spain was only 90, 000.[11]

Indeed, one can only imagine how much this economic scenario has affected the investment in the real estate sector whose losses cascaded into the entire Spanish economy, most particularly the labor sector. As a proof to this, from 2007 to the first quarter of 2008, it can be observed that Spain had experienced a significant growth slow down, and from the second quarter of the 2008 to the last quarter of 2009, the Spanish economy was already in deep recession. This clearly explains why the unemployment rate in Spain at the height of the financial crisis has fallen significantly. As data show, the unemployment rate in Spain rose from 8.3% (which is equivalent to 1, 834, 000 unemployed workforce) in late 2007 to 20.1% (which is equivalent to 4, 632, 000 unemployed workforce) in late 2000.[12] It is interesting to note at this point that unemployment was very high among the younger population, which amounts to 40% of the total number of unemployed individuals.[13] This is all the more interesting if we take note of the fact that the youth sector in Spain takes a big share in the total number of abled workers (both skilled and unskilled). Needless to say, if a big portion of the labor force lost jobs, then it would put a significant strain in the economy. This is exactly what happened in Spain recently.

The banking sector

The banking sector, as already mentioned, was one of the key player in the Spanish financial crisis. As stated previously, Spain has greatly benefited from the European Central Bank’s policies on low interest rates during the pre-crisis period. As we can see, Spain borrowed so much money from the European Central Bank during this time in order to finance the high demands in the construction industry. However, with the emergence of the global financial crisis, the Spanish banking sector found itself unable to fulfil its obligation to the European Central Bank. Indeed, at the height of the global financial crisis, the Spanish banking sector suffered enormous losses. In fact, in terms of solvency, the Spanish banking sector is now among the worst of the countries in the European Union. For example, in 2009, the Spanish banks’ solvency is at 11.9%, which is almost two points below the average in the Eurozone.[14]

According to the financial experts, the collapse of the Spanish banking industry was due mainly to its high risk concentration in construction activities and property development both on the supply and demand side. As is seen, in late 2009, credit granted to the construction and property development sectors by the Spanish savings bank accounted for 56.3 % of the total financing for productive activities and 27.7% of its loan portfolio to the resident private sector.[15] Also, in late 2009, credit for the acquisition and rehabilitation of housing represented 41% of the total loans granted.[16] This high risk concentration, according to Carballo-Cruz, is extremely worrying because it continued to affect the growth of default rates as well as the high value of real estate properties that were repossessed by the banks.[17]

With the intensification of the Spanish financial crisis, we see also a sharp contraction of the annual economic growth rate in Spain, which eventually became negative due to the prolonged crisis. And the type of credit that experienced a greater contraction during the crisis was the credit to companies and credit to households. As a matter of fact, in late 2009, the growth of credit to companies has become negative which reached its maximum in the first half of 2010.[18] In other words, for nearly three quarters, companies especially in the construction industry have not borrowed money from the Spanish banks for productive purposes. This means therefore that there was not enough profit in the construction sector for about a year, and this clearly explains why the unemployment rate in the construction sector was too high. As data show, the growth of credit in the construction industry remains stagnant since the first half of 2010. This gives us the impression that the construction industry was the most affected by the financial crisis.

Now, what we can observe in the overall scenario of the Spanish economy as a result of the collapse of the banking sector are twofold, namely, 1) the accumulation of huge debt and 2) the steady growth of unemployment. Let me briefly discuss the specificity of these issues as they provide us the key to determining the extent of the crisis in Spain viewed from the vantage point of the two factors, namely, the real estate sector and the banking sector.

On the one hand, data show that since the start of the crisis, the Spanish public debt was equivalent to 60.1% of the GDP at the end of 2010, while private debt represented around 224% of the country’s overall products.[19] Also, household debt amounts to 902 billion euros, while firms’ debt reaches 1.47 billion euros. Since 2004 until 2010, Spain’s total debt had increased by over 71%.[20] And in late 2010, the Spanish economy’s external debt was 1, 740 billion euros, which is equivalent to 164% of the GDP. It must be noted that these huge debts, which were accumulated during the pre-crisis period, has indeed caused a financial hemorrhage in Spain.

On the other hand, the impact of the crisis on employment in the Spanish economy has been devastating. Since the crisis began until the end of 2010, the number of people unemployed increased by 152%, which is equivalent to roughly 4, 632, 000, of which 4 out of 10 are long-term unemployed persons, 1 out of 4 have temporary contract, 1 out of 3 are less than 29 years old, and 6 out 10 are low-skilled.[21] Interestingly, one report reveals that because of this massive unemployment, some Spanish sex workers were forced to seek clients in Switzerland.[22] As Craggs writes, ‘…the number of women officially registered as prostitutes in Switzerland, where the practice is legal, has risen considerably amid Spain’s recession’.[23]

Conclusion

The essay began with a brief discussion on the development of the financial crisis that hit the world in 2007. This was intended to provide a background to the financial crisis in Spain, which is seen as an extension of the international financial crisis. As mentioned, the Spanish financial crisis directly stems from the mortgage crisis in the United States, which eventually affected the economy of the European Union.

The essay has found out that there were two factors that played a major role in the rise and development of the Spanish financial crisis, namely, the real estate sector and the banking sector. The strong economic expansion during the pre-crisis period coupled with the reduced interest rates on housing loans after the Euro integration had been viewed as the primary reason for the boom in the real estate and the success of the banking industry in Spain. However, it is revealed that the collapse of the real estate sector and the banking sector has brought a devastating impact on the Spanish economy. As a matter of fact, the massive unemployment in Spain today can be traced back to these two important factors.

Finally, given the extent of the Spanish financial crisis, no one sees an easy way out. As Isidro López and Emmanuel Rodríguez write, ‘The outlook for economic recovery in Spain remains bleak’.[24] Indeed, the recession is so deep so that any attempt to remedy the problem would require a strong political leadership and a clear economic planning.

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Hi, thanks for reading this essay. You might be interested to read my essay on inclusion in education. Please see this link: http://philonotes.com/index.php/2018/01/01/inclusion-in-education/.

 

by

DR. JEFFRY OCAY
Professor of Philosophy
Silliman University

 

[1] ‘Eurozone Crisis Explained’, BBC News, 2012, http://www.bbc.com/news/business-17549970

(accessed 25 April 2017).

[2] C. Powell, ‘The Pain in Spain: Political Social and Foreign Policy Implications of the European Economic

Crisis’, Elcano Royal Institute, 2012,

http://www.realinstitutoelcano.org/wps/portal/rielcano_en/contenido?WCM_GLOBAL_CONTEXT=/elcano/elcano_in/zonas_in/image+of+spain/powell_pain_spain_europe_trouble_oct12 (accessed 25 April 2017).

[3] M. García, ‘The Breakdown of the Spanish Urban Growth Model: Social and Territorial Effects of the Global Crisis’, International Journal of Urban and Regional Research, vol. 34, no. 4, 2010, pp. 967-980.

[4] F. Carballo-Cruz, ‘Causes and Consequences of the Spanish Economic Crisis: Why the Recovery is Taken so Long?’, PANOECONOMICUS, vol. 3, 2011, p. 314.

[5] J.F. Jimeno and T. Santos, ‘The Crisis of the Spanish Economy’, SERIEs, vol. 5, no. 2 August, 2014, https://rd.springer.com/article/10.1007/s13209-014-0116-8, (accessed 25 April 2017). See also M.I. Cambón and R. Losada, ‘Evidence from Purchases and Redemptions in the Spanish Equity Fund Market’, The Spanish Review of Financial Economics, vol. 13, no. 2, 2015, p. 57.

[6] Carballo-Cruz, p. 314.

[7] Ibid.

[8] Ibid., 314. See also E. Ortega and J. Penalosa, ‘The Spanish Economic Crisis: Key Factors and Growth Challenges in the Euro Area’, Documentos Ocasionales, no. 1201, Banco de España, 2012, p. 19-21.

[9] Carballo-Cruz, p. 314.

[10] Ibid.

[11] Ibid., p. 315.

[12] Ibid., p. 310.

[13] Ibid.

[14] Ibid., p. 316. See also Jimeno and Santos, pp. 131-134.

[15] Ibid., 316. See also M.V. Ruiz-Mallorqui, ‘Relationship Banking and Bankruptcy in Spain: The Impact of Size’, The Spanish Review of Financial Economics, vol. 15, no. 1, p. 21.

[16] Ibid.

[17] Ibid., p. 317.

[18] Ibid.

[19] Ortega and Penalosa, pp. 15-17. See also D. Quijones, ‘The Banking Crisis in Spain is Back’, Wolf Street, 28 May 2016, http://wolfstreet.com/2016/05/28/spain-banking-crisis-is-back-banco-popular-capital-npl/, (accessed 26 April 2017).

[20] Carballo-Cruz, p. 318.

[21] Ibid. See also F. Rocha, ‘The Economic Crisis and Youth Unemployment in Spain’, Social Europe, 4 June 2012, https://www.socialeurope.eu/2012/06/the-economic-crisis-and-youth-unemployment-in-spain/, (accessed 26 April 2017).

[22] R. Craggs, ‘Spanish Women Turn to Prostitution in Switzerland’, World Post, 11 June 2013, http://www.huffingtonpost.com/2013/11/05/spanish-women-prostitution-switzerland_n_4219099.html, (accessed 26 April 2017).

[23] Ibid.

[24] I. López, I. and E. Rodríguez, ‘The Spanish Model’, New Left Review, vol. 69, 2011, p. 27.

 

References

Cambón, M.I. and R. Losada, ‘Evidence from Purchases and Redemptions in the Spanish Equity Fund Market’, The Spanish Review of Financial Economics, vol. 13, no. 2, 2015, pp. 57-70.

Craggs, R., ‘Spanish Women Turn to Prostitution in Switzerland’, World Post, 11 June 2013, http://www.huffingtonpost.com/2013/11/05/spanish-women-prostitution-switzerland_n_4219099.html, (accessed 26 April 2017).

Carballo-Cruz, F, ‘Causes and Consequences of the Spanish Economic Crisis: Why the Recovery is Taken so Long?’, PANOECONOMICUS, vol. 3, 2011, pp. 309-328.

‘Eurozone Crisis Explained’, BBC News, 2012, http://www.bbc.com/news/business-17549970 (accessed 25 April 2017).

García, M., ‘The Breakdown of the Spanish Urban Growth Model: Social and Territorial Effects of the Global Crisis’, International Journal of Urban and Regional Research, vol. 34, no. 4, 2010, pp. 967-980.

Jimeno, J.F. and T. Santos, ‘The Crisis of the Spanish Economy’, SERIEs, vol. 5, no. 2 August, 2014, https://rd.springer.com/article/10.1007/s13209-014-0116-8, (accessed 25 April 2017).

López, I. and E. Rodríguez, ‘The Spanish Model’, New Left Review, vol. 69, 2011, pp. 5-28.

Ortega, E. and J. Penalosa, ‘The Spanish Economic Crisis: Key Factors and Growth Challenges in the Euro Area’, Documentos Ocasionales, no. 1201, Banco de España, 2012, pp. 19-21.

Powell, C., The Pain in Spain: Political Social and Foreign Policy Implications of the European Economic Crisis’, Elcano Royal Institute, 2012,

http://www.realinstitutoelcano.org/wps/portal/rielcano_en/contenido?WCM_GLOBAL_CONTEXT=/elcano/elcano_in/zonas_in/image+of+spain/powell_pain_spain_europe_trouble_oct12 (accessed 25 April 2017).

Quijones, D., ‘The Banking Crisis in Spain is Back’, Wolf Street, 28 May 2016, http://wolfstreet.com/2016/05/28/spain-banking-crisis-is-back-banco-popular-capital-npl/, (accessed 26 April 2017).

Rocha, F., ‘The Economic Crisis and Youth Unemployment in Spain’, Social Europe, 4 June 2012, https://www.socialeurope.eu/2012/06/the-economic-crisis-and-youth-unemployment-in-spain/, (accessed 26 April 2017).

Ruiz-Mallorqui, M.V., ‘Relationship Banking and Bankruptcy in Spain: The Impact of Size’, The Spanish Review of Financial Economics, vol. 15, no. 1, 2017, pp. 21-32.

 

 

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