U.S. News

Spain’s Banking Mess

FLOYD NORRIS|The New York Times

It’s not just sovereign debt.

Christopher Groenhout | Lonely Plant Images | Getty Images

Just when markets were focused on the risks of a Greek default and the possibility of contagion to other countries, Spain’s central bank reported this week that things were getting worse for that country’s banks — but not because they held a lot of Greek debt or bonds issued by other troubled European economies.

The problem, instead, is the same old one. With Spain’s economy weak and home prices falling, bad loans are growing. And the central bank thinks things are getting worse.

In a surprisingly frank presentation to investors in London on Tuesday, José María Roldán, the Bank of Spain’s director general of banking regulation, said that Spanish land prices had fallen about 30 percent from the 2007 peak, adjusted for inflation , and that home prices were off about 22 percent.

“In both cases, we expect further corrections in the years to come,” he said. For land prices, he said, the bank’s “baseline scenario” was that prices would fall to little more than half of the peak level. The “adverse scenario” indicated that the decline could be significantly worse.

That was a significant change from a presentation he made in February. Then, with home prices down about 18 percent from the peak, he argued that the decline was similar to past cyclical downturns and that prices were likely to begin rising soon.

Remarkably enough, collapsing home prices have not left Spanish banks holding large amounts of bad mortgage loans, thanks largely to the fact the Spanish mortgage market operated during the boom in far different ways than the American market.

But if lending to home buyers was conducted in a far more prudent manner than it was in the United States, lending to real estate developers and construction companies was, if anything, more irresponsible. The higher land prices went, the more eager the banks were to push out loans.

The story of how Spain’s banks got into the mess — and the way its mess differs from that of American banks — show that it is impossible for banks to walk away from a collapsing bubble in real estate. It also shows that the structure of mortgage markets can make a major difference in how a collapse plays out.

The figures released by the central bank this week showed that by the middle of this year, 17 percent of Spanish bank loans to construction companies and real estate developers were troubled — or “doubtful,” the term favored by the central bank. That figure has been rising rapidly, reflecting the deterioration in real estate values.

The Financial Crisis

When the financial crisis first broke out, in 2008 and 2009, it appeared that Spanish banks were in a better position than most, in part because of regulation that had kept the big banks from making some of the mistakes others made.

But it turned out that smaller Spanish savings banks were heavily exposed to a real estate market that had outpaced even the United States’ market for a time during the first decade of this century. That market continued to rise after the American housing market stopped climbing.

The Bank of Spain has created a program to force mergers of the smaller banks and to bring in better management. It has put about 11 billion euros into the banks to recapitalize them, and is putting in another 15 billion euros in a process that is supposed to be completed by the end of this month, said Antonio Garcia Pascual, the chief Southern European economist for Barclays Capital. But, he added, “our estimate is that the overall number needed is closer to 50 billion euros.”

The banks are bleeding from loans secured by raw real estate, and from loans for construction. The pain is made worse because such lending soared during the property boom. It is those loans that are now devastating bank balance sheets, as developers who borrowed to build offices, stores and neighborhoods saw demand dry up and now cannot pay the banks back.

Other corporate loans are also showing weakness, as would be expected when unemployment is above 20 percent and not expected to improve for at least two years, but less than 5 percent of those loans are said to be doubtful. There are also signs of trouble in car loans and other loans to individuals.

And then there is the mortgage market. Perhaps the most remarkable statistic in the reports released by the Bank of Spain this week was the low percentage of mortgage loans that appeared to be in trouble. It is just 2.5 percent, half a percentage point less than in mid-2009. If American mortgages were doing as well, there would be far less angst here.

How Can That Be?

How can that be?

The most important fact may be that refinancing is very unusual in Spain. They are generally unnecessary; since mortgage loans are made at variable rates, there is no need to take out a new loan if rates are declining. The absence of refinancing, along with the absence of home equity lines of credit, meant homeowners could not take out cash to spend on other things.

As a result, if you bought a house in Spain a few years before the peak, you still have equity in the home, even with prices down. If you lose your job and can no longer afford the payments, you can sell the home and emerge with something.

That would also be true in the United States if mortgages were for only house purchases. But in the housing cycle that led to the recent bubble — unlike previous cycles — it was far easier for homeowners to cash in their equity and use the money for whatever they wanted. So some people who have been in the same home for decades are desperately under water.

There were other differences as well. There were no “originate-to-distribute” strategies in the mortgage markets, so the loans were not bundled into securities to be sold to foolish investors.

Banks that made the loans expected to profit if — and only if — they were repaid. There were few loans to investors who planned to rent or flip homes. Moreover, mortgage loans in Spain are recourse. Buyers cannot walk away if they have other assets, as they can in some American states.

The Bank of Spain has said it is emphasizing transparency in seeking to fix the banking system, and that it is willing to be flexible as conditions change. Its openness may be winning over investors. No one likes to hear bad news, but it is reassuring to believe that the news is accurate, rather than sugar-coated.

I have not seen other banking regulators distributing charts forecasting that the biggest problem facing their banks was likely to get significantly worse, as the Bank of Spain did this week. It has been more common for regulators to seek to weaken accounting rules, on the theory that it will help confidence if banks seem to be strong, regardless of the facts. That is an attitude that has backfired, particularly after the European stress tests chose to assume that all was safe.

Rather than denigrate markets as being foolishly negative — as some other European officials have done recently — Mr. Roldán cited market trends, including the rising cost of credit-default swaps on the banks, as evidence of the problems confronting them.

It is a refreshing attitude in a regulator. When, and if, Mr. Roldán ever starts to say the worst is over, it will be a lot easier to believe him.