Why Spain Is Headed for Default

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Forget the talk of "if Spain defaults." It's just a matter of time now until the world's ninth-largest economy comes to terms with its failure.

I don't say this lightly or to garner a jaw-dropping reaction but do it instead to point out blaring red flags that are only worsening and signal what appears to be an inevitable pirouette off a cliff.

Back in September I took a closer look at Spain's economic figures and felt there were striking similarities between it and Greece. I opined that if something weren't done quickly, the country would find itself begging for financial assistance in relatively short order. Unfortunately, not only have those fears been worsening, but the metrics I homed in on back then have actually been worsening at an exponential rate.

Let me walk you through some of the factors that have me the most concerned and I'll show you why I feel a Spanish default and subsequent bailout are inevitable.

Unemployment rates are skyrocketing
You may have caught last week's headline about Spanish unemployment, but if you didn't, let me recap it for you: 24.4% of the population is now unemployed! That staggering figure doesn't even begin to tell the tale of what's wrong with an economy that has seen unemployment levels triple in just five years.

Source: TradingEconomics.

The real story is how impossible it is for the nation's youth to find work and how quickly the housing bubble has trashed the jobs markets.

One reason unemployment rates are so incredibly high is the rising rates among youth. If you thought 1 in 4 people out of work was terrible, then don't fall over when I point out that 37.85% of all 15-to-24-year-old eligible workers were unemployed in 2009. Youth unemployment more than doubled from 2007 to 2009, and that rate has only continued to climb. According to the U.K.'s Telegraph, youth unemployment stood at a mind-numbing 50.5% as of April 2012.

Source: TradingEconomics. Note: No reliable data was found after 2009.

There are multiple factors built into Spain's economy that cultivate such high levels of unemployment. First, the wage structure in Spain is extremely rigid, which caters to older and more tenured workers. But, more important, a good portion of Spain's jobs are listed as temporary, which caps worker productivity and makes the firing of workers in that country a normal practice.

The other half of this story relates to Spain's reliance on the housing market to drive growth. Without question, I'd place the housing bubble bursting front-and-center in Spain's woes -- and that's a problem for a rapidly contracting sector that accounted for nearly 1 in 7 jobs at its peak. With the homebuilding sector contracting from 13% to less than 9% of the workforce, it's not surprising to see unemployment rates spiking.

The demise of Spain's only growth engine: housing
Between 1990 and 2011, housing provided the best return on investment for Spanish investors, so it wasn't surprising to discover that they put a significant amount of their wealth into their homes. What did shock me was just how much wealth Spaniards tied up in their homes relative to residents of other developed nations.

Source: Oliver Wyman.

As you can see, Spanish homeowners have tied 79% of their wealth into their homes. That's a dangerous proposition considering that home prices are falling (rapidly), and the amount of potential homebuyers is drying up as the unemployment rate rises. People nearing retirement age who are expecting the sale of their home to finance their remaining years may be in for the unfortunate surprise that they didn't net nearly enough from their home to cover their retirement.

But poor allocation of wealth by Spain's savers is just half of the problem. The bottom line is that Spain's homebuilders didn't really think things through.

From a homebuilding perspective, even during the peak, homebuilders in the United States were only building one home per every 2.5 people. That's a lot, but it was reasonable at the time considering the more than 2.1 million homes being sold. Spanish homebuilders, on the other hand, were building at a rate of one home for every person from 1992 through 2010! I feel as if anyone with half a brain should have seen that this was a poor idea that was simply unsustainable -- but alas, no one did.

A more interesting correlation is that of wages and housing price. From 1995 through 2000, Spanish wages and home prices increased at similar levels, which made Spain's housing growth somehow sustainable. But since then, the difference between workers' wages and home prices has grown disproportionately and unsustainably large. At their peak in 2008, Spanish home prices had more than tripled from their 1995 levels, with wages at the time up by only 70%. This divergence just didn't make sense. Although home prices have fallen about 20% from their peak, they would need to dive another 30% just to be in line with Spanish wage growth!

An even worse decision by Spain's banks
If one person per house seems like a ridiculous idea, then be prepared to be amazed even more by how willing Spanish banks like Banco Santander (NYSE: STD  ) and Banco Bilbao Vizcaya Argentaria (NYSE: BBVA  ) were to lend money to the booming real estate market.

According to research from Morgan Stanley, of the 1.5 trillion euro lent to commercial real estate developers in Europe, Spain alone accounts for more than 20%!


Source: Morgan Stanley Research.

348 billion euro in CRE exposure may not seem like much, but allow me to translate these figures into CRE exposure as a percentage of national GDP, and you'll see why this is such a huge concern.

Sources: TradingEconomics and author's calculations. Assumes euro-dollar conversion of 1 euro to $1.3259.

I was a little surprised to see that U.K.'s banks had lent so much, but the U.K. is also a remarkably healthy and strong economy in comparison to Spain. As you can see, at 32.8%, Spanish banks have lent nearly one-third of Spain's GDP to commercial real estate developers. That's a problem considering that my research in September showed that 125 billion euro of outstanding CRE loans are being placed in the doubtful category with regards to collection. The Bank of Spain, the overseeing body equivalent to the United States' Federal Reserve, noted in March that questionable construction debt could actually be as high as 176 billion euro. It's one thing when a bank absorbs a one-time cost; it's completely different when the nation's top banks could be forced to absorb losses equaling 10% or higher of Spain's annual GDP!

Foolish roundup
Spain is in a quickening death spiral. Austerity measures designed to reduce government spending will only aggravate unemployment figures further, which, in turn, could worsen housing prices that subsequently impact the nation's banks and those nearing retirement. If Spain chooses to do nothing, the interest payments on what it already owes will become too difficult to manage.

Simply put, there is no fail-safe solution and no white knight in this situation -- just the reality that the Spanish government, the homebuilders, and the banks have created a big mess that will require the collective funds of the world to help them get out of.

Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

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Read/Post Comments (12) | Recommend This Article (32)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 01, 2012, at 3:29 AM, HorrormanAndy wrote:

    Most of the houses being built during Spain's real estate bubble were not being bought by Spaniards - rather it was massive speculative investments by foreigners buying holiday homes.

  • Report this Comment On May 01, 2012, at 3:38 AM, portefeuille wrote:

    The longer term view.

    The Spanish unemployment rate was at around 22% in 1992.

  • Report this Comment On May 01, 2012, at 3:49 AM, portefeuille wrote:

    There are currently 800/7500/4000/3300 BBVA/EWP/STD/TEF shares in my fund with break-even of around $11.43/30.14/6.54/13.44.

  • Report this Comment On May 01, 2012, at 12:10 PM, Teacherman1 wrote:

    Sean, I agree that things are looking bad for Spain, but I think that is one reason that, at least on a National level, they have opted for a change in Govt.

    Because the various Regions are relatively strong, and are for the most part still Socialists, it will be a hard fought battle to bring about basic structual changes: so in that respect, they are very much like Greece.

    They are also like Greece in another very important way, which if you mentioned it, I missed it. Virtually all of their debt is owned outside of the country, where with Italy, only about 20% to 25% is owed to outsiders.

    I am hoping that this means that STD and BBVA are not big holders of Spanish soverign debt.

    As for the real estate loans, most of the other banks in Spain are similar to what S & Ls were historically in the U.S., and that is most of the banks are basically real estate lenders.

    While they hold significant amounts of real estate loans in their portfolios, I do not believe STD and BBVA are relatively as heavy in Spanish real estate debt as most of the others.

    In addition, both have a lot going on outside of Spain which will help them weather this storm.

    Of course, I could be wrong on all counts, but I think further analysis is waranted before I would assign STD and BBVA to the "belly up category".

    In the meantime, I will continue to add on dips and bad news.

    JMO and worth exactly what I am charging for it.

  • Report this Comment On May 01, 2012, at 12:11 PM, ETFsRule wrote:
  • Report this Comment On May 01, 2012, at 12:16 PM, NanushNanush wrote:

    With one of the lowest birthrates on earth, who exactly were they building for? The kind of geriatric migration that populated Florida, just didn't work for Spain: Older German's and Brits want to talk to doctors in their native tongue.

  • Report this Comment On May 01, 2012, at 12:50 PM, TMFJebbo wrote:

    Enjoyed the article, so I checked out Sean's profile. " I just can't see why I'd change my investing style if some of the easiest "gimme's" are in the non-socially responsible sectors."

    It figures this guy would select a screen name that sounds like a cigarette!

  • Report this Comment On May 01, 2012, at 2:08 PM, TrackUltraLong wrote:


    The name actually originated from having picked so many leveraged ETFs during the market lows of March 2009.

    And on a personal level, I can't stand cigarettes, but I also don't believe in narrowing my investment opportunities so I do consider tobacco companies when looking at possible future investments.


  • Report this Comment On May 01, 2012, at 2:09 PM, TrackUltraLong wrote:


    Any evidence for this? I'd love to look into that becuase as far as I can tell, the majority of housing was built for Spain's residents.


  • Report this Comment On May 01, 2012, at 2:48 PM, cevcror wrote:

    Good topic but the initial article - as some comments i believe pointed out - needs more specific understanding of the Spanish context. Just one example: comparing housing rates in the USA with those in Spain may not be realistic. US housing as investment I understand historically has been very poor while in Spain has been very good i.e. in the long term people in Spain have seen investment appreaciate a "lot". Let us say that according to present value analysis has not been so much but an additional motivation for Spanish speaking people (as a culture) is that there is a "need" to own their houses. To add to this there was a lot of speculation in Spanish housing market i.e. people signed for a purchase option for something not built yet and sold it for a nice profit before even having to get a mortgage i.e. housing rate not always linked to housing needs but to how much speculation was feasible. On top of that getting a mortgage for a first or secondary house was so easy that people not only financed a 100% of the cost but added to the mortgage funds for a new car, vacations, you named ......

    Another point: it is a sort of deja vu that a socialist party leaves governent with +20 unemployment rate to the right party. Would new right government fix it again? I do not know but this situation is a repeat. Now most of the regions - as never before - have a right governement and central government can rule on its own (enough majority). Is this enough? I do not know.

    Is Spain same as Greece? I tend to disagree. To start with Spain never faked the "economy numbers". Agree the Socialist government did not tell the truth with regards to the deficit but never faked the national numbers. The impact or rescuing Spain is far higher than Greece i..e may be the EU can leave with the Greek rescue but can do it with an Spanish default? Eberything I heard here in Spain is that it may not

    Bottom line Spain with the new government is heading to a far different direction so an historicall analysis of what took Spain to the current sitiuation IMHO is by far less relevant than whether the new government´s actions can take Spain back on track

    Disclaimer: I moved to Spain ten years ago, has a mortgage and I do not disagree that the article by Sean is bad at all but ..... Spain is different so you need to get into the specifics

  • Report this Comment On May 02, 2012, at 11:46 AM, monsonr wrote:

    I want to give your points credibility, but where did you get those stats on housing per person? No way did the US industry build housing at a rate of one per 2.5 population. At the peak of a SAAR of 2.7mn, that was less than one per 100.

    And there is no way that Spain ever built housing uits at a rate of one to one - you are implying a rate of 36mn. Can you explain exactly what you are calculating?

    I would hate to think that dodgy research has undermined your whole article.

  • Report this Comment On May 03, 2012, at 11:11 AM, ETFsRule wrote:

    He means houses built per yearly increase in population.

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