This is the new face of Spain 10 years after the fall of Lehman Brothers: construction cranes no longer crowd the skyline, inequality and precarious working conditions have increased, and what’s worse, many citizens have lost hope of improving their lot in life, the way they once used to. As in John Steinbeck’s novella The Pearl, the property boom was a gift that turned into a curse. But how did it happen? Why didn’t the real estate bubble ring alarm bells?
At the height of the real estate bubble, Spain was consuming a lot more than it was producing. To finance this lifestyle, it was forced to borrow €100 billion abroad in 2007 alone. This unprecedented debt was backed by the country’s property assets. Believing that property prices could only go up, Spaniards became highly indebted to the outside world.
If I hand out €500 bills, Spaniards will spend it on American cell phones, Korean TVs and German cars
Alvaro Nadal, ex-economy minister
This phenomenon was also fueled by the lack of competitiveness – when vast sums of money are introduced into the economy but production does not keep pace, prices shoot up. The Spanish economy lost competitiveness and kept buying more foreign goods and services. In the past, this had been dealt with by devaluing the peseta, but with the euro, this was no longer an option. “Prices in Spain rose by 4 percent and wages by 3.5 percent, while in Germany it was 1 percent and 0.5 percent respectively. The gains made in purchasing power were the same, but the Germans were ahead in terms of competitiveness,” says Álvaro Nadal, former Minister of Energy in the Mariano Rajoy administration.
According to the economist José Carlos Díez, “a Spanish wine producer was better off selling his produce here than in Germany, because he could get a better price.” And as the economist Florentino Felgueroso tells it, it was within this context that unskilled workers were making good money, particularly in the construction sector, thereby obscuring the elevated school drop-out rate and the growing equality gap that was becoming increasingly evident across the developed world.
“Economy books say that if domestic demand is intense, the public sector should step on the brakes,” says Miguel Ángel García, formerly an economist with the Spanish labor union Comisiones Obreras (CCOO). However, the opposite happened. Since 1998, under José María Aznar’s conservative administration, fiscal policy had been expansionary. “Lowering taxes is a left-wing policy,” said the Socialist José Luis Rodríguez Zapatero, who replaced Aznar in 2004.
With measures like Aznar’s liberalizing land use laws and tax breaks for homeowners, a real estate bubble was all but inevitable. “The crisis would have happened anyway in Spain. The spark that set it off was Lehman Brothers. But every year the barrel was being packed with more gunpowder,” says García.
Despite this, there were few warnings from either national or international watchdogs. It was argued that the influx of money into Spain was normal as its economy and those of the world’s richest nations merged. It was even said that imbalances among members of the European monetary union did not matter, in the same way that they did not matter between Alabama and California. It was only in 2003 that the Bank of Spain warned about inflated prices in the housing market. But the bank’s governor, Jaime Caruana, did nothing about it. And lenders continued to hand out bigger loans.
The bubble was the goose that laid the golden egg, and nobody wanted to kill it. And so there is still a debate over whether the euphoria could have been stopped at all. Adjusting for inflation, real interest rates were negative, so getting into debt was free because the interest rates were paid for by inflation. What might have made sense from an individual point of view turned into a kind of collective madness. “It happened in all the eurozone’s periphery countries; inflation was higher there and that meant that investment was concentrated in the south in the quest for higher returns,” says José Manuel Campa, former secretary of state for the economy in Zapatero’s administration.
The spark that set it off was Lehman Brothers. But every year the barrel was being packed with more gunpowder
Miguel Ángel García, economist
“The external deficit should have set off alarm bells for the banks and the northern [European] regulators who were lending the money. With the peseta they would have devalued the currency with a deficit of 3% of GDP, yet the deficit reached 10%,” says Nadal. According to the Bank for International Settlements, foreign banks lent Spain more than €750 billion. And when Lehman Brothers went bust, the credit dried up overnight, as did work in construction and related sectors, where 2.1 million jobs were lost. Overall, the economy shed 3.8 million jobs between the third quarter of 2008 and the first three months of 2014.
This was due to three distinct factors. First, the crisis in Spain was slow to be recognized. In 2008, the G20 group recommended expansionary fiscal policies and the Spanish government was enjoying a surplus. Immediately, Plan E was devised to try to employ those laid off from the construction sector, in the belief that the job losses were purely circumstantial and could be addressed by the public purse. However, this diagnosis proved wrong. “The surplus was not structural. The elasticity of the income coming from construction was far greater than in any other sector. When you buy a home, you pay more taxes than ever,” says Campa. “[When the bubble burst] the government lost around €70 billion in tax revenues, and they still haven’t passed a reform to address this imbalance in the tax system.”
According to Nadal, “If I hand out €500 bills, Spaniards will spend it on American cell phones, Korean TVs and German cars. And it is foreign economies that are stimulated. That’s why the problem always lies with competitiveness. We got into debt to finance an expansion that was partly going abroad.”
The lack of financial control by regional governments was also a contributing factor, as was the lack of bank recapitalization to match that of other eurozone countries. Having avoided the acquisition of toxic financial assets, and having the safety net of additional capital, it was believed that Spanish lenders would be in a better position to weather the storm.
The second factor that exacerbated unemployment was a rigid and highly seasonal job market that adjusted to the situation by laying off workers instead of cutting their wages and hours, as was done in Germany. “If they had adopted an agreement to adjust wages in 2009 as they did in 2012, they would have saved, not millions, but at least hundreds of thousands of jobs,” says Fernando Moreno, a lawyer specializing in labor relations.
And just when it looked as though there might be some sort of a recovery, the survival of the euro was put in jeopardy, which was the third and perhaps most damaging factor. In 2010, in Deauville, German Chancellor Angela Merkel and French President Nicolas Sarkozy put periphery eurozone countries at the mercy of the markets by announcing debt restructuring conditions for overindebted countries. A definitive solution for the heavily indebted Greece was not forthcoming. The European Central Bank did not implement emergency measures until its president, Mario Draghi, declared in July 2012 that he would do “whatever it takes” to protect the euro. Until a political compromise was reached to bolster the euro, Spain was in danger of returning to the peseta as investors fled the field. “We became a kind of emerging country at the mercy of the availability of financing,” says Campa. And that brought the crisis to levels not seen since the war.
On June 9, 2012, the Spanish government requested a rescue package for its banks
The cuts and the drop in wages were inevitable and fueled the crisis further. Unemployment levels reached 26.94% in the first quarter of 2013. Home evictions became the order of the day, rising to 230,000 for primary residences, according to estimates. In response, the Indignados movement was formed as students and the dispossessed mobilized.
Working with the premise of “whatever the cost,” then-prime minister Zapatero was able to stave off a full-blown bailout, although there would be a bank bailout under Rajoy’s administration. Apprehension mounted in Brussels with the unilateral announcement that Spain would fail to meet its deficit targets, the delay in delivering a budget blueprint due to the Andalusian elections, and the fact that one of Spain’s biggest banks, Bankia, was dealing with a crisis of its own while its president Rodrigo Rato refused to step down. Every Friday, the Cabinet met to draft new and painful adjustment measures. “Businesses have four costs: labor, fiscal, financial and energy-related,” says Nadal. “Whether we did a good or a bad job is a moot point, but we did pass reforms that addressed those four costs.”
Amid the uncertainty, with the spread between Spanish and German bond yields in excess of 500 basis points, it was feared that the banking sector could end up pulling the Spanish State down with it. Attention focused on Bankia. Banks needed to be recapitalized and, isolated from the markets, the money had to come from Europe.
On June 9, 2012, the government asked for a rescue package for Spanish banks. And Brussels handed over €41.3 billion. Despite the fact that the conditions were less harsh than for other bailed-out countries, the package was conditional on the implementation of a broad program of macroeconomic measures. “Personally, I wasn’t convinced that an IMF-type of rescue could work with a big economy. But it did,” says one of the “men in black” who oversaw compliance.
“The surprise was how well exports behaved,” adds Campa. The tailwind of the monetary policy, together with low oil prices and tax cuts, gave the Spanish economy an added boost. Since Draghi declared that he would do everything within his power to save the euro, the risk premium began to drop after reaching highs of 638 points. Thanks to its stimulus programs, the Central European Bank has now bought almost a quarter of the Spanish pubic debt.
Ten years after the collapse of Lehman Brothers, Spanish GDP has recovered, but the economy remains vulnerable. The duality of the labor market has not been corrected and the student dropout rate means that part of an entire generation is insufficiently prepared for the current climate.
Moreover, inequality levels are improving very slowly, and the crisis has generated a lack of competitiveness. Shifting private debt into the public sphere means there is little in the State coffers to spare. Add to this the fact that the Social Security system is increasingly stretched as baby boomers reach the retirement age. In short, important reforms are still required.
Ten years on, the conclusion has to be that the response to Spain’s Great Depression was too little, too late, and that not enough measures have been taken to weather a future crisis or a new slowdown of the economy.
English version by Heather Galloway.