2008:2012 Spanish financial crisis - Essay Example

2008 Spanish Financial Crises Introduction Most economists agree that the 2007 global financial crisis was the worst since the 1930’s Great Depression. The crisis was characterized by the threat of complete collapse of large financial institutions across the world, downturns in stock markets across the world, bailing out of banks by national governments and general slow-down in economic growth and development around the world (Shiller 35). In the wake of the bank failures, large reductions in the equities’ market value and commodities, and declining stock indexes, national finance ministers, financial industry players, and world political leaders coordinated their efforts towards mitigating the effects of the crisis (Pomfret 6). It is no doubt that the global financial crisis had devastating economic, social, and even political impacts across the world. Most of the European countries were greatly affected by the crisis, Spain being one of the countries that it severely hit. I was in Spain (Barcelona and Madrid) for two months recently and saw how people live there. During my visit, I found the country to be interesting. However, I felt very sad to see how people in Spain are losing all their businesses and how there is no money in the country. It is against this background that this essay will seek to discuss and understand the 2008-2012 Spanish financial crises. Spain, like many countries, has gone through a series of financial crises prior to its industrialization and after. It is important to note that there are similarities between recessions throughout Spain’s history. Just like in other economies around the world, the roles of government regulation, the political climate, international trade, budget deficits, government spending, and credit institutions have been very important determinants of the nature of the Spanish economy (De Grauwe 3). While the 2008-2012 financial crises can trace its origin in the United States, it has become a worldwide phenomenon, and it has considerably affected small European countries such as Spain. Many economists consider the financial crisis that Spain is currently going through as the country’s worst financial crisis over the last five decades. The crisis in Spain started as an extension of the international financial crisis (Serrano 371). Nevertheless, the role of internal imbalances that accumulated in the pre-crisis period cannot be ruled out from causing and actually aggravating the financial crisis in Spain. In particular, the banking and real estate sectors in Spain have been cited to have been the greatest contributors to the deepening of the crisis in the country (Shachmurove 363). After a relatively long period of economic expansion, which started in the mid-nineties, the Spanish economy began to show the initial signs of exhaustion in 2006. This coincided with the international economic crisis that started in 2007and intensified in 2008. As a result, financial crisis in Spain hastened a situation that triggered severe imbalances’ adjustments that had accumulated during the previous years (Pomfret 10). The fast deterioration of the international macroeconomic context served to highlight the structural weaknesses that the Spanish economy had. After 2008, it became apparent that Spain economy’s dependence on property and construction development activities and domestic demand was an absolute failure. The disproportionate growth in real estate, as well as expansion of credit that was needed to finance the sector was the main basis of the economic imbalances (Shiller 40). The Main Causes of the 2008-2012 Spanish Financial Crises As mentioned earlier, the 2008–2012 Spanish Financial Crises is the worst in the last fifty years. Apparently, the crisis started due to the internal imbalances that had accumulated prior to the crisis as well as as an extension of the international economic crisis. Presently, the incomplete adjustment in the Spanish economy is making it hard for the country to witness any significant economic recovery (De Grauwe 5). In order to provide a clear and comprehensive picture and description of what I saw in Spain in consequence of the crisis, it is important to highlight the main causes of the crisis – that is, the factors that brought Spain to its current state. It is by understanding the factors that one can be able to understand why and how the country is experiencing the crisis (Ghemawat and Stijn 16). In addition, it helps to provide a better way of understanding how the country can hope to recover from the crisis through various interventions, including how the loan can help it recover (Pomfret 15). Spain experienced a long cycle of housing expansion between 1997 and 2007. The cycle was different from the previous cycles in the sense that it was the aftermath of extraordinary construction volume and took relatively long duration of about 11 years. The average annual growth rate during this period was more than 5 percent (Ghemawat and Stijn 16). By late 2007, the construction sector in Spain was one of the largest as it contributed almost 16 percent of the GDP and concentrated about 14 percent of employment. Available data shows that if demand related sectors are included, the employment and output dependent on the construction sector achieved 23 percent of the overall employment and 25 percent of the GDP (Shiller 69). This demonstrates how important the sector was in the overall performance of Spain’s economy. The demand for housing was high during this period, stimulated by a number of factors. One of the main factors was the strong economic expansion that the country was witnessing due to decreased interest rates on loans, and partly due to the real estate rapid growth. The other factor was the immense competition among financial institutions during this period. They were competing to make more revenues by lending more money. As a result, Spain’s population (including the immigrants) was able to purchase houses (Shachmurove 365). The demand for housing was strong at the time, but found a very dynamic response on the supply-side of the market. Between 1997 and 2007, nearly 5.4 million dwellings were completed in Spain; actually in several years during the expansion cycle, the number of housing that were finished per year exceeded half a million. The number of houses rose by about 21 percent between 2001 and 2008, from 20.8 million to 25.1 million (Serrano 374). The rapid demand growth led to an increase in investment in housing from 4.6 of GDP in 1997 to about 10 percent in 2007. Economists argue that the massive housing acquisition that was stimulated by strong demand factors prompted an extraordinary demand for credit by the Spanish citizens. As a result, the number of the Spain’s population that was seeking credit rose rapidly (Ghemawat and Stijn 16). Data from the banking sector indicate that between 1997 and 2007, the housing loans as GDP percentage rose from 28.4 percent to about 103 percent. While this increase spurred the growth of the construction sector, it increased private debts of individual households. Private debt of households increased from 52.7 percent of disposable income in 1997 to 132.1 percent in 2007. Consequently, the individuals’ effort of acquiring a dwelling increased from 4.3 years of salary in 1997 to 9.1 years at the end of the cycle (Pomfret 21). However, Spain’s massive growth in the construction sector was coupled with the inability of the supply side to adjust automatically to the demand side of growth (Miguez, et al., 462). As a result, tensions in prices began to emerge. The rise in real estate prices intensified when expectations of the future growth prices affected the demand, leading to a spiral growth in supply, prices, and demand. For several years, this situation led to average growth of price to come close to 20 percent. According to the Bank of Spain, the average housing price in the country increased by 115 percent in real terms, between 1997 and 2007. It is important to note that this massive increase was also witnessed in other European countries as well. These countries included the UK (140 percent) and Ireland (160 percent) (Pomfret 29). The extraordinary revaluation of real estate in Spain until 2007 revealed that there was a great bubble in the country’s real estate sector, which resulted to strong overvaluation of residential real estate. The impact of this situation became evident in late 2007 when the prices started to fall slightly and sales in the real estate sector experienced a significant decrease (De Grauwe 6). The decrease of prices in the Spanish construction sector was very gradual even though in cumulative terms, it had already began to reflect a considerable adjustment. According to data in the sector, the prices fell between 15 and 20 percent between 2007 and 2011. Cumulatively, the decline in prices between 2007 and July 2011 was 22 percent. The decrease in prices was justified by the decline in the rates of employment, the housing stock growth, the presence of significant credit rationing levels, and the increase in the capital cost. At the same time, the house sales were declining at the rate of about 43 percent (Shiller 71). The supply side also presented a precarious situation to the real estate sector in Spain, which greatly contributed to the 2008-2012 Spanish Financial Crisis. While the number of dwellings developed had increased significantly to reach 25.7 million, the number of unsold homes was increasing. In the late 2010, the number of unsold homes ranged between 700,000 and 1,100,000. The adjustment in the construction sector was slow and long (Shachmurove 367). Apart from the construction sector, the banking sector also greatly contributed to the 2008-2012 Spanish financial crises. Prior to the crisis, the Spanish banking sector had been credited as one of the best equipped and most solid not only in Europe but also across the world. It was considered to be among those that can cope with the liquidity crisis; a consideration that was informed by the country’s conservative baking practices and rules (Ghemawat and Stijn 16). Normally, banks are supposed to demand various securities and proofs from potential borrowers and have high capital provisions as well. However, the Spanish banking sector strongly relaxed this requirement during the long cycle of housing expansion. This situation became more complex owing to the fact that the regulator (The Bank of Spain) failed to take the necessary steps to ensure that all the banking requirements especially those relating to lending were fully complied with. The accounting standards in the country became unusual and misled analysts and regulators by failing to disclose earnings volatility and losses (Pomfret 30). These unusual accounting standards applied the accounting technique known as “dynamic provisioning” that violated the International Accounting Standards. Due to the relaxed banking rules, more and more institutions and individuals were heavily indebted with the banks, and the debts extended over time, thereby increasing the bubble size (Serrano 379). The mainstream banks and the semipublic saving banks loaned huge amount of money to the real estate companies, which made them to go bankrupt at the end of the housing expansion cycle (Martinez 183). Unlike some of the other countries like Ireland, Spain did not undertake nationalization. Instead, the central government bailed out banks and semipublic saving banks. The problem in the banking sector was further compounded by the process of bank concentration, which led to massive dismissal of the bank employees (Shachmurove 370). The dismissals contributed to the problem of unemployment in the country. However, what was more devastating is the fact that from the year 2007 to the year 2012, the evolution of the banking sector in Spain became highly conditioned due to the bursting of the housing bubble in the country and the extent of the international crisis. The lack of confidence in the country’s banking sector and the generalization of the international financial crisis have considerably restricted banks’ access to financing in the international markets (Shiller 66). Recent years have witnessed the following internal factors greatly affecting the profits in the sector: increase in unemployment, economic downturn, and increased banks’ exposure to real estate. These factors have decisively led to the increase of the default rate and consequently affected the solvency levels of the sector (Miguez et al 464). The Main Impact of the Crisis The main effect of the occurrences prior and during the 2008-2012 Spanish financial crises was the employment crisis. Spain recorded near full employment in the second half of the 1990s and in 2000s due to impressive economic performance and growth in key economic sectors such as construction and banking sector. However, the country suffered a setback in late 2008 when unemployment levels started to rise rapidly. Between November 2007 and October 2008, the unemployment rate in the country rose to 37 percent (House and David 5). This predicament was mainly because of the crisis in the housing sector and the banking sector, as well as the effects of the international economic crisis. During this period, the country suffered the worst unemployment increase to ever been recorded. As at now, the country is suffering the biggest unemployment crisis in Europe. The unemployment situation in the country seriously harms the country’s ability to remain competitive, earn foreign reserves to enable it pay down its debt, and to maintain production (Richard 105). It is estimated that about 2 million people lost their jobs between 2008 and 2009. For the first time in Spain’s history, the country had more than 4,000,000 people who were unemployed. In March 2012, the unemployment rate had hit 24.5 percent, which was twice the average in euro-zone. The rigid labor laws of the country have been compounding the problem of unemployment as it prevents wage reductions (The Economist 7). As a result, employers are left with only one option – that of dismissals. Moreover, since dismissals are costly, companies have been hesitant to recruit new workers, which have prompted many workers to seek employment abroad. The rigid labor laws have also made the Spanish labor market to be uncompetitive. The problem of unemployment has had dire consequences in Spain seeing that the country heavily relies on the inter-generational family structure for a substantial share of the social safety net. Therefore, unemployment especially of a significant rate spells doom to majority of the country’s population (Shachmurove 371). The Impacts of the Crisis on How People Live in Spain Being in Barcelona for two months made me come face-to-face with the realities of the 2008-2012 financial crises. As has been mentioned, the crisis was a result of the extension of the international economic crisis as well as the internal factors. What became apparent to me was the fact that the implications of the crisis on the Spaniards were wide and dire (Richard 106). From what I saw, the crisis really changed people’s way of life. While I loved the country, I must admit that I was very sad to see how people were losing all their businesses and how the country was without money. It is in the light of this that it is important that I put the impact of the crisis in perspective. However, it should be noted that while these impacts may be specific to Spain only, it somewhat resembles the impacts of the financial crisis in other countries (Richard 107). After an upward phase in the Spanish economy for over a decade during the expansion cycle, the country’s economy began to spiral downward in 2007. Five years after the crisis in 2012, an economic recovery is yet to be achieved in Spain. In late 2007 and early 2008, there was an economic slowdown, and from the second quarter of 2008 until the final quarter of 2009, the economy experienced recession (Serrano 380). The recession period was unusually long since it took seven consecutive quarters. The recession normally does not extend beyond four quarters. The first quarter of 2009 was the hardest hit stage as it witnessed massive job destruction and product breakdown; GDP fell 6.3 percent and the number of unemployed by nearly 800,000 people (Pomfret 29). The economy of Spain started to recover in 2010, although the recovery was very modest compared to the accumulated production loss in the last two years. I came to realize the fact that as Miguez and his co-authors point out, the unemployment rate is still very alarming, especially among the younger workers aged between 16 and 25 years, and among foreigners as well (465). The available data shows that there was a strong growth in long-term unemployment in 2010 representing about 42.5 percent of the total unemployment. This means that majority of Spanish people would be unable to meet their basic needs as they do not have sufficient disposable income. In addition, it means that the businesses will continue to make losses and many people will lose their businesses, as there is no money in the country (De Grauwe 6). The problem of unemployment that the 2008-2012 financial crises brought about and the desperation it brings is evident in the increasing rates of emigration in Spain. Throughout 2008, there was large-scale immigration to Spain despite the harsh employment (Shachmurove 371). However, the immigration has turned into emigration. OECD has confirmed that the total number of people who are leaving Spain, both Spaniards and non-Spaniards had exceeded the total numbers of arrivals in 2011 (Schneider 4). Available data also indicate that between 2011 and 2012, Spain has been a net emigrant nation. The situation has been so horrible that even the established immigrants have started to leave. However, it has also appeared that those who are leaving are retaining their households in Spain, which is a sign that they still hold hope that the Spanish economy will eventually recover from the crisis (Schneider 4). Furthermore, the impact of the 2008-2012 Spanish financial crises on how people live in Spain is evident in the differentiating aspects compared to the euro zone. While the product’s fall is the same in terms of Magnitude, the composition presents considerable differences. Research indicates that the domestic demand in Spain went down by 7.6 percent between 2008 and 2010, while in the euro zone; it went down by a mere 1.6 percent (Shachmurove 370). In addition, the sad situation in Spain due to the financial crisis is apparent in the housing investment that fell by 41 percent. It is no doubt that the lives of Spaniards has significantly deteriorated economically. This is evident in the households’ reduced saving rates that have fallen to historically low levels (Miguez et al 481). Economists have argued that the reduced saving rates of the households hugely contributed to the rise of the households’ debt in 2007 to 130 percent of the Gross Disposable Income (GDI). Presently, the situation is no different as the ratio of debt is about 125 percent, which is much higher than the euro zone average (98 percent), lower than the UK’s (151 percent), and near similar to that of the US (118 percent). The slow pace of the deleveraging of households has mainly been attributed to the long-term debt amortization for purchase of houses and weakness of household income, which has hindered rapid depletion of liabilities (Richard 108). Spaniards’ Hope that Loan will help them Other European countries, the Spanish Government, and the Spaniards have realized that without a doubt, the Spanish financial crisis is real and that there is need for actions to mitigate its effects. The government has already taken measures towards economic recovery and mitigating the effects of the crisis. For example, the government adopted an economic stimulus plan that was estimated to be worth 5 percent of the GDP, in addition to creating a bank bailout fund (Serrano 381). However, since the effects of the 2008-2012 Spanish financial crises have been far-reaching especially within the euro zone, the attention of the European countries on Spain’s crisis has intensified. Its public deficit of over 11.2 percent of GDP in 2009 attracted the attention of European countries. Apart from the measures that the government is taking such as increasing taxes on the wealthy, loan from other European countries has been considered as one of the measures that can help the country recover economically (Shiller 78). Recently, the Euro zone finance ministers agreed to lend the Spanish government a loan of up to $125 billion in order to shore up the failing banking sector in the country (Martinez 182). This move instilled a lot of hope among the Spaniards who viewed it as one of the crucial steps towards the economic recovery of their country. In addition, it brought a ray of hope regarding their lives and their economic prospects. However, the economists in the country argue that the loan may not really solve the debt crisis in Europe and may not ease the pain of high unemployment rates in the country. That notwithstanding though, they agree that the loan is likely to ease and calm the financial markets, and at the same time create an environment where the policy makers can work to improve the country’s economy. It is no doubt that Spain still has plenty of troubles to address especially in the banking sector and reducing unemployment. Therefore, while the loan can provide a sigh of relief, it should not be lost to the Spaniards that they have fundamental problems to solve (Miguez et al 467). The loan would be channeled to the banks in a bid to help ease the immediate financial crisis in the country. As at now, the immediate crisis is the deterioration of the nation’s banks. It became apparent to the Spanish government and other Euro zone countries that efforts by the Spanish government to rescue the banks would have threatened it with bankruptcy. It is this realization that prompted the Spanish government to ask the Euro zone countries to lend it money to rescue its banks (Serrano 382). The Spanish people are optimistic that the loan would not only help their country recover economically, but it will also help improve their overall wellbeing. Prior to the lending arrangement, they were worried and had lost hope because their government was resisting the pressure of seeking help from elsewhere to solve the financial crisis. Besides, their hope that loan would help them was informed by the realization that their country received the loan without necessarily agreeing to deeper cuts in its budget (Pomfret 27). This is unlike other three European countries namely Greece, Portugal, and Ireland that received financial help after agreeing to deeper cuts in their government budgets. Apart from the hope that the Spanish people have about the loan helping them recover, they also hope that the loan will help the larger Europe to recover from the financial crisis. Most of them believe that this loan will enable the European policy makers to have more time to strengthen the euro (Martinez 184). The stimulation of economic growth across Europe and strengthening of the continent’s currency presents good prospects for better economic, social, and political stability to the people of the continent. Individual European countries can only grow their way out of the crisis through stimulated economic growth in the entire region. It is this realization that gives hope to the Spaniards. However, economists in the country still argue that the loan deal alone will not significantly help Spain recover from the crisis (Shachmurove 373). Actually, they predict that economic crisis in the country might get worse this year as the economy shrinks and more people lose their jobs. Conclusion All evidences indicate that the 2008-2012 Spanish financial crises had a very devastating impact on the overall economy of Spain and the lives of Spaniards. Currently, most people in the country are losing all their businesses and there is no money in the country. However, most of them hope that the loan will help them out of the crisis and that they will be able to get back to the path of economic recovery, and eventually to prosperity (Richard 109). It is important to point out that whereas the loan may help them in some way, it will not help them entirely. It is in the light of this fact that it is important for the government to use proper and appropriate ways to help the country recover fully from the crisis. It can achieve this by addressing the main causes of the crisis and implementing reforms in critical sectors (Martinez 186). Since it is a known fact that the banking sector significantly contributed to the crisis, there is urgent need to undertake comprehensive reforms in the banking sector. Already some reforms have been undertaken – in the wake of the crisis, a new institution with the fundamental role in restructuring the banking sector was created. This institution is known as the Fund for Orderly Bank Restructuring (FROB), and its primary purpose is to reinforce the solvency of the banks by providing funding in order to facilitate restructuring processes (Richard 111). The main aim of creating the institution was in order to provide solutions for the financial institutions with particular difficulties, thereby reducing public resources use. Since the year 2010, a number of measures have been implemented to increase transparency in the financial sector, as well as improving investor confidence in the sector (Miguez et al 461). Moreover, regulations provisions were tightened in order to prevent re-occurrence of the crisis in the future. Another way that can help Spain to recover fully from the 2008-2012 financial crises is through a comprehensive labor market reform. As mentioned earlier, the rigidity of the country’s labor laws dampened the possibility of recovery from the economic crisis. The institutional structure of the country’s labor market tends to not only cause inter-generational injustice, but it also makes it difficult to resolve labor crisis when it arises. Therefore, it is important that labor market reform be geared towards making the labor market in the country more flexible. In addition, the reform should seek to reduce wage rigidity and duality (Richard 114). In conclusion, while the loan deal will provide reprieve to the Spanish people, the government of Spain still has a long way to go before turning around the country’s economy towards the path of recovery, and eventually prosperity. Therefore, the government should spearhead efforts of stimulating the country’s economic growth, elevating debt, and creating more employment opportunities. Most importantly, the government should implement comprehensive reforms in all sectors that contributed to the financial crisis, in order to prevent future crisis. Works Cited De Grauwe, Paul. ‘Crisis in the Euro zone and How to Deal with It.’ The Centre for Economic Policy Studies Policy Brief, 204, 2010:1-6. Ghemawat, Pankaj, and Stijn Vanormelingen. "Reinventing Spain's Economy." Fortune 166.2 (2012): 16. House, Jonathan and David Roman. Spain Jobless Crisis Deepens. Wall Street Journal, (Apr 28, 2012). Martinez, Maria-Teresa Sanchez. "The Spanish Financial System: Facing Up To The Real Estate Crisis And Credit Crunch." European Journal Of Housing Policy 8.2 (2008): 181-196. Miguez, Gonzalo et al. "Effects Of The Great Recession On The Spanish Economy." Current Politics & Economics Of Europe 21.4 (2010): 461-483. Pomfret, Richard. "The Post-2007 Crises And Europe's Place In The Global Economy." CASE Network Studies & Analyses 439 (2012): 1-31. Richard Soparnot, et al. "How To Emerge From The Crisis And From Crisis: Lessons Learned From A European Survey." International Business Research 5.6 (2012): 105-116. Schneider, Howard. Spain’s Unemployment Prompts a Look Elsewhere. Washington Post, (May 2, 2012). Serrano, Felipe. "The Spanish Fiscal Policy During The Recent "Great Recession." Journal Of Post Keynesian Economics 32.3 (2010): 371-387. 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