Edward Harrison here with an article I posted last evening at Credit Writedowns. Since I posted this, the markets have sold off in Asia and Europe. The U.S. will open way down. Clearly, contagion has spread. The areas where I could see contagion spreading beyond Spain should be Ireland because of their banks and Eastern Europe because of their public finances and integration with Western Europe. Because all of Europe is undergoing fiscal austerity right now, these pressures will likely increase.
Last spring and summer I wrote a series of articles on the bleak situation in Spain, centred on the Spanish Cajas (savings banks), the imploded housing market and the high level of unemployment. The gist of these posts was that Spain faced an uphill battle since the jobs market was in a world of hurt and Spain’s Cajas were hiding billions in real estate losses via forbearance.
The problems with the Cajas, who have been frequent users of ECB liquidity, became urgent during the depths of the recession in March 2009 when Caja Castilla La Mancha was rescued. By April, reports that Spain’s savings banks may have 40 billion in writedowns were widespread. For me, it was revelations last July about GMAC and Hypo-Real-Estate’s speculations in the Spanish mortgage market that made it clear how deep the forbearance problem was. GMAC was selling Spanish mortgage assets for 14.5 cents on the dollar while Spanish house prices had only fallen 13%. I asked "What does that tell you about likely losses in the Spanish banking system going forward?"
Well, with the nationalization of CajaSur, the planned forced merger of two Cajas and the forced merger of yet four other Cajas this week, we have the answer. Now, the Spanish are moving forcefully to clean this mess up. But clearly, their are a lot of dud assets on Spanish banks’ books – just as there are on the books of banks in the US or Germany or Ireland to name a few conspicuous countries. As I have been saying for a while, all of these problems didn’t magically disappear, they have been lurking, waiting for economic weakness to re-assert themselves.
The question for me, with Spanish austerity and all, is how is Spain going to prevent this from spiralling out of control? I mean, now that a lower growth path is all but assured, this has to drive unemployment, foreclosures, and non-performing loans higher. From where I sit, this looks like a situation which will get worse, not better. Can someone explain to me what I am missing here?