More Pain for Spain

World Policy Journal interviewed Jonathan Carmel, of the New York-based firm Carmel Asset Management (CAM), about the deepening economic crisis in Spain. He explains why Spain is currently in a much worse economic position than most people think, what the implications of its financial crisis are, and what policy steps should be taken. The accompanying charts were also compiled by CAM, and serve to illustrate these points.


World Policy Journal: To start off, why is Spain in such a vulnerable and worsening economic situation?

Jonathan Carmel: Its economy was based on construction and because of the entrance into the euro, they had interest rates that were far lower than they had experienced in the past. Asset prices rose, and construction was the main driver over the last couple of years. At this point they have no real industries or competitive advantages to replace that.


WPJ: In brief, how are Spain’s regional governments exacerbating the debt problem and hindering effective policymaking at the federal level?

JC: Only 11 out of the 17 regional governments are of the same party as the PP which controls the national government. One thing about Spain is that health care is paid for by the local or regional governments, so cutting the deficit by getting these governments to cut their expenditures is going to be difficult. Health care is one of the more difficult things, for any government anywhere around the world, to cut expenditure on.


WPJ: What policies led to or contributed to the real estate boom in the first place in the 2000s?

JC: There were some government policies, but far and away the biggest factor was the entry into the euro. The interest rates within the euro zone, which allowed borrowing at far lower rates—far, far lower rates—than Spaniards had been used to, was clearly the biggest contributing factor.

WPJ: Just how bad is the commercial real estate bust and how long will it continue to cripple Spain for?

JC: We think the residential prices have to come down 35 percent and we think it will take anywhere from two to three years. Commercial real estate is an amalgamation in Spain of half-built projects and some of what we would think about as “real” commercial real estate here in the U.S. The number of transactions has been low, in fact almost zero on the commercial real estate side over the last year or two, so we think that the rectification period could actually take longer. They will have to find other ways of selling those properties.

WPJ: How is the Spanish labor market holding Spain back from recovery?

JC: The government has instituted some reforms in the last few months, since they were elected last fall. But Spain has some of the most restrictive laws in terms of what you must offer somebody in severance, how many holidays, etc. The World Bank, prior to the recent reforms, had rated Spain the worst developed nation in terms of labor rigidity. So the effect is that employers do not want to hire people, because it takes so much to fire them, especially in an uncertain economy. But it is getting a little better.

WPJ: How dangerous do you judge the situation of Spanish banks to be and will they need a bailout from the federal government?

JC: They will need a bailout probably from the EU. I don’t think the Spanish government will have the firepower to bail out the banks. But the EU probably does. We’ve heard some rumors in the last week or so that there will be an EU-led bailout of Spanish banks, which under the ESM is possible, under the EFSF was not, and we think that that is a possible route. Although you can paper over a lot of insolvency with liquidity, which the ECB has done, we still think that many of these banks are probably insolvent if they had to mark their books fairly. This will be especially true if housing prices, as we predict, go down another 35 percent.


WPJ: Is the Spanish government being open and forthright with the public about the tasks that it needs to tackle?

JC: Many governments around the world don’t own up to their problems. Spain is doing no better or no worse about owning up. I do think that it was probably more realistic on their budget deficit targets when they came out unilaterally and said it was going to be 5.8 percent of GDP in 2012. The EU had been asking for 4.4 percent, and they settled for 5.3 percent. I think that is an unrealistic target, but at least Spain was honest in saying they were not going to meet the targets for 2012.


WPJ: Will such high unemployment and deteriorating economic conditions cause significant social strife? Will strikes, protest rallies, and riots cause further economic harm to Spain’s finances?

JC: Well that’s always a possibility. We have seen a number of violent or semi-violent protests in Madrid and some other cities, but no worse than what we really saw in Athens. I think the brunt of the cuts is going to be borne by pensioners and elderly people, and I don’t see pensioners rioting. We have not seen the level of social unrest that one might expect at this point in time.


WPJ: What policies would be best for the federal government to adopt to tangibly address the problem of nearly 50 percent youth unemployment?

JC: It would be a difficult choice but I do think that if Spain left the euro, which would be “a disaster for everyone else,” then it could really truly devalue its currency, make its workforce truly competitive and move on. Otherwise there has to be, perhaps, more fiscal integration and loss of ultimate sovereignty. I think that truly we would have to see the United States of Europe where everyone in Europe votes for the same President, is taxed by the same authority, and there are truly fiscal transfers that take place.


WPJ: How will rising oil prices and the likely possibility of a continuing recession in parts of the rest of Europe affect Spain’s economic plans for recovery?

JC: Spain is a big importer and one of the things they import the most of is oil, or energy. Any geopolitical tensions in the Middle East will obviously be very bad for Spain. Most of Spain’s exports go to the rest of Europe; very little is exported to non-EU or non-Eurozone countries. We think that’s going to be a critical factor going forward. They have one of the worst current account deficits of any European country.


WPJ: Given all of this, how realistic do you think the chances of Spain defaulting and leaving the Euro would be? Is an EU bailout even within the realm of possibility?

JC: A bailout is within the realm of possibility, yes. We think it is more likely than the market thinks; we think there are a lot of things that can be done between here and any sort of Spanish default. In fact, in our presentation we think that things are going to get worse, but we never state that we think Spain will actually default. I think it is a real possibility, but not a likely possibility; this means we think maybe a 1 in 5 chance, but we don’t think it’s over 50 percent.


WPJ: To finish up, how would you evaluate the new prime minister’s first steps so far? Do you think there are any very good policy decisions that he can realistically take in the near future or is it too little, too late at this point?

JC: I think he’s in a very difficult situation. I actually commend him for a number of things that he’s done. Reforming labor laws would be one. Getting the banks to try and hold more capital would be another. But I also think they’ve wasted a fair amount of time getting this budget out, which only came out in the last few weeks—nearly a quarter of the way through the year, and more than 100 days since he was put into office. Just like we have here, the first 100 days are probably the most critical. I think they went decently far, but they should have gone further.



By Jonathan Carmel, Carmel Asset Management,

and Michael S. Lerner, Interviewer for World Policy Journal

[Photo of Spanish flag courtesy of Shutterstock]

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