Harbinger Of Doom: European Recession Next?

European Recession Looms As Spain Crumbles

By Ambrose Evans-Pritchard | 18 July 2008

The eurozone is tipping into a deeper downturn than America itself despite the tremors in the US mortgage industry, and may already be in full recession for the first time since the launch of the single currency. Industrial production for the EMU bloc fell 1.9% in May, according to fresh Eurostat data. It is the sharpest one-month decline for the region since the exchange rate crisis in 1992. Officials in Berlin have warned that Germany's economy could contract by as much as 1.5% in the second quarter as export orders crumble.

Industrial output in both Italy and Greece has slumped 6.6% over the past year. Portugal is off 6.2%. "It is a very ugly picture: we're on maximum alert," said Emma Marcegaglia, head of Italy's business federation Confindustria. Rome is now lobbying for a "New Deal" to revive Italy's economy through massive infrastructure projects. The idea is to use bonds issued by the European Investment Bank, allowing EU states to circumvent the 3% limit on budget deficits imposed by the Maastricht Treaty.

Jacques Cailloux, Europe economist at the Royal Bank of Scotland, said a "reverse decoupling" is now under way as Europe goes down harder than the US— just as it did after the dotcom bust. "There is loss of momentum across the board. We can't exclude a recession," he said.

Spain is now spiralling into the worst crisis since the Franco dictatorship. "The economy is in dire straits," said Dominic Bryant, Spain expert at BNP Paribas. "Some of the housebuilders are going to go bust, it is as simple as that. Over 10% of Spain's economy has been building houses. This compares with 6%-7% in the US at the height of the bubble. The adjustment will be enormous," he said.

Fear haunted the Spanish property sector yesterday after the share price of developer Martinsa-Fadesa crashed by more than 50% in two days, leading to a suspension in trading by the Madrid bourse. The real estate and shopping mall group has so far failed to secure refinancing for its €5.1bn ($8.2bn) debt. The board held an emergency meeting yesterday. Finance minister Pedro Solbes said the Martinsa-Fadesa crisis was turning "more complicated" but denied that there is any risk of a chain reaction across the sector. Banco Popular is understood to be the most exposed bank.

The crunch engulfing Spain's property market is rapidly turning into a full-fledged national drama. The developers' association APCE said house prices had already fallen 15% since September. Unemployment has risen by 425,000 over the past year, reaching 9.9%. Deutsche Bank said the property crisis is more serious that the collapse in the early 1990s. It expects a 35% fall in real house prices by 2011 as the market slowly clears the vast overhang of property, now estimated at nearly 700,000 homes.

In Castilla-La Mancha— Don Quixote's region— some 69% of all houses built over the past three years are still unsold. Spain's premier, Jose Luis Zapatero, blamed the European Central Bank for making matters worse by raising interest rates into the teeth of the crisis last week. He called the move "irresponsible". More than 98% of home loans in Spain are priced off floating rates linked to Euribor, which has risen 1.45% since August.

Mr Zapatero has resorted to a fiscal boost worth 1.5% of GDP to help cushion the slump. But Spain's budget surplus is turning into a deficit as tax revenues collapse. Car sales, for instance, fell 31% in May. The Bank of Spain is concerned about the health of smaller regional lenders with heavy exposure to the mortgage market. Deputy governor Jose Vinals has called on banks to set aside more against bad debts. "Provisions need to keep rising throughout the year. Prudent coverage levels are needed to face this situation with confidence," he said.

The precipitous slide now under way in Europe has yet to cause investors to lose their ardour for the euro, but a number of analysts, including Bill Gross, head of the giant bond fund Pimco, say there is no justification for the euro's 25% to 30% 'over-valuation' against the US dollar. "We're turning incredibly bearish on the euro," said BNP Paribas. The counter argument is that the US has merely stolen growth from the future with this spring's one-off fiscal stimulus package. Dollar bears expect a nasty second leg to the crisis later this year, forcing the Fed to slash interest rates to 1% or lower.

Goldman Sachs said Europe is the "tie-breaker" for the whole global economy.



Spain Drops Reassuring Gloss As Crisis Deepens

By Ambrose Evans-Pritchard | 18 July 2008

Spain's finance minister Pedro Solbes has stunned the markets with an admission that his country faces the worst economic crisis in its history as the full effects of the property crash spread through the economy. "This crisis is the most complex we have ever lived through given the plethora of factors on the table at the same time," he told Punto Radio in Madrid, breaking with past efforts to put a reassuring gloss on events.

Mr Solbes said the Madrid bourse had suffered an "earthquake", crashing 27% since the start of June. He blamed the toxic cocktail of high oil prices, the global credit crisis and the sharp slowdown in the key export markets of North America and Germany. The comments follow this week's bankruptcy of Martinsa-Fadesa, Spain's biggest corporate failure. The property developer— with an empire of housing estates, hotels, shopping malls and hotels— collapsed after failing to refinance €5.1bn ($8bn) of debts. The company's demise was a textbook story of aggressive over-expansion at the top of the cycle, driven by high debt gearing. It has €11bn of assets.

Mr Solbes has pursued a rigorous "no bailout" policy, saying Martinsa-Fadesa took "excessive risks" and must now face the consequences. He has reportedly clashed with cabinet colleagues, who are now searching for any means to stop the downward spiral in the economy. El Pais reports that house prices crashed by 20% in the second quarter compared with a year earlier, based on 183,000 completed transactions.

The Martinsa-Fadesa collapse has sent tremors through the whole property and construction sector. The share price of giant developer Sacyr has halved over the past month. The two banks with most exposure to the Martinsa-Fadesa are Caja Madrid, at €900m, and Banco Popular, at €400m. Goldman Sachs has issued "sell" recommendations on a clutch of Spanish banks, including Bankinter, Banco Popular and Banco Sabadell, warning that the sharp turn in the credit cycle could prove worse than the recession in the early 1990s. "The consumer is more leveraged today than in any of the previous cycles," it said.

The ratings agency Standard & Poor's has not yet taken a decision on whether to downgrade Banco Popular and Caja Madrid.

In reality, this is unlikely to be the worst economic crisis in Spain's history. Philip II defaulted on his sovereign debts three times in the 16th century after he bankrupted the Spanish Empire to pay for his Counter-Reformation wars against Protestants. He crippled the Italian banking system in the process— much to the benefit of London and Amsterdam.


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