All bubbles burst

Some 11 months later, (322 days to be precise) since my rather pessimistic review of Spain’s prospects nothing has changed to merit a change of tone on my part. Moreover, recent data published by the FT on the comparable performance of housing markets since the market peak in late 2006 / early 2007 has raised my concerns a further notch.

In said article, Edward Chancellor of institutional asset manager GMO, points to the perplexity surrounding the gravity defying performance of residential real estate in Spain. For, along with Australia, Spain stands today, some 4 years after the start of the nationwide price drop experienced in US real estate (which would soon be followed by unprecedented sharp falls in Ireland and the United Kingdom), on a league of its own having experienced what amounts to a minuscule 15% drop in real terms.

Some would argue, and indeed many do, that this is reason for joy and optimism, in lieu of my ill-placed concern. A minor price correction would indicate that the forces of supply and demand have played their role and a market that was clearly “frothy” between 2000 and 2007, to use the words of Alan Greenspan, has now worked its way back to equilibrium. Edward Chancellor’s article actually points to some apparently sound reasons for this view.

For one, the prevalence of adjustable-rate mortgages (a feature that is shared with the Australian mortgage industry) has made life considerably easier for actual and would-be Spanish homeowners given the historically low rates in place today. Secondly, the lack of an established rental culture, which implicitly labels renters as little less than social outcasts, certainly contributes to a price-inelastic demand for owned homes.

Be that as it may, I can’t help but think that these rather peculiar and country –specific factors amount to little more than bubble-prolongation drivers. Quite clearly the forces at work in the opposite direction are much larger and permanent in nature.

Firstly, the reasons for the striking stubbornness of the housing market to adjust are by no means based on the steady ground that applies to the only remaining equal, Australia. Down-under things could not be more different, with unemployment rates are less than half those of Spain, the performance of the country’s large commodity driven industries (mining and gold) has been stellar and the migratory flux continues almost unabated. These factors add-up to real economic growth, which to some extent explains recently rising home prices.

Spain on the hand is grappling with 20% unemployment, an enormous glut of undigested housing (over 1.2 million homes at the last count) and a sudden halt of immigration flows. Additionally, housing transactions have collapsed and in rather opaque fashion, banking institutions and the mortgage-heavy savings banks have been known to keep housing assets at well above true market value.

Summing it all up does not result in a pretty picture. Spain is enjoying today hugely lower lending rates than it would otherwise, were it not for the implicit EU-subsidy. And yet in spite of this cheap money, no liquidity exists in the market place, with sellers unwilling to come to terms and convert into real losses their current “paper-gains”. In essence the country, both through the actions of its ill advised home owning mass and the bubble perpetuating measures of its government is not only delaying the inevitable but in fact laying the ground for a very hard landing.

If there’s one thing that should be clear by now to any observer of asset markets, it is that ALL bubbles burst and the bigger they become, the harder they fall. I just hope that for everyone’s sake Spain enters the process sooner rather than later.