The Spanish Financial Crisis

PREPARED BY
NAGARJUN VENKATA SUBBARAO

Table of Contents
1. Origins (financial and economic)
2. Consequences (financial and economic)
3. Recommendations

INTRODUCTION
The Great Recession in Spain began in 2008 during the world financial crisis of 2007
08. In 2012 it made Spain a late participant in the European sovereign debt crisis when
the country was unable to bailout its financial sector and had to apply for a 100 billion
rescue package provided by the European Stability Mechanism (ESM).
Spain was facing its worst crisis in the last fifty years. The crisis began as an extension
of the international financial crisis, but the internal issues of the country aggravated the
economic slowdown. This paper describes the origins of the economic crisis in Spain.
The Real estate sector (The Property Bubble) and the Banking sector are looked upon
in detail, as they played a key role in the deepening of the crisis. We will also discuss
the main factors that have delayed the economic recovery up to now (unemployment
and indebtedness), and present some alternatives /recommendations to safely bail out
Spain from the Deepening crisis.

1. ORIGINS OF THE ECONOMIC CRISIS

The financial crisis, starting in 2007, has had a lot of impact on the entire western
civilization. It hampered economic growth hampered and unemployment figures have
risen dramatically. In this paper the financial crisis will be discussed for Spain
specifically. The paper will start by summarizing the general origins, spread and impact
of the financial crisis, and on how this crisis influenced Spain specifically.
What is the origin, spread and impact of the financial crisis for Spain?

1.1 The global origins and spread of the financial crisis

Let us first try to understand what caused the Global economic crisis to get an insight
into the Spanish economic woes:
The initial cycle of the crisis was caused by declining house prices in the United States
(Wilkinson, 2010). These declines led to repayment problems in the real estate market
which was also the case for Spain1. These problems spread to other U.S. financial
markets, because the real estate market was backed by a lot of complex financial
instruments.
The problems spread to other countries because these countries also held U.S.
financial instruments2 and other factors increasing the crisis were the breakdown of
trading and the failure of major institutions.

www.imf.org/external/pubs/ft/scr/2015/cr1501.pdf

www.norges-bank.no/.../Spong-Macroprudential%20Supervision.pdf

1.2 The Spanish origins and spread of the financial crisis

Spain entered the eurozone in 1999. After entering, the interest rates for Spanish
borrowers dropped significantly, because the euro interest rate was backed by strong
and stable economies such as the German one (Stratfor, 2009). This encouraged the
Spanish consumers to spend more. This caused to a great increase in the demand in
several markets, such as automobiles and houses, bought on credit. This lead to the
Spanish housing boom, which increased the amount of mortgage lending and the
building industry. In 2006, 700.000 new houses were built in Spain3. This was more
than were built in the U.K., France and Germany combined. The housing industry
became increasingly important to the economy, leading to a point where it was
accounting for ten percent of GDP. A lot of mortgage loans were even given for more
than 100 percent of the value of the house, leading to a lot of unbacked financing. Along
with the fact that a lot of people lived in houses they couldnt really afford, an
abundance in houses were created because of the increase in the construction industry.
Therefore, the financial crisis hit Spain even before it did most other countries. While in
2007 the Spanish government had a GDP budget surplus of 2.2 percent4, in 2008 it had
a GDP budget deficit of 3.8 percent. This was mostly due to the bankruptcy of major
real estate players, such as Martinsa-Fadesas in July 2008, and because of a collapse
of the construction industry. In December 2008, housing prices dropped a stunning 26
percent.5
2. Consequences of the Economic Crisis
Because of the great dependence of the Spanish economy on the construction market
(since it became so big), the collapse in the construction industry led to a great increase
in unemployment figures. The employment in the construction industry declined by 8

Spain: Financial Sector Assessment Program - Technical Note - Housing PricesPg 1999

Spain: What Everyone Needs to Know - Page 167

https://www.stratfor.com/analysis/financial-crisis-spain

percent in the second quarter of 20086, followed by a 13 percent decline in the third
quarter and a 20.7 percent decline in the fourth. In 2007, the construction industry was
accountable for 13.9 percent of all jobs in Spain, so the impact of this decline is huge.
The Spanish unemployment is still rising at this moment (September 2010), hitting 20%
(Trading Economics, 2010).
The Spanish government tried to decrease the unemployment by creating public works
projects, accountable for 200.000 jobs7. This spending meant that the budget deficit of
the Spanish government increased significantly, with 50 billion euros. The public debt is
estimated to have increased to 55.6 percent of GDP in 2009, from 36.2 percent in
2007). This in turn led to a downgrade of the rating of Spanish sovereign debt from
AAA.

The Financial Crisis in Spain | Stratfor

wikileaks.org/gifiles/docs/16/1677868_for-petercomment-take-2-.htm

In February 2009 the general industry production level declined by 22%, after a
decrease the year before by 20.9%. Along with the above problems in the construction
sector, the GDP growth rate went negative in 2008 and 2009, hitting an annual adjusted
GDP growth rate of -1.7 percent in the first quarter of 2009 (Trading economics, 2010).
This is partly due to the fact that only 27 percent of GDP is dependent on export in
Spain, compared to exports of around 50 percent in Germany (Stratfor, 2009). During
2009 there was also deflation in Spain, of around one percent in July 2009 8. This further
hampered the economy, because when deflation kicks in, consumers postpone their
purchases in the hope prices will continue to drop.
One can conclude that the financial crisis has had a significant impact in Spain, and still
does. Unemployment has risen, government debt increased and dropped in rating,
industry production dropped and GDP went down.
3. RECOMMENDATIONS

To overcome this situation of low economic growth, high unemployment and

elevated debt. It is essential to redefine the growth model by choosing labor
intensive. We need to provide a boost for the economic sectors, especially the
services sector so that labor reforms can take place too. In the short term, a
move that could boost competitiveness is the so-called competitive devaluation9
already implemented in other countries. This measure consists in reducing the
taxes paid by companies to Social Security, thereby lowering labor costs. This
measure would also contribute to job creation (and unemployment reduction),
thanks to its lower costs, which in turn would then contribute to the recovery of
household incomes.

www.tradingeconomics.com/spain/inflation-cpi

http://www.bloomberg.com/news/articles/2014-10-10/lew-warns-against-competitive-devaluation-as-

dollar-gains

In the medium term increases in competitiveness require more investment in

education and R&D and higher levels of competition in some sectors which can
be tapped into. The two key sectors which contributed to the extent of the crisis,
real estate and banking, should stabilize. The banking sector has a key role in
the elimination of unsold new homes. In the normalization of the real estate
sector, the government also has an important role. However, the rental market
needs to be boosted by increasing the simplification of contracts.

In the Spanish labor market, it is necessary to introduce a single employment

contract and various international organizations10. This type of contract will
promote the creation of stable jobs and the accumulation of human capital.

10

https://ideas.repec.org/e/pji14.html

CONCLUSION
The impact of the financial crisis on the real economy caused a sharp drop in output
and an enormous rise in unemployment. The burst of the real estate bubble produced a
very strong shock on economic activity and employment. The high exposure of banking
to construction and real estate activities was the means of transmission of the housing
crisis into the banking industry. The consequence of this is that the Spanish banks have
faced serious solvency problems, especially from 2009.

Currently, the recovery of economic growth is strongly affected by the high level of debt,
especially private debt, and the high unemployment rate. Additionally, the serious
financial situation of the private sector together with the financing difficulties in the
international markets, adversely affect the banking system, which have serious
problems to finance the economy.

REFERENCES

www.imf.org/external/pubs/ft/scr/2015/cr1501.pdf

www.norges-bank.no/.../Spong-Macroprudential%20Supervision.pdf

Spain: Financial Sector Assessment Program - Technical Note - Housing

PricesPg 1999

Spain: What Everyone Needs to Know - Page 167

https://www.stratfor.com/analysis/financial-crisis-spain

The Financial Crisis in Spain | Stratfor

wikileaks.org/gifiles/docs/16/1677868_for-petercomment-take-2-.htm

www.tradingeconomics.com/spain/inflation-cpi

http://www.bloomberg.com/news/articles/2014-10-10/lew-warns-againstcompetitive-devaluation-as-dollar-gains

https://ideas.repec.org/e/pji14.html

"TWO-TIER LABOUR MARKETS IN THE GREAT RECESSION: FRANCE

VERSUS SPAIN". The Economic Journal. 2012. Retrieved 2012.

"Spain: Still in the Throes of the Great Recession - The Spanish Economy Sinks
Further". European Economic Snapshot.

Emma Ross-Thomas and Simone Meier (30 April 2012). "Spain Slips Back Into
Recession In First Quarter: Economy". Bloomberg.

"Spanish banks to get up to 100bn euros in rescue loans". BBC News. 9 June
2012. Retrieved 9 June 2012.