What Goes Around, Comes Around

Rarely (not to say never) mentioned in the literature on the mechanics of asset price bubbles is the mass of participants, always entering late and therefore doomed, that can only be called hedgers. In the case of the dot-com affair, for example, this implies the entry of multitudes of innocents convinced that the risky option was missing out on the bonanza - in normal parlance, the opportunity cost was too excessive not to be hedged against. Compounding the situation, in the case of recent real estate hyperinflation in Spain, was the mass of legitimate buyers who forced themselves into the market in order to avoid the seemingly inevitable fate of never being able to afford a home. To accommodate this lot, as the pool of flush but sensible buyers dried up, the Spanish banking industry concocted the 50 year mortgage. As the reader can see from the table, the strategy of doubling repayment periods nets fewer and fewer more eligibles at every stage. The last, from 24 to 48 years moves down the income ladder by a mere 139€ a month. Clearly it was a sign of desperation on the part of an entire industry.

Having, in 2007, reached the depths of diminishing marginal returns to this game (notice that doubling from 48 to 96 years liberates only 39€ of monthly income towards the purchase of a 100,000€ home at 5% fixed), the country's financial sector now finds itself being similarly bailed out of an untenable situation by the Banco de España. According to an article in Cotizalia (hat tip to David Murphy), the BE is personally supervising the calculation of 2008 bank results, on an individual basis, to avoid (read - extend out the self-same diminishing return time line) the insolvency of any. Targetting specifically loans to, and direct investments in, constructors and promotors that are still functioning but have no chance of remaining solvent over any medium term, the governor of the state bank, Miguel Ángel Fernández Ordóñez, is forcing his subjects to slowly begin writing down these investments now - against what, in normal times, would be considered pure operating profits. The assumption, a longshot in itself, is that there will continue to be same over the amortization period.

The reader should note that what is being questioned here, in contrast to the situation in the United States, is not the value of property itself, but the ability to remain out of bankruptcy of companies in the real estate business. The difference may seem a touch finely tuned - and might turn out to be nonexistent, but this writer thinks it takes into account that the deeply ingrained cultural belief that land is worth more than money might make (were it possible to effect) a short-British-property/long-Spanish-likewise a wealth conserving trade.

As to Mr. Murphy's question, the banks and kin sure won't remain solvent be if this latter doesn't hold - and he can certainly expect intervention at the level of the cajas de ahorros, soon.

*This behaviour is most noticeable around race tracks when the punter, having taken it on the chin betting a series of well-considered, short-priced cans of dog food, starts tiptoeing further out on the tail 'just in case' the 20:1 shot that caught his eye in the post parade actually comes across.

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