Spanish Economic Policy Breakthrough

Following the collapse of the Soviet Union and Marxism's coincident general loss of cachet, the Spanish communist party renamed itself Izquierda Unida - United Left - in a failed attempt to arrest its decline into electoral irrelevance. No surprise, though, that this party would be sponsor of a non-binding resolution in the Madrid community (read province, not city) assembly making illegal the full recourse mortgage that is the standard in this country, and retroactively, to boot. Normally, this type of fringe party populism would not even make it to print, unless the majority grouping of said assembly, the right wing Partido Popular were to pick up the ball and run with it. Led by every right thinking socialist's arch-enemy, the evil Comunidad de Madrid president Esperanza Aguirre, this is exactly what has happened. Hard on the heels of her announced determination to submarine the PSOE's proposal to remove mortgage interest costs from the list of available income tax deductions, Espe is making every effort to have this measure presented in the national congress - and the PSOE, defenders of the downtrodden detritus of unbridled capitalism that they are,... are having none of it.

But that's really the point of the whole exercise, isn't it? What benefit, other than the outing of the truth that the socialists are saving the banks first, could be had from promoting legislation allowing pressured home owners to return the keys to the bank and walk away that could well push Caja Madrid (the savings giant that Ms. Aguirre is fighting tooth and nail to control), with its league leading six percent delinquency rate, over the edge?

Of course, if you live here and pay attention to these kinds of things, the only thing unexpected is that the right, easy targets that they normally are, might for once get a bit of traction for their efforts. Suffering from the eternal Mediterranean social debility of being fully willing to sacrifice a war in order to win a battle, Spanish politicians in general always ignore good policy when presented with the opportunity to make the opposition squirm in its ideological seat.

The recent soicalist example of this are recent changes to the abortion law, so meritorious of attention and effort in fun loving times such as these. The inclusion of a provision allowing sixteen year-olds to undergo the procedure without parental consent was guaranteed to make certain sectors, the usual lot, of the PP go absolutely nuts - confirming again to all socialist believers that a vote for the right would be equivalent to a court order to heat General Franco and Pope Pius XII out of their cryogenic stasis.

On a personal level (and with his historical memory fully intact), the writer wants to know which of this lot he should vote for in the upcoming elections to the European parliament. Should it be the right, the bunch that brought his grandfather - the staunch monarchist Enrique Mackay - up on invented charges that he, as director of the Escuela Superior de Ingenieros de Montes during the war, had allowed the republicans to fabricate chemical weapons in the school's laboratories? Or the left, the ones that fatally infected his aunt (daughter of the above) with tuberculosis when they imprisoned her for being a fascist bigmouth?

Reader suggestions always welcome.

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How To Rescue A Cartel

With a hat tip to the usual suspect, FT Alphaville recently published an item on mortgage delinquency rates in Spain, with specific respect to their effects on bank-issued mortgage backed securities. The accompanying chart is on the left (with our annotations to make it more comprehensible).

Readers will note that the problems suddenly begin with the 2005 series. Our own personal observation that properties became appreciably more difficult to move at some point in 2006 is possibly be confirmed by the spike in delinquencies that corresponds to this and subsequent years. A simple explanation would be that it was at this point that lenders were forced, in order to salvage the cartel they had formed with builders and promotors (noted here), to start financing the economically marginal buyer - particularly hedgers, panic stricken (perhaps aided and abetted by the hard sell from their branch manager?) by the possibility that prices would never again be accessible.

An ugly surprise is the instantly upward trajectory of the 2008 figures. This might reflect that no amount of new-found prudence on the part of banks was able to compensate for the massive unemployment resulting from the real estate bust.

Also worth reflecting on is the value of the 'index'. Presumably weighted according to gross value of mortgages contracted (would there be any other way?), it is joind at the hip to two of the eight data series - 2006 and 2007. Evidently, the more untenable the situation became, the more long real estate the financials got, much-touted Spanish counter cyclical provisions nothwithstanding.

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Counter-revolution

Accidentally, we had occasion to witness the early stages of last Thursday's Madrid euro-demonstration 'against' the crisis, unemployment and pension reality, held under the auspices of various trade unions. Walking down Recoletos towards Atocha station to catch the Jaén cattle transport home (following a reasonably optimistic progress report on the missus' March hip surgery) we found ourselves going counter to the flow of many thousands of flag wavers heading towards their marshalling point - and made some attempt to estimate the typical age of the participants.

Hoping to not pretend to convert anecdotal observation into science, we'll limit ourselves to saying that the under-35 age group that is currently sporting a 30-something percent unemployment rate was not, by any stretch, adequately represented. The group that was out in force, however, might best be characterized as 'pre-retirement'. Our very charitable guess would rate the median age at somewhere north of 45 years old. How far we'll leave to cruel and merciless statisticians to calculate, but there sure were alot of fifty and sixty year-olds.

The effects on both politics and policy of this very unrepresentative representation are evident. The unions, with their considerable political clout via the process known as diálogo social, are fighting tooth and nail to forestall any attempts to make the Spanish labour market more flexible and responsive as demanded by business groups. What they mean by this is that they want no changes to be made to the tenured status of their most loyal constituents, preferring the current situation in which virtually all of the considerable burden of flexibility is borne by the non-unionized legions of precariously, regardless of skills and education, employed. These are the under-35's.

Aside from leaving us, yet again, with troubling doubts concerning the adequacy of the post-WWII western power structure and political process in the present circumstances, we tried to imagine a situation in which young people showed up in sufficient numbers - let's start with the 40-plus percent of total Spanish unemployed that come from this group. In a perfect world, they would be marching up, and not down, la Castellana bearing placards exhorting the oncoming brigades of old folks from the UGT and Comisiones to get out of their way. Now!

Then again, the boomers have almost guaranteed the survival of this earthly paradise by having raised their kids to be irremediably stupid. We can't think of the last time we heard someone under 35 betray the remotest interest in, or even awareness of, policy issues. That would be one of the benefits of the information superhighway, we suppose.

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The Parlay

On the North American standardbred racing circuit, the race track that was known as the 'graveyard of champions' was located at Queen St. and Kingston Rd., a few steps from the lake in east end Toronto. Sold to developers - as were all city centre ovals over there - during the 1980's real estate boom, Greenwood was capable of inducing the most unexpected results from the very best, and presumably the most predictable, pacing and trotting horses. The case of a three year old pacing colt with the endearing name of 'Guts' comes to mind.

Shipped north from the Meadowlands to get a race in on this fabled death trap a week in advance of the million dollar North America Cup, Guts found himself entered against local stock of no great merit and went to post at a perfectly legitimate one-to-twenty - if one didn't know that he was a touch sore and therefore had almost no chance of negotiating one and a half trips around Greenwood's 5/8 mile without breaking stride. And behind him he dragged a parade of parlay bettors who, in turn, set up possibly the best bet ever placed by the punter penning this blog (who did know that Guts was lame, by the way).*

In short, the cinch favourite went to the front, opened by four or five lengths, and, knees mercilessly aching in the second of the three tightest turns on the continent, he jumped - and finished last in a six horse field. So did the parlay crowd - out of a sixth floor window - as the many tens of thousands of dollars amassed from the successful laying down of money to win, place and show on similar unbeatable short priced chalks went up in smoke.

At the top of the page is clip from a spreadsheet comparing the results from parlaying winnings from an investment system that returns 10% a year for 9 years to one in which the annual profits are removed, reinvesting only the principal in the system, and invested in fixed income at 3%. The parlay system returns, naturally, more than the other. The second chart shows the effects on equity of various losses in year 10. At about -24%, the ten-year returns are approximately equal for both systems - if no leverage is used in the parlay system. At the six times that seems to have been the quite typical margin before the markets went off stride, that number is considerably closer to zero, and explains fairly simply exactly why there is no money left.

Not that we are proponents of limiting individuals' abilities to enter into contracts, even if they are operating from some misguided belief that history has been vanquished, but there is something wrong with an incentive system that encourages managers to ignore the Greenwoods of this world.

*The writer was an avid observer (and bettor on the anomalies regularly found therein) of the pari-mutuel betting pools, which are real-time public information at North American race tracks. In the case of this race, so much money was bet to show on the favourite that, had he finished in the money, the other two horses sharing the third place pool would have also paid the minimum of $2.10 - probabilities overwhelmed by the sheer weight of cash. The effect was that virtually no show money was placed on any other horse. When Guts failed to make the board, the winner (by far the best of the rest) paid the anti-probable $9.20, 11.40 and 15.50. The writer had done his calculations prior to going to the window, and took the last option.

Guts, by the way, went on to earn nearly two million dollars in that year, 1984. But not at Greenwood.

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What's Wrong With This Picture?

Thinking about the American 'bank stress test' worst case scenario of 10.3% unemployment through 2010, we have cause to wonder - based on the following observations:

1). The U.S. unemployment rate is currently 8.9%;

2). The same for Spain is 17.4%

3). The U.S. loan delinquency rate, as of the end of 2008, stood at 4.59%;

4). The same figure for Spain appears to be 4.1% at this point in time.

Some suggestions:

1). Methodological differences make the data sets not comparable;

2). The portion of defaults originating from home mortgages will be altered by the fact that they are full recourse in Spain, and non-recourse in the U.S.;

3). One, or both, of the unemployment rates is mistaken.

Keeping in mind that few American banks would be left standing with 17% unemployment whilst only one caja, representing about 1% of the Spanish banking industry, has been intervened - we invite readers to suggest solutions to this conundrum.

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Parsing Bloomberg On Covered Bonds

Bloomberg's coverage of just about everything economic is generally tainted with peaches to pears comparisons fortified with out of context quotes. But these journalistic conceits are dwarfed by the extravagance of their headline writers. Take yesterday's Ambrosian 'Covered Bond Market Seizes on Plan for ECB Purchases'...

...and the random, and randomly organized, smattering of facts, few of which actually confirming the title, that follow:

1). The bid/offer spread, a measure of the cost of trading, for some five-year French covered bonds has widened to 30 basis points from 20;

2). Banco Santander SA issued 1.5 billion euros of covered bonds on May 11 in the first sale of the debt by a Spanish bank in almost a year. The bid/offer spread on so-called cedulas issued by groups of banks has increased to 50 basis points from 30 basis points before the central bank's announcement;

3). The ECB's plan has narrowed the yield spread over benchmark rates that investors demand to buy French covered bonds, known as obligations foncieres, by about 20 basis points to 120 basis points more than the benchmark mid-swap rate.

And, in conclusion:

4). 'It's clearly a very strong positive for the market; the problem is we don't know how positive', said Richard Kemmish, the London-based head of covered bond origination at Credit Suisse Group AG.

To translate, for the lost and confused:

1). The bid/offer spread in the secondary market for some, but not all, French covered bonds has widened by 10 bps;

2). Santander issued 1.5 billion in cédulas. The bid/offer spread in the secondary market on some Spanish cédulas has increased by 20 bps since the BCE announcement. The reader could be forgiven for not understanding that these two items are not related. The issue was sold 4 days after the BCE announcement;

3). Yield spreads in the primary market, which are the real issue for cash-strapped issuers, for French covered bonds narrowed by 20 bps following Trichet's declaration. This is a good thing;

And, in conclusion:

4). 'It's clearly a very strong positive for the market; the problem is we don't know how positive', said Richard Kemmish, the London-based head of covered bond origination at Credit Suisse Group AG.

Thankfully, Bloomberg was considerate enough to provide us, one day later, with the definitive definition of 'seizure':

BNP, La Caixa Lead Biggest Covered-Bond Sales in Almost a Year.

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Let Me Clarify That

A couple of commentors wanted to know (and with good reason, given the inadequate presentation) how two years of tax advantage is going to goose the Spanish housing market.

It's like this...

Those that currently enjoy the tax deductions that accompany home ownership, or avail themselves of them in the next 19 months, will continue to do so into the foreseeable future - with all the appropriate caveats. Those that do not get in under wire will not.

The measure should accomplish two objectives.

The first is to generate activity from the higher income brackets (those with complex situations that use accountants to calculate their taxes). This is a group of serious hoarders in the current environment.

The second is that the combination of the cancellation of the tax break plus the possibility that a price bottom will be put in in its wake will bring out the hedgers - the interested and financially able who might see the risk of future price increases, and the certainty of higher taxes, as outweighing the rewards to be had from continued adherence to the deflation strategy. In Spain, with its religiously held belief in the desirability of home ownership, the participation of this group is crucial.

Do we think this is a viable long term solution to anything? Umm, no. Then again, one doesn't consult with an architect to solve the immediate problem of a stampede for too few exits from the reader's favourite stadium.

Our apologies for yesterday's too-quick treatment. Something about ruminants making lousy hunters.

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Them That's Got Shall Not - In 2011

Americans wondering what action might breathe some life into their mortgage interest deductible residential real estate market, a brief look at the first bright idea the current Spanish government has had since... well, forever.

Currently, Spanish tax law permits the deduction from income of 15% of the cost of buying a primary residence to a maximum of about 9,000 euros a year. During today's policy presentation, president Zapatero announced that, in 2011, this privilege will no longer be available to citizens earning more than 24,000 euros annually.

Couple introduced and guaranteed de facto inflation in two years' time with the very agressive marketing of foreclosed homes on the part of the banks and cajas, the lowdown, visceral loathing the average Spaniard feels at the prospect of having to pay taxes and an expected loosening of mortgage credit in the wake of M. Trichet's recent announcement, them that's got will start shelling out the shekels in short order.

Not that we think it will be sufficient to clear all of the housing inventory, but if the recent flurry of literary activity in what was a moribund Spanish real estate blogosphere indicates anything, the timing of this might turn out to be perfect.

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Houdini Does Frankfurt

We recently had occasion to notice that a structural change has taken place in the universe of Spanish property transactions - at least as they are practiced in this town. Formerly, the cash, black money portion of the payment was made in a side room located on the very premises of the notary before whom one had signed the contract. This is apparently now frowned upon and has to be done in a car, or some other neutral spot. The effect, by the way, that this has had on the spread between official taxable values and real world sale prices - and hence, the size of the shopping bag one has to haul around to such events - has been somewhere between nil and negligible.

But this small change does raise the question of the importance of official structure in economic affairs. Take the case of the eurozone, for example, whilst looking at the instantaneous reaction of credit markets to the announcement that the ECB would begin to engage in the structurally impossible activity of buying up covered bonds. Behind the chart on the left and its generalized decimation of sovereign debt spreads lies an abrubt rise in bund (and other lower risk) yields and a marked decrease in the same for the outliers, only one of which has much to gain from this specific policy, by the way - Portugal, Ireland, Italy and Greece.*

PIIG, if you're texting.

In the face of the many pundits (both pro- and anti-euro) who have, since the beginning of the financial crisis, found irrefutable proof of the imminent demise of the EU in its structurally determined inability to enact adequate policies, this writer has always shouted back that the rule set is determined by local political necessities while the actual policies are ruled by circumstances. If we recall, it was impossible for the ECB to backstop failing banks, Germany would immediately veto EU aid to members at risk of default, and so on. The latest to begin to fall is the impossibility of the ECB bond. How Trichet and company accomplish this without upsetting the ideological apple cart is another matter, but the ECB will be financing the purchase of cédulas, pfandbriefe, and the like with some sort of what will be effectively common debt.

The reader might note that the further down the risk line that a country found itself at the time of the announcement, the more muted was the bond market's reaction to the news. That is called convergence - a euro interest rate in the making.

*Note that Spain falls in the group that saw interest payable rise - the delineator between the European haves and have-nots.

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Canine Roundup

Readers who follow this kind of thing will note that we have already bailed out of the most recent spread trade. That happened at Monday close, but a broken computer, followed by disruptions in Telefónica's DSL service, have us reporting it today. It is clear what went wrong.

Inherently a bear market punt - betting, as it did, on Iberdrola Renovables not ordering all the wind turbines they have contracted from affiliate, Gamesa - thrown into the teeth of a short term bull. The loss was around ten percent (three of which being attributable to having thought about it for too long), and taken when IBR's 4.5% rise at the beginning of the week was nicely offset by a 14% same for GAM. The usual problem with countertrend plays - the more they go against you, the more convinced you are of your take. We might be back for that one another day.

A Bit of Publicity

A friend has begun publishing a monthly subscriber newsletter that distills the contents of recent academic research pertinent to followers and players of markets. We think it is a brilliant, and brilliantly executed, idea. Readers can look over the first issue of Academic Research Monitor here.

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Them That's Got Shall Get

A couple of blog posts generated in England in the past few days are worthy of some comment.

First, Mr. Sánchez* draws our attention to the kind of Animal Farm socialism that has evolved as the government's - and the trade unions' - official response to Spain's horrific unemployment figures and meagre economic prospects.

The more equal of the equal, salaried employees with indefinite work contracts, are seeing their right to only be removed from their posts under the most onerous of terms for their employers defended to the bloody end by the social progressives. On the other hand, the half of the active population that are damned to an existence of constantly hoping to renew a short term contract, as well as the self-employed and the already dismissed are being tossed the bone of unemployment insurance - which might not be not be all too meaty due to both the length of time worked and the generally lower salaries used as a base.

The evident fact that progressivism seems to have now come merely to mean the politics of the prevention of regress for a certain privileged sector of the population, rather than that of the salvation of the disenfranchised, which they still self-righteously claim to be their mandate, has not escaped our attention. The PSOE must sincerely believe that the new unemployed and unrepresented class which is being created to save the union membership will not come back to bite come election time.

The second post which interests us in this regard comes from Unpublishable Thoughts (hat tip to David Murphy). The writer, left to the point of quoting Karl Polanyi, laments in the following manner the failure of his political leaders to make any contribution at all to the resolution of the current economic crisis:

Almost as distressing as the collapse of the free market model of free-wheeling finance is the failure of the Left in the West to say anything very much about it. The Labour party in the UK timidly pushes up income tax - from 40% to 50% for the top 1% of earners - but is otherwise mainly concerned with piecing back together the financial system so it can carry on as before. Obama is certainly a departure in the US, but his main radical goals are not particularly revolutionary: universal healthcare, achieved everywhere else in the West half a century ago, and a tax system which will remain less redistributive than it was under Ronald Reagan. The left in continental Europe halfheartedly adopts liberalizing reforms, whilst clinging on to the 'conquests' of protected 'insider' workers and pensioners.

We may find the right wing to be insufferably and unacceptably stupid since the time that the same Ronald Reagan took office, but the left has descended into the ethical black hole of defending only a restricted number of vested interests. In the case of Spain, this is at the direct expense of approximately 11 million economically active (or at least wishing to be) people - this number to date.

Random Spaniard used to publish fairly regularly in English. For some reason, he seems to have abandonned that plan.

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