Moody's Meets Zapatero

That Moody's will be deciding whether or not to downgrade Spain's credit rating on the same day that President Zapatero presents his 2011 budget proposals to the Spanish congress is just too beautiful a piece of coincidence for words. Seems all bets, however few there actually seem to be, are that they downgrade to aa1. That the Spain 10-year/bund spread seems to be hanging in at its range of the last period and that CDS don't seem to be reacting - at least judging by the lack of mention in the press which so much loves the knee jerk volatility of those things - may imply that this is all yesterday's news.

But since we stupidly missed the opportunity to present the 'no change' prediction in our earlier piece on Sacyr Vallehermoso (depriving ourselves of the chance to give readers the leg up on a 19 percent gain in three weeks in the process), we'll take a run at it here. What if Moody's fails to downgrade because, for example, the Ministry of Finance is on track to halving the fiscal deficit for 2010?

1). Expect the 10-year yield to drop below 4 percent, as it has recently threatened to do on a number of occasions;

2). Spanish banks will be the big stock market beneficiaries;

3). For American ADR punters on BBVA and Santander, this will probably be amplified by continued euro strength.

A stop, not tight enough to get hung out to dry in the event that a downgrade turns into a non-event, is recommended.

Most importantly, readers should contribute their own homework to the task.

QorreO has again asked for our opinion... this time on Wednesday's general strike. The article can be found here.

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The 'Caso Malaya' Begins

From the RTVE website, a shot of the 95 ex-politicians and municipal employees accused of bribery, extorsion, malfeasance, forgery and all other manner of corruption in the management of construction licences in Marbella over the first years of the decade and whose case is finally coming to trial - the charges and evidence occupying 200,000 pages. Readers might note the minimal eye contact between vermin finding themselves adjacent to one another. Every last one of them tried to escape by ratting out the others. And they all know that.

To the immediate left of the policemen in the front row is Juan Antonio Roca, presumed mastermind of the entire episode, who seems to have managed to go from bankruptcy in the mid-90's to having a net worth of about 2 billion euros when he was arrested in 2006.

For a nice slide show of yesterday's courthouse entrance, go here. The beginning and end of the video are pretty good, too.

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July Mortgages

The INE has published mortgage issuance statistics for the month of July - and various elements of the local press corps are having a field day with it. Expansión, for example, heads its report with: 'Residential mortgages fall for the third consecutive month'. A few details are worth noting with regards to this analysis.

1). They are referring to year-on-year comparisons. Monthly numbers would be best described as 'flat' for the last three periods - as the light blue line on the chart shows;

2). Looking further back along the graph to the months of May, June and July, the reader might take note of marked spikes in activity. These correspond to a resumption of house buying and mortgage lending activity following the chaotic hiatus in the wake of the bankruptcy of Lehman Brothers. Lots of purchase and lending decisions that were left on the back burner over the winter of 2008-2009 suddenly found themselves coming to pass over a three month period (September 2009's jump is also related to a bit more credit market confusion encountered over the summer) - all this the opposite effect to the sag in purchases in the U.S. following the expiry of house purchase subsidies in July.

Barring unforeseen events, headlines like the above will not be so easy to generate when October's data is released come Christmas.

More interesting is the continued rise in average amount loaned - now at 17-month maxima and nearly 10 percent higher than cycle lows set in August of last year. And readers could also take a look at the minimal effect that last spring's attack on Spain's creditworthiness, by a still hormonally charged blog and press army with no war left to fight, had on the mortgage market. Russian troops/Germany/1945?

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Housing Costs (again)

Against the grain to our last breath, this blog has always maintained that the real life, low carry economics of home ownership in Spain would:

1). Preclude any kind of disastrous fall in home values on a national level;

2). That mortgage foreclosure rates, currently at about 2.6%, would not threaten bank balance sheets;

3). That the financial industry's policy of accepting residential property in lieu of debt owed by real estate developers was an acceptable strategy under the extreme economic circumstances, rather than the standard claim that the policy was a method of avoiding the public admission of presumed insolvency;

4). That widespread predictions to the contrary with respect to any of the above were a result of a misapplication of the U.S. housing model to Spain.

New readers can work their way through our category of 'Real Estate Economy' to get the gist of our argument. But for the sake of those already familiar with it, or those who know what Spanish home ownership costs are, we're going to direct their attention to a map and table published at creditloans.com. Clicking on the graphic to make it bigger and scrolling down to the bottom, those interested will find a state-by-state rundown of median property taxes throughout the U.S.A., further detailed by calculations of taxes as a percentage of median house value and median home owner income. These measures can generally be calculated as hundredths of one percent in Spain.

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Homie Nation

The writer of this blog has a thing about one-input models. He likes them. Although readers might find in this admission a proof of what they always suspected - that he is lazy, simple and facile (an olive grower by any other name) - he would defend himself by saying that the simpler the relationship between elements, the easier and more effective the policy changes intended to procure a certain outcome. Falling under this heading would certainly be the real effective exchange rate cause of economic uncompetitiveness and the resultant cure - internal revaluation. Keeping in mind that one had better make certain that the relationship proposed is actually true or all manner of undesirable outcomes might result, we offer the first two charts on the left as an addendum to our earlier, less than convinced, post on the REER.

The first of these lines up, for the year 2009, exports as percent of GDP (vertical scale) against the Eurostat CPI-deflated REER for 10 EMU economies. While Germany and even Austria may seem to confirm the hypothesis, as might France, Spain, Greece, Portugal, and Italy (if you ignore the fact that it doen't quite work when restricted to this latter group alone), it fails in the case of Finland and is of no use at all when it comes to the Netherlands and Ireland.

The second chart replaces the vertical data of the first with the percentage share of intra-EU exports of the same group of countries relative to those in the year 2000. One would imagine the easily predictable outcome of higher REER equalling sinking share. This one seems to work a bit better (ignoring Ireland again), but it goes no distance towards explaining how of the eight countries that had lost competitiveness over the period five managed to increase market share. Of course, none of this goes explains why France, Italy, Spain, Greece and Portugal struggle to achieve exports valuing greater than 25 percent of their GDP's.

As readers might expect, Ibex Salad has a theory. But be forewarned - it suffers from the near insurmountable drawback of being based on his personal experience of the Real World.

Working on the, we think, correct (given our general experience here and our many years of dealing with tourists in Canada) assumption that the educated classes from the five last mentioned counties seem to believe that they come from cultures and nations that are without equals on this planet - perhaps other places are not beneath contempt but they are quite apparently not worthy of serious consideration. We don't think that attitudes of this sort are very conducive to a transformation into an exporting power (although they are assets if imperialism is the sytem) and, believing that one is not going to learn the language of a country that doesn't make it onto the radar screen, we think we've found a way to test this.

The European Commission, in 2005, published a study comparing the self-assessed proficiency of citizens of member nations in languages foreign to their own. The results are revealing - particularly when referring to the lingua franca of modern business, English. On the left we have graphed proficiency (as perceived by the respondent) in this idiom against exports as a percent of GDP.

Including Ireland is, admittedly, a bit dumb. Readers should feel free to ignore it despite its aesthetic appeal. Greece appears to be an outlier and, although we know nothing, we suspect it is an artifact of the 'self-assessed' basis of the survey. Beyond those details, here we have a chart that line up its ducks properly. More lingua franca, more exports.

Policy options stemming from this really simple and apparently good model? Seeing that in Spain the widespread teaching of English has not produced English speakers in any quantity, maybe showing something on television about foreign countries that is not a nature documentary or a news report on a tornado ripping through an Oklahoma trailer park might work as an incentive to take other countries seriously over a long enough period. The educational system, simultaneously (if it could actually find teachers who didn't suffer from the same deficiency), might start treating the ultramar as having some value in its own right.

Or maybe the widespread popularity of the EU Erasmus exchange program will be accomplishing this on its own - this assuming that anyone under the age of thirty-five actually ever finds a job again.

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Siestus Interruptus

A reader who goes by the monicker Ole Miss has a habit of coming up with good questions via the comments section. Yesterday's contribution was:

the first 1 million of interest is tax deductible in the US.

She's right - which requires that we also admit to having neglected to include the deduction of 15 percent of one's total house payments - both mortgage and interest - that Spanish tax law permits.

Despite being currently a bit tired of this obsessive looking into the details of everything, we'll compare the two.

The American who buys yesterday's 265,000 dollar home pays, in the first year of the mortgage, 5,240 dollars in interest.... STOP RIGHT THERE! US tax return forms give a taxpayer the option of a 5,350 dollar, no-questions-asked and no-proof-required blanket deduction (and not just for homeowners) for items like interest payments, donations to charitable organizations or the costs incurred in having a tasteless tattoo removed from their teenager's buttock. The net benefit to our buyer - unless he or she foregoes income by giving to an NGO dedicated to saving the Dalmatian armadillo (or whatever) - is zero. According to this fairly detailed piece on the mortgage interest deduction, only about half of American homeowners even bother do the extra paperwork.

In the local case, however, 15 percent of the 18,000 euros - 1,350 to be exact - put out every year over the life of the mortgage can be lopped off one's gross income. Assuming for the sake of argument a 30 percent tax bracket, that turns into a savings of 405 euros a year over the life of the mortgage. Including this in yesterday's figures by subtracting the resulting 12,150 euros from the total costs in fact increases the Madrid buyer's return on costs from 244 percent to 261.

Somebody else was wondering how we calculated the final value of the homes in question. That would be 1 percent inflation on the portion of the flat actually paid off. The principal portion of the first payment gets 29 years of inflation. That of the last gets nothing.

Can we go back to sleep now?

We could imagine some Chicago resident, faced yet again this coming January with a truly evil polar wind barrelling unimpeded down the 500 kilometre length of Lake Michigan, thinking that some place on the beach in Malaga province might be a reasonable life option. That person will have to settle for the 244 percent. This tax break ends at the end of December - but only for those who have not bought before that date.

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And Now the Rewards

One last stab before we drop the subject for a while.

We tried to deal equitably with the differences in ownerships costs between possibly comparable* urban areas in Spain and the United States in the previous post. Now we're going to look at the relative rewards.

For the two apartments worth, respectively, 265,000 dollars and 405,000 euros we assume:

1). A 3.5% 30 year mortgage for 100% of the value;

2). An inflation rate of 1% per year, applicable to taxes, fees and the owners paid off equity, over the entire period.

In the Chicago example, by the time the mortgage is paid off the owner will have spent 411,951 dollars on fees and taxes and will have full, unencumbered ownership of a flat worth 302,736 dollars - a meagre 73% of the expenses paid.

Our madrileño, on the other hand, will by 2039 have disgorged 189,411 euros supporting a purchase which will then be worth 462,673 euros - 244% of what he or she is out of pocket.

In the interests of fairness, we've also calculated this in the event that electricity, heat and water are included in the monthly fee in the US example. Adding 1800 euros a year to the first month for the place in Madrid, then increasing it by the same one percent a year (first person to cite their January natural gas bill as proof that our annual figure is wrong loses their voting rights), we come up with the 2039 value of 183% of expenses paid.

This is what is called a 'no brainer'. One gets lots of bang for their housing buck in this country. And anybody that insists that Spanish housing prices, on the basis of price to income (or anything else), should track a trajectory etched in North America simply does not know what they are talking about.

*One reader, rightfully, questioned whether we were making a justifiable comparison. It's a hard question to answer - and these two countries are so different that there is no proper way to do it. But our guess is that the Chicago example is, despite the rakish appearance of the building, at the lower end of the price scale. It was built in 1969, is being sold 'as is' (meaning it needs repairs) and seems to be located a few kilometres outside of the centre of the city. At the lower end also, one can find similar square metres in, say, Alameda de Osuna at 400,000 euros.

We have readers in Chicago who should feel free to point out errors, omissions and plain old stupidities via the comments section.

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The Pursuit of Knowledge

We had originally intended to write a simple post on today's release of the quarterly INE house price index for Spain. It has, however, turned itself partly into an exercise in how difficult it is to actually know anything with any certainty - this despite the assurances against ambiguity that numbers might be thought to provide. On the left we've posted a graph showing the IPV, new home and used home indexes provided by the above, as well as the Tinsa proxy and the version emanating from the Ministry of Housing. The latter two have been normalized to adapt to the date range of the INE numbers.

What cannot be known with any sureness is the trajectory of new home prices from the beginning of the chart to some point in 2009 - at least as they are compiled by the INE. Their new home price index is just plain misleading, and we can't help but feel pity for those that bought on the basis of this evidence thinking that the market continued to run away from them. As readers can see for themselves, the value reaches maxima a year to 18 months later than any of the other measures. This is the residual effect of off-plan purchases being delivered. Given the lag between leaving the down payment and taking delivery of one's new place, the index ends up showing us prices that are about two and a half or three years out of date. That method of builder financing had clearly ceased to exist by late 2005.

The INE composite index also suffers, as it must, from this drawback, but not as much as does the MVIV version - this despite the fact that this latter bunch throw everything but the kitchen sink into their calculation. Clearly the miscreant result of a ministry of no particular utility having too much time on their hands.

The more accurate series in the graph are certainly the INE's used home sales and the Tinsa assessed value index. The very rapid drop of the former particularly over 2008 is probably the effect of speculator liquidation. That the Tinsa numbers don't reflect the severity of the plunge (but do end up in the same place) may be fruit of a certain amount of marketing discretion on the part of that large property assessment company. They were, after all, until just a couple of weeks ago owned by the nation's cajas de ahorros.

Other interesting tidbits that can be surmised from the chart include:

1). That the INE composite index refused steadfastly to be kept pointing upwards by the apparently very strong new home component through Q2 2008 shows fairly well how few off-plan or outright purchase new home transactions were being concluded by that time - in fact very similar to current numbers;

2). The INE new home line shows current prices higher than they were in 2007. This should be read, for the same reasons, as 2005 - the year in which prices were actually contracted. The market was already dead in '07, the year in which the banks and cajas began to take back equity for debt. Confirming this would be the fact that current Tinsa assessed levels are equivalent to those of five years ago.

We have, by the way, no explanation for the divergent results for the most recent period. The INE claims actual price increases, Tinsa mild declines and MVIV says that prices continue to fall at a hefty one and a quarter percent every three months. Let it be said, however, that having waded our way through lots of their really badly constructed data, we trust this last lot the least.

Our personal opinion is that Tinsa is on the mark. Even though they remain negative, it looks like their index might be showing flat to slightly positive annual changes in six months time.

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July House Sales

The INE has released house sale statistics for the month of July in Spain. The notable features are the 16+% year on year increases for both new and second hand dwellings. These numbers come from the registry offices and hence probably more reflect purchases actually made in the month of June than anything else.

In light of this it would be easy to assume that some of the purchases are a result of avoidance of the one percent hike in sales tax that went into effect on July 1. That's reasonable, except that the new tribute doesn't apply to second hand sales - which are actually at 24-month highs.









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Home Ownership Economics 101

One of the curiosities of social life among the educated classes in Spain is the widespread adoration of titles. We're speaking here of the professional, not noble, sort. Topping off the hierarchy of such things are the abogados del estado - lawyers for the state - followed by notaries, property registrars, surgeons, engineers and architects among others, whose introduction to one will always include their qualifications. It's sort of like living in some wierd parody of one of those British period pieces so lavishly produced by Boston PBS where everything is just so and perfectly in its place - except for that nuisance murder that is at the heart of the action.

One can add university professor to this list, as long as one is willing to differentiate between its two categories. The standard, run-of-the-mill prof and the catedrático. The former is a person with a doctorate in his field, but the other comes equipped with the earned right to decide the fate of future Ph.D candidates. This is a fish of a superior scale, and there is one who is regularly quoted on economic stuff in the nation's press. Introduced as catedrático de economía de la Universidad Pompeu Fabra, José García-Montalvo'regularly, despite his honours, provides misinformation concerning the equivalencies between the Spanish and U.S. housing markets to his readers (and presumably his students).

From idealista.com (translation ours):

In the U.S. the gdp per capita adjusted for the ability to purchase* is 35,000 euros, while in Spain it is 25,800 euros, 27% less. Nevertheless, the median price of homes is almost equal in both countries.

Although in the different context of why banks, builders and homeowners don't feel compelled to dump stock on the market at any price in Spain, we've dealt with all this before (here and here), so we'll merely throw up a screenshot from a Chicago real estate site (this will disappear when the place gets sold) with a bit of explanation for readers whose native language might be Spanish. In the table below the photo:

Taxes means impuestos - the IBI;

Association Fees means gastos de comunidad;

To derive square metres from square feet, divide by 10.

Numbers, of course are universal. The first costs, in the case of this property, 748 dollars a year. The second, 713 dollars per month! On the basis that the comunidad for an equivalent place in Madrid is going to run about 120 euros and the taxes, say 150, we'll do some calculations.

First, we'll assume (to avoid issues of opportunity cost on different sized down payments) that the purchase of the 265,000 dollar Chicago condo is made via a 100 percent loan. At 3.5% interest over 30 years, the mortage comes out to 1,190 dollars a month. Add 64 for taxes and 713 for fees and the place costs a buyer 1,967 dollars a month before he or she ever sets foot in it.

Now we'll try it in Madrid. 13 euros a month for taxes and 120 in fees leaves us 1,834 to pay the same mortgage on a home worth a bit over 405,000 euros.

The lesson here? Multiply U.S. home prices by about one-and-a-half to arrive at actual equivalent ownership costs - then get back to us.

*Isn't he discounting purchasing power from income twice here? Sure looks like it.

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Index this!

We are lucky enough to be living in one of those marvellous and rare historical moments in which economists finally get a chance to have real life prove, or disprove, any of a variety of theories and axioms that heretofore had had to equivalate 'true' with 'my peers think I'm right'. That the capital asset pricing model (for which a Nobel was awarded) and various eternal verities of monetarist economics (for which a Nobel was awarded) have already failed to some degree or other to make the cut should serve as a warning... and we'd like to jump on that bandwagon.

The well-respected and much-lauded Harvard economist Dani Rodrik, using a painfully simplistic 15-slide Powerpoint presentation, brought to centre stage at a conference earlier this year the issue of Spain's lack of international competitiveness - coming to the boilerplate conclusion that the only exit from the country's malaise was the tool of internal devaluation, a wholesale and mandated redution in wages and prices. He showed the two accompanying graphs to prove his point. The charts illustrate what is known as the 'real effective exchange rate' - the first calculated using CPI as the deflator and the second, unit labour costs. Aside from the debating trick of placing the one that proves one's point the best last (so often mentioned by Umberto Eco in his rants against Berlusconni's control of Italy's media), the salient points to note are:

1). That they are indexes, referenced to the year 2000;

2). That the source for the information is the IMF.

The first is the problem that makes this 'data' less than acceptably useful. The second will turn out to be the proof of this assertion.

The technique of creating indexes, often called 'normalization', involves the (often arbitrary) act of creating a reference point in which the raw data is said to have a value of 100. This particularly facilitates the comparison of distinct sets having vastly different nominal values. We use it when we construct our mortgage issuance charts. The convenience it offers, however, comes at a cost - that the results up and down the line are very sensitive to the placing of the initial reference point with its assumption that all the data points on that date were equal. This is true to the degree that they probably won't be reliable proxies for real values, but will show trend. In the case of the REER, the IMF assumes that all economies were equally competitive in the year 2000.

To illustrate this effect, we've made up a graph showing the value of the 2009 CPI-based REER for 4 eurozone economies substituting, in turn, every year from 1994 to 2008 as the reference. Arguments that the selection of the year 2000 was not arbitrary, will have to deal with the fact that Eurostat, from whose data this was drawn, uses 1999 as the base year and with the interesting observation that the slightly less than 120 that results from using 2000 as the base corresponds very closely with the IMF figure and both are about 3 points higher than the 1999-based result.

The above may go some distance towards explaining how an economy that is functioning under a 16, or 19, percent exchange rate yoke - at a point in time in which buyers know they can squeeze margins for the last drop of blood - offers up the graph shown on the left.






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For Future Consideration

There is widespread speculation that Sacyr Vallehermoso will find itself ousted from the Ibex 35 in the third quarter index readjustment. The construction and infrastructure company is one of those basket case casualties of the Spanish building boom kept alive through the indulgence of the bankers. For investors looking for a play with some downside protection, a couple of details are worth noting...

1). Sacyr, the infrastructure part, continues to be a major international player. They are one of the prime contractors on the expansion of the Panama Canal;

2). Their current market cap of 1.1 billion euros includes a 20 percent direct stake in Repsol-YPF whose market cap is 23 billion;

3). In normal times, companies involved in moribund industries, like real estate in Spain, and with debt-to-equity ratios of 300-plus are candidates for the bone yard. However, SYV does not ever go to zero;

4). Because their stake in REP is fruit of a covert appeal from the Spanish government for a white knight when the oil and gas company found itself in the sights of private equity.

Readers should do their own homework, but this is a good one to have disappear off the index radar.

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June Mortgages

This stuff becomes less interesting with the passage of time - and the failure to appear of that inevitable crash - but here are the June residential mortgage issuance graphs for Spain.

Perhaps worth noting is the slight downward move in the 12-month averages of both numbers of mortgages and total amount loaned. The reader might note that one of the two upward spikes in activity in 2009 has fallen off the series - leaving the plunge that accompanied credit market doubts later that year in its place. This, in turn, was followed by another surge after the summer. When that one (and the fall that ensued disappears - in three or four months, we might be looking at a positive slope for these lines. Volatility leaves a legacy of false signals.

Marginally interesting, also, is the continued recovery in average amount loaned, although we'd hesitate to interpret this as an indication of improved housing prices.

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