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Abstract

The long pre-crisis period of growth and employment creation in Spain was based mainly on the construction
sector. This, facilitated by cheap bank loans created jobs for the millions of immigrants arriving in the country.
The crisis made the Spanish economy sink into a deep recession in 2008.
The 20082011 Spanish financial crisis is part of the world Late-2000s financial crisis. In Spain, the crisis was
generated by long term loans (commonly issued for 40 years), the building market crash which included the
bankruptcy of major companies, and a particularly severe increase in unemployment, which rose to 21.4% in
October 2011. The Spanish government official GDP growth forecast for 2008 in April was 2.3%. This figure
was successively revised down by the Spanish Ministry of Economy. In reality, this rate effectively represented
stagnant GDP per person due to Spain's high population growth, itself the result of a then continuing strong
level of immigration. Currently most independent forecasters estimate that the rate was actually around 0.8%
instead, far below the strong 3% plus GDP annual growth rates during the 1997-2007 decade. Then, during the
third quarter of 2008 the national GDP contracted for the first time in 15 years and, in February 2009, it was
confirmed that Spain, along other European economies, had officially entered recession.
The aim of this article is to describe the Spanish crisis-management in the past years. The extremely high
unemployment rate and the indebtedness made policy-makers to adopt austerity measures and realize the
necessity of profound reforms. The biggest transformation processes began among the savings banks and on the
labor market. Endowments like the excellent infrastructure and successful companies, stronger export activity,
international presence and innovation can provide the bases for such a durable growth .While the conclusion
includes the recent initiatives being taken by the country and European union and the future possibilities.

Introduction
The sovereign debt crisis in Europe developed as countries experienced higher deficits and growing debt and
European governments became increasingly unable to pay back this debt. Eventually, credit-rating agencies
downgraded the sovereign bonds of several European countries, which made issuing new bonds extremely
expensive. In 2010, Greece was the first country to buckle. To prevent Greece from defaulting on its debts, the
Eurozone countries and the International Monetary Fund (IMF) granted Greece a loan. Later in the year, the
Eurozone and the IMF provided a similar loan to Ireland. In early 2011, Portugals Prime Minister quit after the
government was unable to agree to austerity measures to address its own debt crisis. It, too, will receive a
bailout. Spain has experienced similar financial worries, and some are speculating a Spanish bailout is on the
horizon. Whether it is through bailout funds or Spains own austerity measures, it is imperative that Spain
survives the economic crisis because of its economic power and size.
Spain fell into an economic downturn in 2008 due to the collapse of its housing market, and economic
conditions worsened when it became clear how entrenched the countrys unregulated savings banks were in the
real estate market. Increased public benefits caused higher government spending and government debt
skyrocketed. Like other European nations, with Spains rising debt, investors became more reluctant to invest
and Spains economy further declined. This briefing paper will describe the major causes of the Spanish
financial crisis. It will also discuss what Spains survival means to the Eurozone as a whole, and analyze
possible outcomes for Spain and the Eurozone after the crisis and the impact those outcomes would have on the
regional economy. Finally, it will describe the actions the Spanish government and the European Union (EU)
are taking to repair the Spanish economy and ensure a crisis of this magnitude does not happen again.

I. Spain: A Flourishing Economy


In order to join the EU, the Maastricht Treaty requires that countries converge on certain criteria, including
interest rates, inflation rates, and government deficits. Since 1990, Spain had faced budget deficits as large as
6.5% of GDP. Because of the strict requirements in the Maastricht Treaty, by 2005 the Spanish government
began posting budget surpluses.
The Maastricht Treaty also called for Spain to reduce its long-term interest rates. As a result, businesses and
individuals saw their borrowing capacities increase because they could afford paying loans with lower interest
rates. More people, especially those in their twenties who had recently graduated from a university, took out
loans to purchase homes. Traditionally in Spain, the younger generation lived with their families after school

until they married, but in the past ten years, more bought their own residences before marriage because
obtaining credit was easy and interest rates were low.
The construction market flourished because of the increased demand for housing. As more Spaniards bought
houses, more construction companies required unskilled labor which prompted an increase in immigration to
Spains labor market. From 2000-2008, Spains population grew from 40 million to 45 million, and from 1999
until 2007 the Spanish economy created more than one-third of all employment generated in the Eurozone. As
more immigrants came to Spain, more housing was necessary and the cycle continued. During this time, prices
of houses increased dramatically, as did the number of loans used to purchase them. The construction market
continued to build, heedless that the growing housing market would inevitably begin to cool.

II. Crisis in Spain


Because of the dramatic increase in construction of new homes and the long time between the beginning and
end of a construction project, by the time the demand for housing had slowed in 2007, available housing was
just reaching its peak. By this time, construction accounted for 13 percent of total employment in Spain. When
prices began falling and housing demand halted, unemployment jumped up 10 percent.
As unemployment skyrocketed, so did unemployment benefits. In a welfare state like Spain, unemployment
benefits are generous. However, what was a sustainable unemployment level quickly became a drain on the
Spanish government. The reduction in the Spanish governments tax revenue, which is heavily dependent on
real estate, exacerbated the problem. These drains on the economy turned a previous budget surplus of over 2
percent of GDP into a deficit of almost 4 percent of GDP, violating the limits of the Pact.

The Spanish Banking System


Spanish regional savings and loan banks, called cajas, account for half of Spains banking system. There are
around 24,000 branches of cajas throughout Spain to serve its 46 million residents (one branch for
approximately every 1,900 people). The United Kingdom, in comparison, with a population of around 62
million, has only 10,000 total bank branches (one branch for every 6,200 people). Cajas are not publically
traded, and usually regional politicians control the cajas instead of shareholders. The majority of cajas clients
are families, small and medium-sized business, and non-governmental organizations such as health care
facilities, environmental groups, and cultural groups. Before the crisis, cajas often loaned to those that the larger
banks turned away because they were considered undesirableclients that were less likely to pay back their
loans. Unlike the rest of the banking system, cajas were relatively unregulated, and they were not required to
disclose certain information such as collateral on loans, repayment history, and loan-to-value ratios. This
nondisclosure prevented the Spanish government from understanding cajas financial situations before and

during most of the crisis. The government was also unaware of the depth of cajas investment in the real estate
market.
When Spains two largest banks, Santander and BBVA, slowed lending in 2007, the cajas continued to lend
heavily into the cooling housing market. By 2009, cajas owned 56 percent of the countrys mortgages, and loan
payments from property developers accounted for one-fifth of the cajas assets. Because the cajas were not
required to disclose much of their investment information to the government, their continued lending to the real
estate market went relatively unchecked.
When the housing market crashed in 2009 and debtors fell into bankruptcy and bad loans dramatically
increased, the cajas were paralyzed by a lack of income from these delinquent loans and the high costs
attributable to this bloated caja system. The Bank of Spain estimated the amount of potential troubled loan
exposure in the Spanish banking system (any problematic loans that may face default) in the real estate market
was around 180.8 billion in mid-2010. According to some analysts, Spanish banks were only capable of
handling losses of only a third of that amount, and the cajas could handle much less.
By 2009, the construction industry owed billions of euros to the Spanish banking system. Many construction
companies had already gone bankrupt. The regular, listed banks had delinquent loans including construction
loans of approximately of 3.2 percent of their portfolios, while troubled loans at cajas reached 4.4 percent. In
March 2009, the Spanish government announced its first bailout of a caja. Although there is a difference
between cajas and banks, investors saw this first bailout as an indicator of the unhealthy status of the Spanish
financial sector as a whole. After the bailout, investor confidence in Spanish banks plummeted, causing bank
shares to plunge. Banks needed more cash to pay the depositors who lined up to extract their deposits, creating a
run on the banks. During the first four months of 2010, depositors withdrew 21.6 billon. This caused more
bank bailouts by the Spanish government. While these government bailouts kept the banks from going bankrupt,
investor confidence in the Spanish economy sunk even lower.

III. Where is Spain Now?


The main cause for concern when banks have made too many loans is that the borrowers will not pay back the
funds and the banks themselves will go bankrupt. In the United States, for example, this is especially
concerning because most U.S. loans are non-recourse. In a non-recourse loan, the creditors recovery is limited
to the loan collateralthe asset the borrower commits as a guarantee of repayment. When a borrower defaults,
the creditor is only allowed to foreclose on the collateral (i.e., a residence) and cannot go after other assets of
the borrower. Even if the collateral is worth less than the value of the loan, that is the extent of the creditors
recovery.

Unlike the United States, Spanish loans are typically recourse loans. With a recourse loan, if the borrower is
unable to make payments on the loan, the creditor is not limited to pursuing the collateral for loan recovery but
can pursue the borrowers personal assets. Because of this, most Spanish borrowers have continued, however
possible, to make their loan payments out of fear of losing all their assets. In an economy such as Spains right
now, people will not begin borrowing again anytime soon because many are still trying to repay their previous
loans. Less money will be spent in other sectors because more money will be needed to make mortgage
payments each month. Therefore, some analysts claim recourse loans generally ensure people make their loan
payments but also hinder the rest of the economy. However, in Spains case, recourse loans might lure possible
investors in the cajas as part of their recapitalization efforts.
The current statistics surrounding Spains economy illustrate the dire economic situation. As of February 2011,
unemployment in Spain still hovers around 20 percent of the labor force (4.3 million people), the highest in the
industrialized world. Unemployment for Spaniards under 25 years old is a staggering 40 percent. The
unemployment rate for Spanish residents with university degrees is at 9.4 percent, twice than in the rest of the
EU. Not surprisingly, the Spanish government estimated that 70% of the jobs lost after 2008 were related to the
construction sector. However, despite the staggering unemployment (which leads to higher government
spending on public benefits), Spains public debt as of 2010 was estimated to be 63.4 percent of GDP, lower
than the debt of the United Kingdom and Germany. Finally, analysts estimate that there are 1.5 million vacant
homes in Spain, and it will take an estimated six years to sell all these properties.

IV. What Went Wrong?


There were many contributing factors to the Spanish financial crisis. The failure of the Stability and Growth
Pact highlights the lack of regulatory authority within the Eurozone. Despite the Pacts reform, there is still little
supervision. Although the Eurozone members use the same currency, and the Pact sets guidelines, there is no
oversight of fiscal policies. Eurozone nations are left to self-regulate, even though the Eurozone economies are
integrated.
An easy target to blame is the Eurozone itself. The introduction of the euro meant that Eurozone countries had
the same monetary policy but completely different fiscal policies. Because there was no uniformity between
member states fiscal policiesmeaning that members were able to maintain their own spending and taxing
policiesmember states have found themselves in the vastly different economic positions, and the inability to
devalue the currency has hindered recovery. Although the euro was seen as the next logical step in integrating
Europe, it has become a major hindrance in the Spanish (and European) crisis. Critics warned against some of
these eventualities, but by the time danger was apparent, it was too late.

Another factor causing the Spanish financial crisis was the lack of regulation of Spanish lending institutions and
the real estate market. As previously mentioned, cajas made too many loans to individuals and corporations
(especially to those less likely to be able to repay the loans in a crisis). Many of these individuals and
corporations invested those loan proceeds in the real estate market. Because the cajas had not released their
information to the government, the extent of their real estate exposure was unknown. The instability of Spanish
banks has led to low investor confidence in the Spanish market. Many investors have pulled out of the Spanish
banking market or have refused to invest in the ailing cajas, hindering the Spanish recovery.

V. Spains Financial Future


The future financial position of Spain is unclear. However, some outcomes are more likely than others because
of Spains current economic position and the purpose and status of the EMU.

A. Spain Leaves the Euro zone


Spain could pull out of the Euro zone and return to its own currency, the peseta. However, if Spain even
suggests leaving the Euro zone, many fear that depositors will move their funds to safer locations, causing a
damaging run on the countrys banks. To prevent this, Spain would most likely implement capital controls and
limits on bank withdrawals to slow the drain on the banks, but these measures would restrict commerce. Upon
stabilization of its monetary policy, Spain could devalue the peseta, promoting exports and decreasing imports.
This plan is unlikely because integration into the Euro zone is complete, and Spain would probably not risk
losing more funds from its banks. The technical difficulty itself is daunting: reintroducing a national currency,
reprogramming the monetary system, printing money, and minting coins. The risks associated with pulling out
of the Euro zone are too great, and Spain is unlikely to take this drastic step. Although Spain and other countries
may regret joining the Euro zone because of their lack of control over their own monetary and foreign exchange
policy, it seems there is no turning back now.

B. Spain Toughs It Out


Spain could simply tough the crisis out. Both the Spanish government and Spanish citizens would have to cut
back on spending. The unemployed would continue to receive fewer benefits from the government as the
government implements measures to decrease government spending. The government would most likely have to
exert greater control over private debt (like that of the cajas) to avoid an EMU bailout. Not receiving a bailout
(if a bailout should become necessary) would be painful in itself. However, by showing that the country is
willing to endure tough austerity measures to avoid defaulting on its loans, Spain might bolster investor

confidence in its future. Although this would mean many difficult years ahead for Spain, it would avoid a
bailout and the EMU austerity measures that come with it and would remain a member of the EMU.

VI. What Is Happening Now?


Spain has begun to implement regulatory changes. It passed a new law requiring that cajas reinforce their
capital by September 2011 or face partial nationalization. The government has given the cajas time to find new
investors or merge with other banks. However, if they are unable to recapitalize, the government will take them
over.
Mergers have already begun, and there are now 17 cajas as opposed to 45 before the crisis. The Spanish
government is strongly encouraging (by threatening nationalization) the cajas to recapitalize on their own by
attracting private investor capital. Uncertainty regarding Spains financial future, resulting in low investor
confidence, will likely prevent a complete recapitalization by private investors, and the cajas will probably have
to tap into other government resources like the Fund for Orderly Bank Restructuring mentioned below.
The cajas are complaining that reform efforts are moving too quickly. They fear the efforts will most likely lead
to the end of the cajas through nationalization or through mergers with larger listed banks. Although the cajas
are complaining, it does not appear the government is concerned with their survival, but only with the recovery
of the Spanish financial system as a whole. So far the government has overhauled regulations to allow the cajas
to become joint-stock companies and list themselves on the market. New regulations will also require the cajas
to be more transparent in their lending practices. Some analysts fear the cajas have covered up some of their
losses and the government still is not aware of the full extent of the damage.
A new law also requires that a financial institution have enough equity to cover at least 8 percent (and up to 10
percent in some cases) of the banks risk-weighted assets. Risk-weighted assets are the assets of bank, such as
loans, measured by their credit risk. These moves are meant to protect financial institutions by requiring them to
hold more capital if, for example, they make risky loans. The goals set in place by the law must be met by
September 2011, or the banks will face nationalization. Some cajas (those with concrete plans to begin trading
publically) will have more time to allow them to find private investors to raise capital.
The Spanish government also created the Fund for Orderly Bank Restructuring (FROB) in June 2009.
FROBs purpose is to provide funds to manage bank restructuring. The Spanish government guaranteed 9
billion in capital, but FROB has the capacity to loan up to 99 billion to banks for restructuring efforts.
However, to tap into these funds, banks must follow the rules laid down by the government, and banks
eventually must repay the FROB loans. Banks have been slow to request these funds. Some waited until mid-

2010 to begin the mergers required by FROB to receive funds. By March 2011, FROB had only disbursed about
12 billion.
In order to cut government spending, the Spanish government has begun implementing austerity measures to
slow the increase in the government deficit. For example, it has announced that it was cutting a monthly subsidy
for the long-term unemployed. Spain also cut public wages by 5 percent, froze salaries and pensions in 2011,
cut a government benefit for new mothers, and raised the retirement age from 65 to 67. These reforms also
apply to regional governments, which hire almost half of all public workers and control health spending. While
there have been protests by workers unions regarding these measures, the opposition did not compare to those
that immobilized cities across France in 2010 when President Nicholas Sarkozy increased the retirement age
from 60 to 62.
The entire EU is also taking steps to solve the current problems as well as prevent another crisis from occurring.
The EU created the European Financial Stability Facility (EFSF) in 2010 after the IMF and Eurozone
countries bailed out Greece. The EFSF is an entity designed to issue up to 440 billion of debt on capital
markets. The funds received from the issuance will provide loans to EU member states in financial trouble. If a
country receives a loan from the EFSF, it will be subject to strict austerity measures such as tax and pension
reform, decreases in public wages, and privatization of some industries. EU member states will guaranty the
EFSFs bonds. However, once a member state receives a loan from the EFSF, it is not required to guaranty loans
made to other countries. Clearly this could lead to problems if too many countries request loans.
The EFSF is scheduled to expire in 2013, at which time it will be replaced with a permanent crisis mechanism
called the European Stabilization Mechanism (ESM). The ESM will provide loans to a member state that is
threatened with severe economic difficulties and will require borrowers to follow austerity measures similar to
those from the EFSF. The ESMs purpose is to avoid any future crises in the Euro zone.
The European Commission has also adopted a legislative package designed to prevent future economic crises
and reform enforcement of the Stability and Growth Pact. This legislation requires closer monitoring of
members fiscal policies. Warnings, and possibly fines, will be issued if a member state has deviated from the
policies. The fines will be returned to the member if the deviation is corrected quickly. Perhaps most important,
the legislation sets out minimum requirements for members fiscal policies. It also orders more frequent
surveillance. If during surveillance, a severe fiscal imbalance is discovered, the European Council may make
recommendations and enact an excessive imbalance procedure. The member state would then have to provide
a plan of action to correct the imbalance, and the European Council must approve the plan. Finally, if a member
repeatedly fails to act on these imbalances, it will have to pay a yearly fine equal to 0.1 percent of its GDP.

These measures are a significant step toward tighter regulation of member states fiscal policies and attaining
the goals and purposes of the Pact.
As of now, these policy changes still do not appear to be calming investors worries. Moodys, a well-trusted
credit rating agency, downgraded Spains public bonds in March 2011, causing heavy stock market losses
because a lower credit rating suggests to investors that buying Spanish debt has become more risky. On the
same day of the downgrade, the Spanish government issued a statement that it will only need to provide about
20 billion in new capital to the ailing banking system (a figure it has maintained for about a year). However,
other analysts estimate this amount to be anywhere from 40 to 120 billion. While a spokesperson for Moodys
commented that the agency did not consider Spain as risky as Ireland, there is still too much uncertainty in
Spain over the cost of recovery.
It is also important to note that while many EU members are suffering financially, EU countries are still joining
the Eurozone. Estonia completed its integration into the Euro zone in the midst of the financial crisis. While
some critics of the euro say that Estonia and the other countries on track to follow (like Latvia and Lithuania)
have nothing to lose, their integration is still a sign of faith in the future of the Euro zone. Other members of the
EU, like Poland and Hungary, have promised they would join the Euro zone but do not seem to be in a hurry to
do so anytime soon. These nations will most likely wait to see how the Euro zone crisis is resolved before
committing to the euro.

Conclusion
Spain still remains in a dire financial position. However, the Spanish government and the EU are working hard
to ensure its recovery and stability. Spain found itself in a unique situation because of its real estate market and
the actions of the cajas. When the real estate market collapsed, it brought the entire Spanish economy down
with it. While the Spanish government perhaps should have acted sooner, it is acting now and making necessary
changes to bring about recovery. Spain still may not see increases in employment or growth for many months,
but Spains important position within the Euro zone and the resiliency of its government and people suggest that
Spain will survive this financial downturn and will hopefully learn from its mistakes. The EMU will also learn
from the mistakes made and will change its regulatory scheme to prevent future crisis.

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