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Zapatero Depletes Surplus as Housing Shakeout Reduces EU Growth

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  • Zapatero Depletes Surplus as Housing Shakeout Reduces EU Growth

    Zapatero Depletes Surplus as Housing Shakeout Reduces EU Growth

    By Ben Sills

    March 28 (Bloomberg) -- Miguel Angel Lopez and Virginia Pardo watched the steady rise of interest rates last year as they expected their first child and wondered whether they would be able to keep up with the mortgage on their two-bedroom Madrid apartment.

    Then the government introduced a 2,500 euro ($3,947) payment for each newborn, the first in a series of benefits and tax breaks aimed at cushioning the impact as Europe's biggest housing boom shudders to a halt. Permits to build new homes, which peaked in 2006 at 734,978, two-thirds more than Germany and the U.K. together, will drop to 500,000 this year from 675,000 in 2007, according to Banco Bilbao Vizcaya Argentaria SA, Spain's No. 2 lender.

    ``Lots of people may have to stop paying their mortgages if rates keep increasing,'' says Pardo, a 29-year-old homemaker whose husband makes about 1,000 euros a month as a warehouse manager. ``This will give us room to breathe,'' she says, cradling their 2-day-old daughter, Ainhoa.

    Prime Minister Jose Luis Rodriguez Zapatero, whose Socialist Party retained control of parliament in March 9 elections, is increasing government spending to avoid a real estate fire sale. In a country with an 86 percent home ownership rate, highest in the 15-nation euro region, the collapsing housing market is already slowing the economy.

    Growth will dwindle to 2.5 percent this year from 3.8 percent in 2007, according to forecasts by the Paris-based Organization for Economic Cooperation and Development.

    Wealth Tax Pledge

    Zapatero, 47, and his People's Party opponent, Mariano Rajoy, 53, made the economy the centerpiece of their campaigns. Both pledged to end the wealth tax on assets, which has ensnared more and more Spaniards because of rising home values.

    The Socialists also promised to give workers an annual income tax rebate of 400 euros and boost the lowest state pensions by 26 percent. That's on top of the surge in infrastructure investment already budgeted for this year.

    ``We've saved, we've managed our finances well and we've got a bigger surplus than expected, so we can stimulate the economy and help families,'' Zapatero said in a Jan. 29 interview on Spanish public television. ``This is a prudent measure.''

    Residential construction, which accounts for about 6 percent of Spain's economy, peaked in 2006 after a decade-long surge fueled by a drop in interest rates, growing incomes and vacation home purchases by Britons, Germans and other northern Europeans. Housing prices gained 11 percent a year on average, as even ordinary Spaniards speculated in real estate.

    Consumer Spending Power

    Spain's economic growth, which outpaced the euro-region average, provided a quarter of the single-currency area's new consumer spending during the past four years, according to the European Union's Luxembourg-based statistics agency, Eurostat. That's more than five times the contribution of Germany, where the economy is three times the size.

    Now, a glut of properties weighs on the market, and interest rate increases and tighter bank lending standards make it more difficult for buyers to finance. The supply of new homes in 2006 outstripped demand by about 50 percent, according to government estimates.

    Mortgage interest rates more than doubled since 2005 as rising credit costs sparked by the U.S. subprime crisis compounded eight increases by the European Central Bank. The 12- month euro interbank offered rate, or Euribor, calculated monthly by the Bank of Spain and used to set mortgage rates, was 4.79 percent in December, the highest since 2000.

    It eased to 4.35 percent in February, 26 basis points above a year earlier. (A basis point is 0.01 percentage point.)

    `For Sale' Signs

    The slowdown can be seen on the streets of Madrid, where buildings are plastered with ``For Sale'' signs and it's getting easier to find a seat in the normally packed cafes.

    ``People just don't have any money,'' Antonio Romero, a taxi driver, says. ``With so many people on low wages, the price rises are really being felt and people are cutting back on unnecessary expenses.''

    Romero, 53, says his earnings have fallen by a quarter since last year. Customers who might have taken a 25 euro cab to the airport when they went on vacation are now asking to be dropped off at the metro station, which is usually a fare of less than 10 euros, he says.

    Residential construction may decline by as much as half before it reaches a sustainable pace, Zapatero said on Feb. 22. Industrial production contracted the most in more than five years in December, while a survey of executives suggested service activity collapsed in January.

    Milk Prices, Unemployment

    Accelerating price gains, caused by global pressure on the supply of food commodities and oil, are eating into wages, and new jobs are becoming scarce.

    The price of milk rose 28 percent in the past year, bread rose 12 percent and gasoline was up 17 percent. Unemployment claims rose for a fifth month in February. G14, a trade group representing the country's largest developers that is lobbying for subsidized loans, estimates 1.1 million residential and commercial construction jobs will be lost.

    Real estate has a special place in the Spanish psyche. The constitution, which sealed Spain's transition to democracy from dictatorship after General Francisco Franco's death in 1975, grants every Spaniard the right to ``a decent and fitting home.''

    While it also charges the government with preventing speculation, most new developments are dotted with banners showing mobile phone numbers of people who signed up for apartments with plans to flip them to new buyers for quick profits. Immigrants from North Africa, eastern Europe and Latin America flocked to Spain to find work building homes.

    Home Prices, Inventory

    Home prices rose 4.8 percent in the fourth quarter, the smallest increase in more than a decade. They may fall this year by as much as 8 percent, according to Frankfurt-based Deutsche Bank AG. Unsold inventory may be as much as 1 million, about 5 percent of all homes, according to Ignacio Carvajal, an analyst at Zurich-based UBS AG, Europe's largest bank.

    Investors are increasingly reluctant to lend to Spanish banks on concern that falling property prices may hurt their credit ratings. Banks have responded by making it harder and more expensive to borrow.

    Half of Spanish banks toughened mortgage-lending standards in the fourth quarter, requiring large down payments by reducing the amount they're prepared to lend against a given property, according to a January report by the Bank of Spain. That compared with a similar tightening by about 10 percent of banks across the single-currency area.

    Late Mortgage Payments

    Mortgage-lending growth at Madrid-based Banco Espanol de Credito SA, the retail bank majority owned by Banco Santander SA, the country's largest bank, fell by almost half in the fourth quarter, while the number of borrowers missing payments for the first time doubled. Mortgage-lending growth may slow to 6 percent this year from 15 percent in 2007, the Spanish Mortgage Association said in February.

    Some banks have had to turn to the ECB to fund their business as demand for their mortgage-backed bonds evaporated. Spanish banks tripled the amount of their ECB borrowings to a record 52.3 billion euros in December compared with July, according to Bank of Spain data. Spanish banks haven't raised money in the public mortgage-covered bond market since November, according to data compiled by Bloomberg. That compares with more than 35 billion euros of such notes sold to investors in the European bond market in the year through November, the most among the 15 countries sharing the euro, according to Paris- based Societe Generale.

    Growing Yield Gap

    The price of debt outstanding slumped on investor concern that declining house prices may undermine the quality of Spanish bonds. The difference in yields between AAA-rated notes backed by Spanish home loans and benchmark rates rose more than sixfold since July to a record 1.2 percentage points, according to Milan-based UniCredit SpA, Italy's largest bank by assets.

    Bankers say they are confident they can manage the risks. Spanish banks have more than five times the bad-loan provisions of their U.K. counterparts. The ratio of reserves to bad loans in Spain was 2.69 to 1 in 2006 compared with 0.56 to 1 in the U.K., according to the Spanish Banking Association.

    Aiding risk control, banks originate and manage all Spanish mortgages; in the U.S., banks have such total responsibility for less than half of home loans.

    ``Our economy and our financial system are very solvent,'' Banco Espanol Chairman Ana Patricia Botin said at a Jan. 11 press conference in Madrid. ``The structure of our mortgage market is very different from the U.S.''

    `At the Limit'

    The impact on struggling borrowers is much the same on both sides of the Atlantic. Pavel Santa, a Romanian construction foreman, brought his wife and son to live in Spain last year after he joined the management committee of the property company where he's worked for five years. Then his mortgage interest rate reset, causing the monthly payment to take up almost all of his 1,800 euros monthly salary.

    ``I'm at the limit,'' says Santa, 38, who earns 600 more in overtime. ``I live worse than I did in Romania.''

    On the advice of his boss, he's taking government-funded courses to earn qualifications as a foreman and crane operator so he can go to work on the railways should the residential slump continue.

    The government's effort to soften the blow for people like Santa is helped by a record budget surplus of 23.4 billion euros, equivalent to 2.2 percent of gross domestic product.

    `Room to Maneuver'

    ``What could prevent a more dramatic downturn in 2008 is that the Spanish government has ample room to maneuver to accommodate the shock,'' says Gilles Moec, an economist in London at Charlotte, North Carolina-based Bank of America Corp.

    The surplus will be cut by almost half this year, according to official forecasts. Deutsche Bank, Germany's largest bank by assets, sees it dwindling to 0.2 percent by 2009 as the government dips into the public coffers to bolster the economy.

    Spain has already increased spending on public infrastructure projects, accelerating a 250 billion euro transport plan that aims to upgrade highways and build a 10,000- kilometer (6,214-mile) high-speed rail network by 2020. Infrastructure investment will increase 16 percent this year to 20.3 billion euros compared with average spending of 15.5 billion euros envisaged in Zapatero's 2005 plan.

    ``That's only the start,'' Jose Luis Martinez, a strategist in Madrid at New York-based Citigroup Inc., says. ``The numbers are on the table, and they have to be faced. Infrastructure spending will increase further, and there will be additional tax cuts.''

    High-Speed Link

    In February, workers completed the high-speed link between Madrid and Barcelona, which cut the time for the 659-kilometer journey between the country's two biggest cities to 2 hours 38 minutes from around 7 hours. Valencia and Granada are among the next cities that will join the steel-and-concrete network of railroads slicing through the Spanish mountains.

    Business and consumer confidence may be harder to restore. Luis Mochon, an engineering lecturer at Madrid's Comillas Pontifical University, says his family of four barely makes it to the end of each month before the money runs out.

    ``There's a crisis coming, and in Spain we're all going to feel it,'' he says. ``Real estate is obviously one source of the trouble, but there may be others. We just don't know.''

    Zapatero has his work cut out for him, judging by the estimates of economists surveyed by Bloomberg News. Based on the median of 11 forecasts for 2009 and 15 for 2008, growth will decline to 1.9 percent next year from 2.4 percent in 2008. That would be the slowest expansion in 16 years.

    "There's one way to find out if a man is honest-ask him. If he says 'yes,' you know he is a crook." Groucho Marx