Over April, the Spanish Debt Crisis began to take centre stage as investors turned their attention away from Greece. Despite a brief rally in the market, it seems as though European debt is again going to exert its influence on North American Stock Exchanges for the near future. But just how bad can this crisis be, given that we’ve already seen the Greek issue resolved. Doesn’t this mean that the European Union has stepped up to the plate to resolve the EU debt issues as they arise, and ensure an orderly restoral of market certainty? Unfortunately, this sort of outcome is unlikely.
While the Greek crisis has generally been addressed, it simply warmed us up to the kind of volatility that we can expect to see over the coming years. As the issue escalates across the continent, we can expect to see larger and larger amounts of funds at extreme risk being addressed by the European Union. More importantly, we will also see the increased volatility continue to have an impact on our personal investment and savings portfolios. Because of this risk, it is important that we understand just how severe this risk is, and how it will impact us.
Even in the early 2000s, Spain presented itself as a fairly robust economy, with a financially sound banking system. Financial Institutions kept cash reserves to cushion against instability, and employment was reaching near-full levels. However, by the middle of the decade, cracks in the economy became evident in the form of an increasing trade deficit, and increasing inflation. This can mainly be attributed to the way in which
Spain imports many of its natural resources. Since commodities were reaching all time high costs during this period, Spain had to pay increasing amounts to meet its demand for products such as petroleum. This meant that the country had to borrow and spend more money, while banks were lending more and more funds for people to purchase homes. These conditions all added to the country’s inflation.
From a residential standpoint, Spanish home prices have been building into a bubble since the early 60s, when the government started encouraging home-ownership as an ideal. As consumers began taking on mortgages that stretched out for more than 50 years, and write off as much as 15% of the loan itself. While this makes home-ownership affordable, it drives up the demand for houses, and therefore the costs.
As people take out bigger and bigger loans to purchase homes that builders are scrambling to build more of, we eventually hit a breaking point where the market is unable to continue supporting such a high price. Since prices are beginning to fall, people are seeing that they are beginning to owe more money than their home is worth. As this debt reaches an extreme point, consumers begin to walk away from the mortgages that are secured against their worthless homes. The end result is that the bank gets stuck with a mounting loss, and a whole bunch of houses that nobody can afford to buy now that they have essentially declared bankruptcy. Sound familiar? It should, this is a bit like what happened in the USA, just with a little more European style.
Now that we understand a bit more about what’s going on here, we can use the next article to discuss how it is that this specifically impacts our personal investment portfolios, and how we can protect ourselves against the coming Spanish Debt Crisis, now that we’ve already survived the Greek equivalent.
