Could the decline in Spanish house prices be bottoming out? Not just yet...

A quick update on Spanish house prices, given that the latest quarterly statistics were released this morning.

As the graph highlights the second quarter of 2013 saw the smallest decrease in house prices quarter on quarter for some time. A few points to note here, though:

• Q1 2013 saw the largest decline for some time so the rebound could be impacted by the fact that the previous decline had been extraordinarily large. The rate of annual decline, at 12%, remains rapid.
• House prices, according to INE, have now fallen by 37% from their peak in Q3 2007. This is clearly a huge decline, but as we have pointed out before, a decline of up to 50% cannot be ruled out, meaning prices may still have some way to go before they bottom out.
• As with other statistics in Spain, there could be some seasonal impact which is yet to be accounted for.
  

• As the graph above shows there is also a wide range of regional variation with some of the richer areas beginning to fair better.
• The year-on-year decline, from Q2 2012 to Q2 2013 is seen to be around 8.8% by INE. However, recent statistics from Tinsa put the decline over the same period at 10.5%. It’s hard to say which is more accurate but this is a notoriously difficult area to accurately measure. There is some (fair) concern that the indices may fail to capture the true decline in house prices in Spain as they do not accurately reflect market transactions, so any data should be read with that in mind.
• Interestingly, it has also been suggested that that while domestic demand has continued to fall, 2013 Q2 saw a pick up in interest from foreign buyers. This could be a positive sign, although (as we have pointed out for the wider economy) foreign demand is not likely to be sufficient to offset a cratering in domestic demand.
• The growing difference between new and second-hand housing is also interesting, if not unexpected. The construction sector will likely continue to struggle as long as new buildings do. The slightly positive signs for second-hand housing could also be positive for the banks, since the majority of their mortgage portfolios will be linked to these properties – if they begin to show signs of recovery the mortgage books may begin to look less toxic (early days though yet). Clearly, as the decline continues and other factors (such as unemployment) continue to push up the level of bad loans that banks hold, they are likely to continue to struggle.
• All that said, the problems with prices of new houses do not bode well for the significant amount of unsold new housing stock floating around in Spain (though to be around 1 million properties) or the large swaths of un-developed land owned by the banks. Clearly these factors will drag on the economy for some time.

Housing, real estate and construction are likely to continue to be a drag on Spanish economy. The concerning point remains that the Spanish economy has been slow to adjust and rebalance towards new areas for growth. Meanwhile, with the ECB's asset quality review (aka 'stress tests') coming up at the start of next year, the attention to the state of bank balance sheets and their links to the housing crisis are likely to once again intensify.

How to prevent bubbles

The new year sees the launch of the EU’s new financial supervisors: the European Banking Authority, the European Insurance and Occupational Pensions Authority and the European Securities and Markets Authority. If you haven't already done so, have a look at our take on the new EU supervisors here.

Green MEP Sven Giegold (Germany), who took the lead on the issue in the European Parliament, seems to be their most ardent supporter. He told German TV channel ARD that the huge structural problems in Ireland's banking sector "could have been prevented by the new European banking supervisors, thanks to their new legal possibilities".

Hmmm, a bit of a simplistic explanation, no?

Giegold doesn't have to look very far to spot the reason why his reasoning is painfully incomplete. In fact, casting his eyes to Frankfurt and the ECB would do the trick.

As often repeated nowadays, low eurozone interest rates, essentially designed for a sluggish Germany, led to an abundance of cheap credit in Ireland, in turn fuelling a property bubble that burst with the financial crisis in 2008, while the Irish government turned a blind eye. The Irish banks became insolvent, and private debt became public debt through bank bail-outs.

Inappropriate interest rates weren't the only issue, but to ignore the problems they caused Ireland is just silly. Therefore, there are several problems with Giegold's view:

1. It's heroic to assume that the EU's financial supervisors - somehow by virtue of being ran at the EU level as opposed to the national level - would spot the credit dangers looming, and act accordingly. It's also not clear why EU supervisors would be less vulnerable to commercial or political "hijack" than their national counterparts.

2. Regulators often find it difficult to spot bubbles, not matter where they sit (in the Spectator, Johan Norberg does a good job of breaking down the flawed assumptions underpinning the thuinking ahead of the 2008 crash). Ireland, for example, had been experiencing sound growth since the beginning of the nineties, thanks to some brave economic reforms. Booming house prices could be seen as 'normal' in such economic circumstances. It's not at all clear that the new EU supervisors would possess the kind of competence needed to really dig into the markets, or know where to look (American regulators quite clearly didn't pre-Lehman).

Having said that, however, in a best case scenario, the European Banking Authority, alongside the European Systemic Risk Board, could in theory serve as important facilitators of information sharing to help regulators/supervisors keep up with new developments, such as the rise of the shadow banking system, and control leverage accordingly. The EBA could also coordinate cases where cross-border banks expose taxpayers and savers in different countries to risks, ideally leading to wind downs of insolvent banks at the minimum cost, rather than more taxpayer-backed bail-outs (solving nothing).

3. But, and here's the thing, even if the EU supervisors were to spot, say, a housing bubble and stop it (through taxes at the national level and regulating the housing market, for example), the problem of excessive cheap credit, fuelled by low interest rates, would not be addressed. There are other things to spend your cash on apart from houses. If money is cheap, risk-taking is easy. And the more risks the greater the scope for bubbles.

The only effective way to stamp out excessive cheap credit in a boom is to make money more expensive, through higher interest rates. But here the familiar dilemma appears yet again: in a currency union it's impossible to tailor the interest rates like this, meaning that the EU supervisors can scream "bubble" all they want.

This is of course a difficult conclusion to reach if you have an ideological commitment to centralised decision making and a single currency for everyone...