Authored by Nick Corbishley via NakedCapitalism.com,

Spain is one of the European economies that was hardest hit by the COVID-19 virus crisis, in part because of its huge dependence on tourism. In fact, according to figures published in February by the Organisation for Economic Cooperation and Development, Spain is the OECD country (out of 38) where the real income of families has fallen the most since the pandemic. It is also the EU country that has suffered the biggest fall in per-capital income since 2020, and has been overtaken on this indicator by Slovenia, Lithuania and Estonia.

Now, after years of falling real incomes, millions of families are facing skyrocketing mortgage payments as a result of the European Central Bank’s rapid-fire interest rate hikes.

Blame Game Begins

The blame game has already begun in central government circles. After taking a thrashing in the recent local and regional elections, Pedro Sánchez’s government now faces an uphill slog in next month’s generals. As Mortgage costs surge, the government is desperate to pin responsibility on the European Central Bank (ECB) and its Spanish subsidiary, the Bank of Spain. Asked in an interview about the state of the Spanish economy and the potential impact of the ECB’s latest round of interest rate hikes on Spanish homeowners, Spain’s Economy Minister Nadia Calviño said:

“You need to ask [Luis de] Guindos, [Vice President of the European Central Bank], and [Fernando] De Cos [governor of the Bank of Spain]; they are the Spaniards behind the rise in mortgages.”

Calviño is right, of course. So, too, was Sánchez himself when he said on Tuesday that “the [Spanish] Government has no powers over monetary policy.” But his government — like all EU governments — is partially to blame for high inflation due to its ongoing support for sanctions on Russia, Europe’s biggest provider of energy and other vital commodities. This is, without doubt, one of the main drivers behind the massive surge in Europe’s energy prices and overall inflation.

But the mere fact that Spain’s prime minister and economy minister are both trying to shift the burden of responsibility for rising mortgage rates to the central bankers is notable, since senior politicians rarely blame central banks for anything unless they are in a truly tight squeeze. Of course, Sánchez could have added that Spain’s central bank also doesn’t have any meaningful influence over monetary policy in Spain, since Spain’s government handed all decision making powers in that arena to the ECB when it joined the euro at the start of this century.

For Spain, where the consumer price index (CPI) clocked in at a relatively low 3.2% in May, further interest rate hikes are no longer necessary, said Calviño, adding a caveat: the ECB needs to consider Europe “as a whole.” And in the Euro Area as a whole average inflation was 6.1% in May — almost double the rate in Spain. In six countries, all of them in Eastern Europe (Lithuania, Estonia, Latvia, Slovakia, Czechia and Poland), inflation is still above 10%.

The ECB embarked on its current hiking path in July 2022, when it increased its main deposit rate from -0.5% to 0%. Since then it has hiked a further seven times, to the current rate of 3.5%, the highest level since 2001. All of this is apparently necessary to squeeze as much life out of the economy as possible by smothering consumer demand, triggering a recession, destroying millions, with the ostensible goal of bringing down inflation to a more manageable level. This ignores the fact that surging prices are, to a large extent, the result of supply-side factors, including, of course, the boomerang effects of the EU’s 11 sanctions packages against Russia, its biggest energy supplier.

While inflation has indeed fallen, the Euro Area, like the US, still has negative real rates. Meanwhile, the ECB’s rapid rate hikes are triggering all sorts of unpleasant after effects — many of them intended. They include rapidly rising costs for homeowners as mortgage rates surge. Spain is particularly vulnerable to this trend since around three-quarters of its mortgage holders have variable rate loan contracts linked to the ECB’s deposit rate, although they are generally adjusted only once a year.

Housing Bust 2.0?

Spain has already witnessed one of the most spectacular housing booms and busts of this still rather young century. During the peak of the boom phase, from 2003-05, around 700,000 homes were being built per year, more than were being built in Germany, France, Italy and the UK combined, with an aggregate population four times greater than Spain’s. By the time the dust from the subsequent bust had largely settled, in around 2015, over 600,000 families had lost their homes (and bear in mind that in Spain mortgages are recourse, meaning that banks can — and in most cases did — go after the borrower for all outstanding debt once the house is resold).

In recent years banks, builders, large real estate developers and the previous Rajoy government have done everything they can to create a new housing bubble, with a certain degree of success. By 2019 prices in some of the country’s biggest property markets, such as Madrid, Barcelona and some of the coastal and island markets, had regained much but not all of the ground lost in the previous bust. However, in other less desirable markets, home prices had barely risen, and in some they were below where they had been in Q1 2015, when the national low point occurred.

In 2020, the year of the COVID-19 lockdowns, Spain’s housing market stalled — as it did in most countries — before picking up pace once again in 2021. In 2022, the total number of residential property sales reached 650,000, their highest level in 15 years.

But that partial recovery is now in serious danger. As I reported in late November, in Something Just Cracked in Spain’s Mortgage Market, Spain was one of the first European countries to introduce emergency measures to blunt the impact of rapidly rising interest rates on families already struggling with soaring inflation:

As data from Spain’s National Institute of Statistics shows, 72% of newly signed mortgages in August were fixed rate while 28% were variable rate. But this is a relatively new trend. In 2020, the ratio was roughly 50/50. In 2016, 90% of all new mortgages were variable rate and in 2009 it was a staggering 96%.

The result is that roughly four million of Spain’s 5.5 million mortgage holders have variable rate mortgages. Of those just over one million qualified for the government’s relief package. The measures, which will be in force for two years, are meant to help families adapt more gradually to the new interest rate environment. To qualify for the relief, a household must have annual income of less than €29,400. Their mortgage burden must also represent more than 30% of their income and their monthly instalments must have increased by at least 20% due to the ECB’s recent rate hikes.

Since the publication of that post, property demand in Spain has begun to sag. In fact, sales began to stagnate in December 2022. In April, just 27,000 mortgages were signed, 18% fewer than the same month of last year. None of this should come as a surprise given the ECB has increased Euro Area benchmark interest rates from 1.5% to 3.5% since November. For holders of variable-rate mortgages, this has meant having to pay significantly more in monthly instalments, just as prices for many basic goods, including food, have also soared. From Capital Madrid:

According to data from the Bank of Spain, families have allocated 41.5% of their income so far in 2023 to pay their mortgage payments, generated added expenses of €18 billion in the first two months of the year. A report from a specialised agent has analysed data from more than 2,000 transactions closed between May 2022 and May 2023 and the outlook is bleak as a result of the rise in interest rates.

According to data from the firm Housfy, the forecast for the increase in the cost of the average mortgage payment in Spain by the end of the year is that it exceeds €5,000 per year on average. “Everything will depend on how we progress in the last quarter, but we can predict that the increases will significantly affect families,” says David Espiago, director of the banking business at Housfy. According to data from INE (the National Statistics Institute), over the past year year the average mortgage payment in Spain has increased by €256, monthly, and €3,073, annually.

As I noted in my previous article, the government’s mortgage relief package almost certainly will not cover enough families:

An average income of €29,400 might be enough to qualify someone for a 25- or 30-year mortgage in one of the more impoverished parts of Spain, such as Extremadura, parts of Andalusia, Castilla la Mancha, Murcia, Ceuta and Melilla, but it will not get you a mortgage in the main centers of economic activity such as Madrid, Barcelona, Bilbao, Valencia, Palma de Mallorca and San Sebastian. Many mortgage holders in these cities are also struggling with rising costs but they will not qualify for the mortgage relief — unless, of course, the relief package is expanded.

That is where we may soon be headed. In the past few days, Work Minister Yolanda Díaz — whose success at restoring workplace protections has made her one of Spain’s more popular politicians — has proposed issuing a one-off €1,000 “bonus” to all households with variable-rate mortgages — as long as the loan is in its first 10 years of life and was issued for a primary residence worth up to €300,000. Díaz argues that such a measure is necessary to cushion the impact of the “double inflation” (rising prices of basic goods and services together with fast-rising mortgage instalments) battering these households.

Around a million families would qualify for the emergency bonus, Díaz says, meaning it would cost a total of around $1 billion. It would apparently be financed through a windfall tax on bumper bank profits introduced at the beginning of the year.

But Diaz’ proposal has met with scathing criticism, including among her own coalition partners. Spain’s Economy Ministry argues that the emergency bonus would amount to a transfer of income from all taxpayers to the banks, since they would be the ultimate recipients:

We are not surprised that the banks want the cost of the measures to fall on the public sector. What astonishes us is that this proposal can have the support of someone other than the People’s Party, which defends the interest of financial institutions.

The Ministry kind of has a point. After all, the last financial crisis ended up crushing the standard of living and work opportunities of millions of (particularly young) Spaniards, large numbers of whom ended up migrating to northern Europe and Latin America. All of this was captured in the 2019 edition of the Bank of Spain’s Triannual Family Financial Survey, which I covered for WOLF STREET at the time. Between 2010 and 2017, the median gross income of heads of households under the age of 35 plunged 18%, from €27,700 to €22,800. Millenials’ median wealth collapsed 92% to €5,300, for the main reason that after the crisis almost all under-35s have been financially excluded from the property market, largely due to their shrinking incomes levels.

Many of these people can barely afford to make rent, which has been rising in many regions for the best part of the past decade, let alone subsidise struggling mortgage holders. But as far as I can see, there are only two other alternatives.

One is to force banks to share the economic pain by sharply limiting the amount by which mortgage instalments can rise.

This is already happening in Greece, where the four largest banks will have to absorb any further interest rate hikes on mortgage loans from May 2023 to May 2024, in order to help households cope with rising housing costs. But for the life of me, I cannot see any Spanish government doing this, particularly one consisting of the conservative People’s Party and far-right VOX, the most likely victors in the next elections.

The other alternative is to do nothing, but that risks triggering another housing crisis.