Property collapse in Spain has only begun…Must read by Voxeu on the Spanish housing crisis.

What is the problem in Spain? It started with a classic housing bubble financed by foreign capital, and as a textbook would predict, once the inflow of foreign capital stopped and the bubble burst, unemployment soared and the financial system went bust as well (Reinhart 2008).

The current fiscal problems mostly reflect the housing bust. The Spanish government is running a large fiscal deficit as the economy remains weak and the ever-increasing losses in the banking sector hang like a sword of Damocles over the public sector.[1]

On this ground, too much attention has thus been focused recently on the Spanish deficit overshoot in 2011 and what deficit might be attainable in 2012. More attention should be focused on the factors behind the deficit. We argue that the root problem is that the Spanish housing bubble was extreme and that the adjustment has simply been too slow. In particular, we provide a novel angle on two key questions: how long it will take to absorb the legacy of the bubble and how much it will cost?

The Spanish housing bubble

Most commentators concentrate on house prices, usually in real terms, as the measure the housing bubble and its developments (e.g. Münchau 2012). Data suggest that house prices have indeed adjusted, but not enough.  Figure 1 shows the house price index for Spain (measured as relative to rents) at roughly the same level as in 2003 and still much above its pre-2000 levels. We favour the price-to-rent index to the real price because it should not be affected by immigration; any increase in demand for housing from that source should manifest itself in upwards pressure on both rents and prices. On the contrary, immigration should put more pressure on rents than on house prices since most immigrants are likely to be short of capital and thus likely to be renting, rather than buying.[2]

The chart confirms that house prices have followed the price-to-rent index since their peak in the last quarter of 2006 but are still higher than the pre-bubble period.

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