Goldman Sachs has warned that house prices in the embattled European Union economy still need to fall another 10%, spelling out further trouble for the country’s already deeply troubled banking sector.
House prices have already plunged 30% from their previous high levels but the investment bank thinks they have not yet reached the bottom valuations and are still over-priced.
Further correction is deemed to be painful. Another 10% fall in Spanish house prices would threaten to put the country under an even greater pressure. Five hundred thousand homeowners are already in negative equity and the government has had to pass laws to avert banks from repossessing their homes.
However, Goldman’s economists Andrew Benito and Sebastian Graves think more homeowners could still be at risk. “Our preferred model values housing based on the relationship between rental yields and real borrowing costs. The current level is consistent with house prices falling by a further 10% to reach an implied equilibrium,” they said.
The economists added further that Spain’s banks are holding back the recovery by “evergreening” loans to unviable businesses: “Too much credit is extended to unhealthy sectors with poor growth prospects, such as construction, and too little net new credit creation towards more growth-friendly entrepreneurial and export-oriented sectors.” They emphasized that “a willingness to call in existing loans to unviable businesses and extend new credit creation to businesses with better growth prospects is important.”
While the bank lending is falling, Goldman said, it needs to be withdrawn from bad borrowers and lent to promising businesses instead in order to drive future growth. Government and ECB policies have so far been helping to avoid a “disorderly deleveraging by banks” that would have been otherwise even more painful to the economy.
However, these same policies are now preventing fundamental economic rebalancing. The economists’ opinion is that “while progress is underway, the Spanish economy still needs a significant economic restructuring… Banks have a central role to play in this process.”
Goldman Sachs’ proposals are similar to those policies already in place in the UK, where banks are being made to disclose their “evergreen” lending as well as set aside sufficient capital to ensure that promising financially sound new businesses continue to have access to credit.
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