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Booming banks and booming property prices are not enough

“Spain’s banking crisis did not come out of the blue. In the 1990s the Spanish suffered a bout of collective madness. Interest rates fell from 14% (with the peseta) to 4% (with the euro) in a matter of weeks. In 1998 the centre-right government passed a law that significantly increased the amount of land for development. Developers got rich, selling the idea that everyone was going to win because property would always go up – never down – in value. German banks financed Spain’s savings and commercial banks, which needed extra funds for high-risk mortgages. Greed made us rich for a while – but then it made us poor, and jeopardised our future.”

ROBERT TORNABELL The Guardian (June 8, 2012)

Spain is the latest country in the Eurozone to show signs of major distress and frantically seek external assistance. But Spain is not Greece; it is Europe’s 4th-largest economy and, until quite recently, a poster-child for rapid economic growth. Just five years ago I visited one of the country’s top business schools, and everywhere around me I saw an economic boom, prosperous families, and the business confidence to take on the world.

So what on earth happened?

The numbers around the Spanish economy are terrible as they stand today: Spain now has a stock of a million unsold properties; hundreds of unfinished housing developments; close to 5 million unemployed people (one in four Spaniards in the working population) – and a shocking unemployment rate of 50% in the 18–25 age bracket.

Robert Tornabell wrote recently that the root of this crisis can be found in the booming 1990s, and this should make nervous reading for Kenyans. Tell me if the following symptoms look familiar:

Extremely rapid property price inflation, outpacing all other sectors of the economy; a procession of banks lining up to finance property acquisition, at historically low interest rates; many middle-class families rushing to buy property, not because they needed to live in it, but because they believed prices would never come down; banks growing extremely rapidly, but filling their balance sheets with toxic debt that would never be repaid.

This unholy matrimony between property speculators and banks has precedents. I wrote on this page a couple of years ago about Ireland: “The Celtic Tiger, it seems, was made of paper. The country’s upturn was reflected most in two places: booming banks and booming property prices. That, it turns out, is a very dangerous combination. Banks kept making outrageous profits, even as the country seemed to lack any other economic engine. The Irish whose incomes were rising all rushed into property, aided by easy-credit polices from lenders.”

I trust you’re sufficiently worried. Sustainable economic booms are not created on the strength of property speculation or from financial wizardry. An economy has to actually create real competitive advantage, in products as well as experiences, for its success to not disappear like froth.

What do we Kenyans share with the Irish and the Spanish? An irrational, almost medieval love of the soil. Kenyans don’t feel a sense of accomplishment until they are landowners. The richest own tens of thousands of acres, and do not feel sated. Even those on the most modest incomes don’t sleep well until they put a down-payment on a tiny plot somewhere. That mania is what creates property bubbles.

Our mortgage market is still embryonic, but our property mania is fully blown. Banks would do well to heed the lessons from the US, Spain and Ireland, and lend to solid investors and homeowners, not feed the frenzy of speculators. Our recent interest-rate hike is a useful corrective, and was overdue.

The bigger lesson is that economic success that lasts must come from genuine value addition in several sectors, based on doing real things better than others can do them.

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