The New York Times

May 20, 2005

Europe: The Unlevel Playing Field


MADRID, May 13 - Like thousands of young Spaniards, Rafael Matito left his home village for Madrid 18 months ago, lured by one of Europe's most thriving capitals. After landing a job as a computer instructor, he and his girlfriend set about achieving the Spanish dream: buying their own home.

"We weren't looking for a villa or anything close to it," Mr. Matito, 28, said. "We just wanted one or two rooms."

Madrid was out of the question because of the sky-high prices, so they hunted in the suburbs. But even there, apartments were twice what they could afford. Disillusioned, they called off the search until the market cools - if it ever does. Spain is in the seventh year of a housing boom that with interest rates at historically low levels, shows no sign of cresting.

Nearly two decades after joining the European Union, Spain is on the leading edge of an emerging, and troubling, dichotomy between dynamic European countries, with fast-rising asset prices, and lumbering countries, with moribund markets, most notably Germany.

Far from converging into a more homogeneous bloc, the 12 countries that use the euro currency are dispersing into sprinters and laggards, with different levels of consumer confidence, industrial activity, and economic vigor. Bustling Ireland, with a growth rate of 5 percent, has little in common with becalmed Italy, where output may actually shrink this year.

This has created a conundrum for the European Central Bank in Frankfurt, which sets interest rates for much of the Continent. Just as the Federal Reserve, to some extent, must take into account divergent conditions in Ohio and Arizona, the European bank is learning that it is even trickier to devise a monetary policy that works equally well from Finland to Greece.

For months, the bank has signaled it wants to lift rates. But it is afraid of hobbling weak countries like Germany and the Netherlands. While the Germans linger on the edge of a recession, Spaniards are surfing on a sea of easy money, taking out cut-rate mortgages to buy and build houses at a furious pace.

"For the Spanish economy, the advantages of being in a monetary union clearly outweigh the disadvantages," said José Luis Malo de Molina, the director for research at Banco de España, the Spanish central bank. "But no monetary policy can address every national problem."

The euro has proved remarkably resilient since its debut in 1999, confounding those who warned that a pan-European currency would be inherently unstable or vulnerable to outside shocks. It has withstood the recent surge in oil prices, and has grown in credibility, particularly as the dollar has lost some of its luster.

But the widening divide between euro countries has revived some of the warnings about the pitfalls of a monetary union.

Those fissures may widen after a referendum in France that symbolizes the fragility of the European experiment. The French are set to vote May 29 on whether to approve a new constitution for the European Union. With unemployment in France running above 10 percent, voters are leaning toward rejecting it as a way to vent their anger at the government of President Jacques Chirac.

Spaniards are more sanguine about their future: they approved the constitution by a wide margin in February. But skeptics say fast-rising housing prices here in Spain, as elsewhere, can be a barometer for other dangers, like an explosion in debt caused by too much money in the system. Mr. Malo de Molina said prices had risen 158 percent since 1997. Even more troubling, loans for new houses nearly tripled.

Last fall, the Banco de España estimated that prices were overvalued by up to 20 percent.

"If you go back to the mid-1980's, Spain has had the most rapid price increase in housing of any large country in the world," said Michael Ball, the author of an annual survey of the European housing market published by the Royal Institution of Chartered Surveyors in London.

For all that, Mr. Ball and other economists doubt that Spain is at risk of a Japan-style meltdown in property prices. The more likely outcome, he said, is for prices to peak and then decline gradually.

As prices continue on their vertiginous path, however, Spaniards are starting to talk about a "burbuja," Spanish for bubble.

"Bubbles grow quicker than we think, and they burst quicker than we think," said José Manuel Campa, a professor of finance at the IESE Business School of the University of Navarra.

Spain's housing boom is fueled by other factors, including rising incomes, mass immigration and demographic trends. But the main propellant is interest rates, which the European Central Bank has kept at 2 percent, a record low in the post-World War II era, for nearly two years.

With inflation and economic output running well above the European average - both close to 3 percent - economists agree that Spain could easily carry a higher interest rate.

Germany is the polar opposite. With an unemployment rate of 11.8 percent and growth of less than 1 percent, prices have been flat or even falling in recent years. Foreign investors are buying German property because it is viewed as a bargain.

On the other hand, housing prices are rising at double-digit rates in Ireland and France.

"Housing-price inflation is the first indication of a monetary policy that is too expansionary," said Jörg Krämer, the chief economist of the HVB Group in Munich. "If we get a bubble, there is a high risk it will burst."

In fact, the European Central Bank has watched the spiraling prices with concern, viewing them as a potential trigger for economic shocks. In February, the bank's president, Jean-Claude Trichet, warned that "the combination of ample liquidity and strong credit growth could, in some parts of the euro area, become a source of unsustainable price increases in property markets."

To economists who dissect such statements, that was a signal that the bank intended to increase rates.

Yet this month, the bank unexpectedly dropped its expression of concern about housing prices from its statement on interest rates. After a battery of negative economic reports from Germany and Italy, the bank watchers say, Europe's faltering growth has replaced asset inflation as the biggest concern of Mr. Trichet and his colleagues.

In such a fragile atmosphere, most economists believe, interest rates are not likely to go up for the rest of 2005. And, some add, they should not: the risk of a recession in Germany, which generates a third of the output of the "euro zone," outweighs the risks of a housing bubble in Spain.

"The E.C.B.'s stance is appropriate for the euro zone," said Manuel Balmaseda, the chief economist of BBVA, the second-largest bank in Spain. The Fed, he noted, is not judged on whether its monetary policy is suitable for New York State, but for all 50 American states.

That analogy only goes so far, however. While New York may grow at a different rate from California, the United States can adjust for these regional disparities in ways that Europe cannot.

There is more labor mobility and wage flexibility in the United States. Americans think little of moving to faster-growing states, like those in the Sun Belt, for jobs. But Germans are not likely to relocate to Spain, except perhaps to retire or buy a vacation home.

In fact, second homes also fuel the Spanish market. More houses will be built this year in sun-kissed Andalusia than in Britain or Germany. "If there's going to be a crash, it's likely to be in these coastal areas," Mr. Ball said.

With this atmosphere of euphoria tinged by foreboding, Spaniards are like partygoers with one eye on the clock.

Storefront real estate brokers have sprouted up all over Madrid and its environs, peddling everything from dingy apartments for $189,000 to elegant villas for $3 million and higher.

In the suburbs, rows of freshly built villas and apartments climb the scrub-covered hillsides. Eight miles southwest of Madrid, a sprawling bedroom town known as Boadilla del Monte has taken root next to the campuslike headquarters of Spain's largest bank, Grupo Santander.

"Spaniards have a deeply-rooted love for investing in bricks and mortar," said Pedro Ruiz-Olivares, the head of Santander's real estate division. Homeownership rates, he noted, are among the highest in Europe.

Some property tycoons have taken on the swagger of latter-day conquistadors. Metrovacesa, Spain's biggest real estate developer, recently announced a takeover bid worth $7.35 billion for a much larger French rival, Gecina.

Metrovacesa's president, Joaquín Rivero Valcarce, said he viewed France as a hedge against a slowdown in the Spanish market. "We made a lot of money in the last 10 years because of the boom," he said. "But we know that Spain isn't going to keep going like this forever."

José and Francesco González-Tejada can relate to that. The two brothers from Seville turned up at a real estate office here the other day to sell an apartment belonging to their sister, who had recently died.

The sister bought the three-bedroom flat in the 1950's for the equivalent of 900 euros. They were hoping to get 240,000 euros, even though it is in one of Madrid's rougher neighborhoods. José, who is 74, said that while he was confident, he wanted to unload it as quickly as possible.

"If we sold it next week, that would be great," he said. "We're living in a new Spain, and everything is more expensive."

Renwick McLean contributed reporting for this article.