An article at the Spanish property portal Idealista.com by Carlos Salas explains how banks and valuation companies helped inflate the disasterous Spanish property bubble by ignoring valuation principles, but have never paid for their transgressions.
Adaptation and translation of an article published by Idealista.com.
Banks who made loans as if they were handing out sweets, clients who borrowed as if they’d found Aladdin’s magic lamp, and officials who looked the other way when faced with the property boom… these are all things we do know about the bubble that burst in 2008, leading to the biggest financial crisis in Spain’s recent history, and the demise of the property sector.
But what many people don’t know is that all this could have been avoided if the banks had stuck to one principle, and Bank of Spain had fined those who didn’t. In reality, everyone turned a blind eye and just let things carry on. So what was this principle? A moral one? Not quite, but almost.
It happens to be the principle that all valuation companies should comply with. Those companies were the ones responsible for the valuation of properties that banks approved mortgages for. Since most valuation companies belonged to the banks, and banks wanted to approve high mortgages to boost business, during the years of financial euphoria there was no way of controlling volume or quantity.
But it turns out there was a way of doing it: a regulation from 2003 stated that valuers should be guided by a series of principles. This is called ‘Orden eco/805/2003, from 27 March, on rules for valuing property assets and particular rights for certain financial purposes’. It was published in the official state bulletin on 9 April that year and can be found on the Bank of Spain’s website.
It transpires that for mortgage loans, there was a criteria that “had to be applied”: it’s called ‘the principle of caution’. The law states the following: “in the face of several equally probable scenarios or choices, the one with the lowest value must be chosen”.
The lowest value? The whole of Spain was immersed in the age of greed, and no one complied with this criteria of caution or forced anyone to comply with it.
Properties went up in price because valuation companies inflated their reports ignoring the lowest price. Their reports were a pretext for banks to approve higher and higher mortgages, which in turn pushed property prices up, but at an irrational rate.
A property market expert remarked during those years that “there were valuations that clearly vindicated the “anything goes” aspect of Spain’s recently burst property bubble”.
In 2007, the government approved a mortgage market law that proposed heavy fines for non-impartial valuation companies, but not a single fine was ever handed out.
For those who are interested, this is the part of the law that details those principles:
Article 1: Credit entities with valuation services and approved valuation companies when make a valuation for any of the purposes included in the scope of this law they must do so by applying, under the terms established herein, the following principles:
a) Principle of anticipation, by which the value of a property being bought depends on the expectations of return that it may feasibly yield in the future.
b) Principle of purpose according to which the purpose of the valuation conditions the method and the valuation techniques to be used. The valuation criteria and methods used will be coherent with the purpose of the valuation.
c) Principle of bigger and better use, by which the value of a property likely to be used for different purposes will be the one that comes from using it, within legal and physical constraints, for the most financially advisable option. Or if it is likely to be built with a different building density, the value will be that one that comes from building it, within legal and physical constraints, with a density that yields the highest value.
d) Principle of probability, according to which, when faced with several reasonable scenarios or choice, the most probable one must be chosen.
e) Principle of proportionality, according to which valuation reports will sufficiently long and bear in mind the importance and use of the asset being valued as well as their market uniqueness.
f) Principle of caution, according to which, when faced with several reasonable scenarios or choice, the one with the lowest value should be chosen.
g) Principle of substitution, according to which the value of property is the equivalent of assets with similar substitutable characteristics.
h) Principle of timeliness, according to which the value of a property is always variable.
i) Principle of transparency, according to which a property valuation report should include necessary and sufficient information for easy understanding and detail the hypotheses and documentation used.
j) Principle of residual value, according to which the attributable value of each of the production factors of a property will be the difference between the total value of said asset and the values attributable to the rest of the factors.
Spanish Property Insight adapts and translates selected articles from the local press for the benefit of non-Spanish speakers.
This translation is based on the following article (in Spanish): El (desconocido) principio que ayudó a hundir al sector inmobiliario
Thoughts on “How Valuation Companies Helped Inflate The Spanish Property Bubble”
Can we stop just blaming the housing crisis on the banks, the economy, the politicians, the valuation companies etc and put the blame on the doorstep of the biggest culprits- PEOPLE WHO BOUGHT OVERPRICED PROPERTY.
The fact is that the banks and the appraisal companies were encouraged, forced even, to lend money to people who wanted to buy property they couldn’t afford, based on mad ideas that “property prices never drop” and “always buy because renting is throwing away money”.
10 years ago everyone and their uncle thought that it was their right to be able to buy property at a whatever price, even though they earned little and had saved up nothing for a deposit. So they played one bank off another, looking for who would lend them the most amount of money regardless of their ability to afford it. Banks make money by lending out money! They had to lend it out otherwise they couldn’t pay the interest on the money deposited by the savers out there (mainly the Germans). The appraisal companies helped by inflating the valuation of properties to allow a better loan to valuation ratio so people could borrow even more money. And the appraisal companies took the attitude “we’ll say this property is worth double it’s true price- because in this bubble soon it will be- and if we are wrong- oops never mind.”
Of course I’m not saying the banks and appraisal companies were powerless or are blameless. Only that they share the responsibility of creating the bubble with the people they lent money to.
What should happen to avoid this:
1. Nobody should be able to borrow more than 80% of the value of the property they are buying.
2. Nobody should be able to spend more than 1/3rd of their net income on paying for a property loan.
3. Appraisal companies should be held professionally liable to correctly value properties.
4. Banks should not be able to pursue borrowers for more than the value of the loan or the property it is secured against, whichever is the LOWEST. i.e. if the property goes below the value of the loan, the borrowers will be able to just give the property back and not have to pay back more.
5. People should realise that the only way to own the house of their dreams- is to wake up from their dream and go and earn the money – or change their dream.
6. People should realise that just because you don’t own a house doesn’t mean you’ve failed in life.
Note that none of these measures will kill the property market- on the contrary, the market would kick back into life tomorrow if, now that the banks are being more selective, people would price their price their property according to what buyers today can really afford.
speakupboy’s response is the most delusional thing I’ve seen on the Internet today.
When I was looking for a mortgage in 2012, even though they were nearly impossible to get, employees in more than one bank said that I could afford to ‘spend more’ than I had budgeted.
But here is the rub: Banks have legal responsibilities to be responsible. Blaming the home buyers, many of whom were duped by real estate agents, city governments and banks is worse than ignorant. It is mean spirited and not true.
quite right speakupboy, anyway the valuation companies were just colluding with banks, agents, buyers etc – they got the valuation instruction on the understanding that they’d co operate with the high price/ valuation etc ; everybody got their kickback and commissions and the punter got what he couldn’t afford…… the punter colluded in Spain borrowing 120% and using the extra for a holiday, a new seat ibiza, flat screen tv …….. the same has gone on in the Uk since the early eighties; dodgy valuations via your friendly mortgage broker who has a tame valuer, tame bank manager etc ………. still going on :(((
BC Man says:
The situation which arose in 2008 was a universal screw-up! But to blame home buyers for the mess is pretty delusional to say the least! Home buyers in Spain were caught up in the agent euphoria! None as HYPE! Here’s an example; agent meets buyer, buyer is a little reluctant as the price seems high, agents response is “prices are rising at 10% a month currently…Wow Buyers is more than happy to shell out the high price. What you have here is a PONZI scheme. Didn’t a guy in the USA get life for running the same scam? Eventually the whole thing has to blow up, its just a question of when and how. Wildly inflationary markets are subject to this type of meltdown, and always will. There is a big difference between natural inflation and unnatural inflation, which I’m sure many knuckleheads in the industry in Spain would like to reignite! The trick is to know when to bail.
Good post BC Man despite huge glut of properties but they want to build more, madness,blue touch paper already lit by a group of agents and developers and PR machines as if all in it together. Previous boom caused by hype or lies and huge commissions mainly Brits duping Brits, just hope people have learnt. So unregulated in Spain.
CAMPBELL D FERGUSON says:
The banks employ the valuers and when the bank is awash with money and the bank manager is being pressured to lend it, if the valuer doesn’t come up to the value the borrower and manager want, the valuer knows he won ‘t get any more instructions. Those are the fear factors. The greed factor is of the borrower who signed the mortgage document after being told by the agent that the stats showed easy % increases over the last few months and years. They saw a straight line graph going upwards and piled in. Everyone is to blame, but at the end of the day only one person actually took action by signing the deed.
And now we have a pile of funds building up again. But the banks are being much more cautious, thus holding so many in negative equity. Now is the time when the banks should be lending 110% as its highly unlikely prices are going to collapse again. As prices rise, the % of loan to value should be reduced so that as the market reaches higher levels the bank’s mortgage and the borrowers loan is well covered if there is a bursting bubble. Last time it was the opposite and that’s what caused the problem.
BC Man talks of PONZI schemes. The biggest one is the UK National Insurance scheme, but that’s another subject!
Graham Hunt says:
Having worked in the market for 16 years, having put up with the banks for most of that time and having written much the same about the responsibility of the valuation companies in the casino of the mortgage market years ago I think that I may have a few pertinent points about this.
The banks employed the valuers and told the valuation companies what price they needed the valuation at. The valuers then used the comparative method, as they should, to search out their own most overvalued recent valuations (Not transactions) to give a “true” comparison. If a valuer refused to play along they were sacked, therefore the whole problem stems from the banks.
The buyers in general had affordability covered as long as interest rates stayed low (13rd of income). The banks explained to the buyer that interest rates would not rise because “they don’t”. People believed the banks because people do. When Euribor, the rate applied to 90% of Spanish mortgages, rose after the financial crisis it caught all of those buyers out. Again the banks’ fault.
There were no backhanders to valuers, they were just paid the rate according to the valuation so the higher it was the more it cost and the higher their pay for doing the valuation. Therefore they had another incentive to value as the banks required them to do.
As for some of the comments here, how mean spirited and not surprisingly just plain wrong on the facts. Caused by Brits duping Brits David? I think not. Even at the height of the property boom only 20% of the market was to foreign buyers. Internal demand powered the market. Speakupboy, just a bigot with an agenda perhaps or maybe a bank schill. Banks were not forced to lend and appraisal companies were definitely not forced to as they don’t lend. Banks chose to lend on property rather than I+D, business loans or whatever because it gave better and more guaranteed returns because they knew that because of Spain’s arcane debt laws and the way the cards are stacked against the mortgage payee that their risk was lowered because they can take the borrower for everything they earn for the rest of their life. As BCMan said, only those who knew how to bail at the right time got out unscathed and there were few of those.
You may have worked in the market for 16 years but not in Spain. I think you have quite a history in the UK!!
Graham Hunt says:
Oh yes Phillip. How would you know. I have lived in Spain for 25 years in total now. The last 17 in Valencia. Good enough?
Credit was too easy. Interest rates were too low. People who owned property were happy to see the value of their assets increase monthly. Politicians were happy that people were happy.
The contributors here have by and large identified all of the issues and simply differ in who should take the blame. The truth is there is no one group to blame. The circumstances just collided with themselves. All of the players have had a share of the fallout. I feel no sympathy nor animosity towards any of them.
Give me an example of a group that has been unfairly affected by the crisis and I will be happy to explain why you are wrong.
@ Graham Hunt I believe you work on the Costa Blanca selling property, an area I’m not to familiar with, however I know the CDS like the back of my hand and it was most certainly Brits duping Brits as well duping other nationalities all over the CDS in the boom days. The CDS was saturated with british owned estate agencies some with chains of offices, unfortunately one can see attempts to start that all over again. In those days nearly all property was severely overpriced due to overvaluations in order to get mortgages, the result now is huge numbers of people are now in negative equity and unable to sell. Those British agents also used in house lawyers then. It was a nightmare time for Brits to figure out who was telling the truth.
Graham Hunt says:
Not at all David, mostly I cover the city of Valencia and the area around. If it was the Costa Blanca then sure, plenty of Brit on Brit scams. However as I said earlier over 80% of the market has always been Spanish in total so the market was mostly fuelled by banks reckless lending practices to buyers and not abiding by the rules the Bank of Spain put in place in 2004.
Graham Hunt says:
By the way David, agreed totally on the point of a nightmare to know who was telling the truth. That is why I try to get truth out there and am totally transparent on social media. Let people decide for themselves.
Graham, I appreciate most of your coverage is in and around Valencia so I’d describe that as more of a niche market, do you market for lifestyle change or investment potential because with the latter I can’t get my head around maybe 20% transaction costs to buy and sell meaning properties have to rise that much to break even? Other investments like stock market only have around 1% transaction costs, well that’s what I pay in total to buy and sell through a leading Bank’s brokerage. Clearly then one could safely buy through you, maybe new buyers should head there because it’s difficult to pick who’s trustworthy elsewhere. Unfortunately the Costas in general are huge both inland and on the coast itself, and that it where many of the Brit on Brit scams definitely took place, well from what I know of the CDS and media reports. I fear similar is already starting again on the CDS from my observations there.
Graham Hunt says:
Mostly for lifestyle change. We get a lot of people who can work from anywhere and would prefer to have a huge pile in Valencia than a shoebox in London for example 🙂 Transaction costs are too high of course but nowhere near 20%. It’s possible to make money as an investor if you buy carefully and sell a bespoke ready to go property as the majority of the properties on sale are, let’s be charitable and say, not presented well.
Personally I think that the stock market is hugely overpriced and a rather large bubble waiting to burst. It’s just like the property market in 2007 or the London market right about now.
Good reasons to keep away from the Costas and do a lot of homework before buying.
Graham as I experienced from buying and selling in Spain, our purchase transaction costs were 11% (+ extras such as Bank remittance and collection fees) plus exorbitant Bank charges thereafter even by staying in credit (one needs a Bank account for bills etc), and our selling costs such as agents’ fees etc were all of 8%, so when I mentioned these costs I meant for buying and selling.
Stock markets are too frothy I agree but with stamp duty of half a percent to buy and £12.95 commission plus £1 levy, plus just £12.95 to sell, transaction costs are less than 1% in reality. The difference with non property markets is that you can buy and sell in an instant unlike property and as we know in Spain many people have been trying to sell for years and at a loss to boot.
Lifestyle change has to be the main plus point of buying in Spain generally and I agree people should do their homework and keep away from the Costas and huge urbanisations.
Jack Siddle says:
I bought a property on a mrtgage in 2007, a few days after the purchace it was dicovered that bankia new that properties were down by 50%, itraser valued the property, knowing that the bank had manyin negative equity. However i complained to bankia that they knew properties were don in price. I wrote to bankia anb they did not reply, after about 70 letterslater still no reply, I then called defenser del cliente, type ombudsman, defenser to date are having trouble getting bankia to reply, It is my intention to get Bankia into court, but it is mandatory tofollow rules first to exhaust all possible amswers. So bankia have yhe answer dumb inscolence, it takes a lot of beating.