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