By Cinzia Alcici and Daniel Gros

Spain faces high unemployment and slow growth. This column focuses on an important sources of those problems ? its housing market. While some adjustment has occurred since Spain's housing bubble burst in 2008, house prices and construction need to decrease more to slow Spain's unsustainable accumulation of foreign debt.

What is the problem in Spain? It started with a classic housing bubble financed by foreign capital, and as a textbook would predict, once the inflow of foreign capital stopped and the bubble burst, unemployment soared and the financial system went bust as well (Reinhart 2008).

The current fiscal problems mostly reflect the housing bust. The Spanish government is running a large fiscal deficit as the economy remains weak and the ever-increasing losses in the banking sector hang like a sword of Damocles over the public sector.[1]

On this ground, too much attention has thus been focused recently on the Spanish deficit overshoot in 2011 and what deficit might be attainable in 2012. More attention should be focused on the factors behind the deficit. We argue that the root problem is that the Spanish housing bubble was extreme and that the adjustment has simply been too slow. In particular, we provide a novel angle on two key questions: how long it will take to absorb the legacy of the bubble and how much it will cost?

The Spanish housing bubble

Most commentators concentrate on house prices, usually in real terms, as the measure the housing bubble and its developments (e.g. M