Monday December 29, 2008
Global turmoil
YEARENDER/BUSINESS
The bursting of the housing bubble in the United States led to the worst global financial crisis since the 1930s and almost every country in the world is getting battered and bruised.
FROM the American Dream to a global nightmare. That is essentially the story behind the economic worries that trouble us all today. Urged on by reckless lending, the pursuit of home ownership in the United States led to the subprime mortgage crisis, which in turn short-circuited the international financial system, thus weighing down economies around the world.
Or we can tell it in a different yet familiar way – it is a typical tale of irrational exuberance, greed, and poor judgement and leadership. Either way, the ripple effect is far from over and there is a feeling that the worst is yet to come.
As with most such things, it began rather innocently early in the decade. Low interest rates fuelled a rise in demand for homes. Property prices rose and so did consumer spending.
Everybody was eager to pour money into the housing sector. The hot mortgage market attracted new lenders and new ways of packaging debts into securities that were sold to investors.
In this feel-good environment, credit controls were eased. This gave rise to the explosion in subprime mortgages, which are high-interest loans given to home buyers with low income or spotty credit history. There was this mass delusion that the value of homes could only go up - the housing boom had become the housing bubble.
US Federal Reserve chairman Ben Bernanke said at a conference on Dec 4, “One unfortunate consequence of the rapid increases in house prices was that providers of mortgage credit came to view their loans as well-secured by the rising values of their collateral and thus paid less attention to borrowers’ ability to repay.”
Bubbles ultimately burst, of course, and when this happens, there are often widespread consequences. Eventually, the housing inventory exceeded the demand for homes, signalling the end of the euphoria.
Many of those who had borrowed to purchase homes were in trouble because property prices had started falling. The subprime lenders, particularly those whose loans had adjustable interest rates, were hit hard. Around the middle of 2006, the delinquency rate for subprime mortgages started soaring. Soon, the stress spread to other parts of the mortgage market.
The financial system and the economy shifted into reverse gear. Previously an engine of growth, housing construction declined. The sagging property values pulled down household wealth and consumption.
The financial crisis reared its ugly head in August 2007. As more and more people failed to repay their loans and lost their homes, banks and investors too were badly hurt by plunging asset values, including those of mortgage-backed securities.
Financial institutions were reluctant to lend not only to house buyers but also to businesses and consumers. This caused a credit crunch that stifled economic activity.
A vicious cycle was in place. The housing downturn had triggered an overall slowdown, which then further softened the demand for homes. This only made things worse for the mortgage and housing markets. And so it went on until something had to give.
A series of casualties and near collapses in the United States shocked the world. These included big names such as Bear Stearns, Wachovia, Washington Mutual, Lehman Brothers, Merrill Lynch, American International Group, Fannie Mae and Freddie Mac.
In particular, the failure of Bear Stearns, Lehman Brothers and Merrill Lynch (three of Wall Street’s five largest investment banks) underscored the point that the global financial system was indeed in much distress.
In Europe, the financial institutions that caught the contagion included Britain’s Northern Rock, Hypo Real Estate of Germany and Belgium’s Fortis.
The crisis also sparked debates on the role of the government – that it could have done more to prevent the mess and that it might be taking on too much in trying to clean it up.
A key move by Washington was the tabling and passage of the Emergency Economic Stabilisation Act, which allows the Treasury Department to implement the US$700bil Troubled Asset Relief Programme to purchase troubled assets from financial institutions in order to promote market stability.
Said Treasury Secretary Henry Paulson on Oct 3, “The broad authorities in this legislation, when combined with existing regulatory authorities and resources, gives us the ability to protect and recapitalise our financial system as we work through the stresses in our credit markets.”
The economic fallout of the financial crisis stems from the lack of liquidity available to businesses. The uncertainties and waning confidence do not help either. In these conditions, companies hold back investments, unemployment creeps up and household wealth deteriorates because of the weak stock market.
The financial crisis spilled over to other businesses. The US automobile industry was next to ask for Government help.
Given these factors, achieving gross domestic product growth is an uphill battle. Inevitably, the US has slipped into recession. Others in the same leaking boat include New Zealand, Singapore, Japan, Iceland and the Euro Zone (comprising 15 countries that use the euro). Britain and Australia are about to enter recession.
With so many developed nations reporting stuttering economies, the rest of the globe is feeling the pinch as well. World trade is waning and the once ebullient commodity prices are well off their peaks.
There is no doubt that the flow of bad news will continue in the coming months. Will it be a long, painful wait before the global economy regains its health? An innovative and co-ordinated response from governments and the industries may be our best bet.
Malaysia to avoid recession
THE impact of the global financial crisis is felt in Malaysia as well. On Nov 4, the Government lowered its expectations for the country’s economic expansion. It revised its projected gross domestic product growth for 2008 from 5.7% to 5%, and cut its 2009 forecast from 5.4% to 3.5%.
Bank Negara Governor Tan Sri Dr Zeti Akhtar Aziz More importantly, on that day, Finance Minister Datuk Seri Najib Tun Razak unveiled the Government’s first major response to the crisis. The plan is to adopt an expansionary policy to boost economic growth, and this is to be implemented via a RM7bil stimulus package.
“The domestic economic growth must be supported, especially by domestic demand spending. Extraordinary times require extraordinary measures,” he said when winding up the Budget 2009 debate.
He reiterated that Malaysia’s economic fundamentals remained strong.
Because it has reduced its fuel subsidy, the Government is able to channel RM7bil towards development initiatives that will yield near-term and long-term benefits.
Among other things, the amount will be spent on housing; education; public transportation; maintenance and repairs of schools, hospitals and roads; upgrading and repairing of police and army facilities; rural roads; and grants, loans and equity capital to attract investors.
Another key measure is to allow employees to reduce their EPF contribution by 3% so that they have more money to spend.
On Nov 28, Bank Negara governor Tan Sri Dr Zeti Akhtar Aziz said Malaysia was well-placed to avoid sliding into recession next year because it had become more resilient since the Asian financial crisis in 1997-98.
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