Overdrawn! Global credit crisis continues to unfold

Overdrawn!

As the global credit crisis continues to unfold at a rapid pace, the leading commentators ask how much more is to come

By Madeleine Heffernan

Warren Buffett says buy shares now. The 78-year-old American billionaire investor says he is buying US stocks for his personal account. 'A simple rule dictates my buying: Be fearful when others are greedy and be greedy when others are fearful.' But even Buffet's recent opinion piece in The New York Times hasn't been enough to persuade investors to re-enter the market.

Perhaps investors were getting their clues from another billionaire mogul, media owner Rupert Murdoch. The News Corporation chief says the global financial crisis has left no sector untouched. Shares in News Corporation have lost 60 per cent in the past year. That situation could just as easily change in a heartbeat, given the incredibly rapid pace with which the current global credit crisis has played out.

Observing the trigger points that have caused it and the subsequent effect on markets, the banking system and governments has put even the best observers through their paces. Even the usual prediction gurus have been left reeling by the gathering momentum.

For many investors, it is a case of continuing to keep an eagle and wary eye on the daily rollercoaster ride of the share market as the complex and intertwined global credit squeeze continues to play out. But, the question on a much broader range of lips is where will it take us next? All we can work with in that regard is what has been publicly disclosed so far.

The International Monetary Fund (IMF) recently estimated the crisis would cost US$1.4 trillion, about the same figure quoted by National Australia Bank CEO John Stewart back in July. Since then, banks across the world have reported losses of more than US$500 billion, and more than $US500 billion of public money has been granted to the banks and the US government-sponsored lending entities Fannie Mae and Freddie Mac.

The banks have also raised in excess of US$300 million from private investors, but Stewart believes there's plenty more of the same to come. Stewart, the outgoing CEO at NAB, forecasts banks will need to raise capital 'by the shovelful' over the next two years. He also says the investment banking model we once knew is gone, and he predicts that banks will be nowhere near as geared as they once were.

The US$1.4 trillion damage estimate is all the more remarkable because it was less than a year ago that Australian investors were drunk on the commodities boom, pushing the ASX200 to above 6800 points.

Nowadays, the index is following the wild gyrations on the US market and has more than once dived below the psychological barrier of 4000 points. Long gone are concerns over the 'inflation genie', monitoring CPI has instead taken the back seat to mitigating a slowdown at best, or recession at worst.

According to Alan Kohler, leading financial commentator of The Eureka Report, now that 'central banks and governments are the only buyers of risk assets, banks are being nationalised and / or governments are forced to guarantee their deposits. A long and deep global recession seems assured and free-market capitalism itself seems to be collapsing'.

He foresees the likelihood of a re-regulated banking system, as people revolt against the use of taxpayers' funds to bail out the mistakes of publicly listed companies. Big banks are likely to emerge stronger, as we saw with the Commonwealth Bank of Australia snapping up the Halifax Bank of Scotland's (HBOS) Australian unit BankWest for a bargain basement price, and the vultures are circling Suncorp's banking and wealth management arms.

Some are even talking about the removal of the Four Pillars system, which maintains the separation of the four largest banks in Australia by not allowing their merger or acquisition by any of the other four, saying competition is less important than survival.

In order to make some sense of it all, it's worth revisiting how 'a US housing problem' transformed firstly into a credit crunch, and later into a global financial crisis, with the possibility of a recession still looming large.

The global financial crisis can be traced back to the late 1990s, when the Clinton administration wanted to boost the level of home ownership among minorities and people on low incomes. The administration amended an act introduced in the 1970s by former president Jimmy Carter which loosened lending requirements in a bid to boost house ownership among minorities.

The 1999 amendment allowed Fannie Mae, which purchases loans made by banks on the secondary market, to soften the credit requirements on loans it purchased from banks and others lenders. This decision by the largest underwriter of home mortgages paved the way for people who did not qualify for conventional mortgages, those with a limited credit history, low or no incomes, or a history of bankruptcy, the opportunity to get a home loan.

The emergence of the so-called sub-prime loan also gave a shot in the arm to Fannie Mae's stock price and allowed banks, mortgages institutions and thrift institutions to widen their home-loan net.

According to The New York Times, the Fannie Mae sub-prime pilot program gave borrowers an interest rate one percentage point higher on a mortgage of less than US$240,000 than a regular, 30-year, fixed-rate mortgage.

The rate would drop after two years if the person made the appropriate monthly payments. Spurred by an ease of access and historically low interest rates, the US Federal Reserve cut rates to 1 per cent after the 11 September 2001 terror attacks on New York's twin towers in a bid to stimulate economic activity.

The US housing market soared 86 per cent from 2000, peaking in 2006 and 2007. Sub-prime lending ballooned, making US$625 billion in 2006, or one-quarter of all new mortgages.

From sub-prime we moved to Alt-A or self-verification loans, where applicants stated their assets and income, and then to NINJA loans, which were given to people with no income, jobs or assets. The rise in house values encouraged people to draw from their mortgages to use the equity they believed they had gained in their homes. But as with all bubbles, it eventually burst.

Rising interest rates, from 1 per cent to 5.35 per cent between 2004 and 2006, pressured home owners. Defaults and foreclosures started to rise to record levels as borrowers (particularly the NINJA borrowers) realised they could no longer afford their repayments once the introductory interest rates were phased out. Default and foreclosure levels soared, pushing down house prices by as much as 40 per cent and creating ghost towns across a number of US states.

Officials in California were, ironically, faced with a mosquito infestation problem because of stagnant swimming pools in abandoned homes. A recent article in The Wall Street Journal stated that one in six US home owners is paying more on their mortgage than their house was actually worth.

And as people defaulted on their loans on a wide scale, mortgage and loans groups throughout the US went bust. One key difference between sub-prime lenders and traditional banks was that most sub-prime lenders were financed by investors on Wall Street rather than through deposits.

With sub-prime, the mortgage assets alongside other loans, bonds and assets were bundled into portfolios (residential mortgage-backed securities or RMBS) and sold to investment banks, superannuation funds and hedge funds throughout the world. And many of these mortgages were placed into the asset pools that backed securities, called collateralised debt obligations (CDOs).

Fear spread as people wondered whether the RMBS were prime or sub-prime, toxic or otherwise. This fear encouraged banks to begin hoarding cash and stop lending to companies, to individuals and to each other. The 'credit crunch' had emerged and it was no longer just a US problem.

Debt was harder to find and more expensive. In a credit-constrained environment, highly leveraged companies such as Australia's Centro Property Group, Allco Finance Group and Babcock & Brown were burned.

Perhaps the first sign of big trouble was New Century Financial, which specialised in sub-prime mortgage, filing for Chapter 11 bankruptcy protection in April 2007. But a real shock to the system was in July 2008, when investment giant Bear Stearns told investors to expect to see little, if any, of the money invested in two of its hedge funds.

This prompted Federal Reserve chairman Ben Bernanke to warn that the sub-prime crisis could cost up to US$100 billion. That the credit crunch had travelled abroad was confirmed in August 2007, when French bank BNP Paribas noted the 'complete evaporation of liquidity' in the market and told investors they could not take money out of two of its funds.

One by one, sub-prime losses emerged from the US and Europe: UBS, Bear Stearns, Wachovia, Citigroup, Merrill Lynch, Credit Suisse and Barclays were among those reporting billion-dollar write downs.

Some investment banks put their hands out to sovereign wealth funds, such as Singapore's Temasek, the Qatar Investment Authority and the China Investment Corporation, but unfortunately for the cashed-up, government-owned companies, these investments did not pay off. Sovereign wealth funds are estimated to have lost US$30 billion on their investments in western banks.

Because of the massive writedowns, the banks could not lend as they used to. Inter-bank lending rates surged. Economic growth was sliced. The commercial paper market slumped. There was a clear indication that it was hard for even strong companies to fund their daily needs. Sharemarkets around the world dived.

Those who most aggressively repackaged sub-prime loans, such as Bear Stearns and Lehman Brothers in the US, were the worst hit.

Investment banks faltered under the weight of toxic real estate and securities, and one by one they have fallen. Bear has been forced into a shotgun marriage with JP Morgan Chase, Lehmans was allowed to fall, and Bank of America took over Merrill Lynch for US$50 billion.

This leaves Goldman Sachs and Morgan Stanley as the last two standing, but they too will desert the shadow banking system for the traditional banking system.

Some companies were deemed too big to fail: Fannie Mae, Freddie Mac and AIG, America's largest insurance group. Others, such as Lehman Brothers, HBOS, and Washington Mutual, were not.

While central banks and banking authorities had been tinkering around the edges, cutting rates here and pumping billions into the banking system, the US Government tried to stop the rot with a US$700 billion bail-out package.

It sought to buy up Wall Street's 'toxic' assets and boost confidence in the financial system by separating the good assets from the bad. Major western economies also moved to guarantee bank deposits.

The central banks and governments in the US and Europe are now taking equity in banks and guaranteeing inter-bank loans. The UK Government said it would make £400 billion of capital available to eight of the UK's biggest banks and building societies in return for preference shares.

Back to Australia, and the Reserve Bank has cut interest rates by two percentage points (at the time of writing). The Australian government has unveiled a $10.4 billion stimulus package and said it would guarantee bank deposits for three years and has lent its AAA rating to Australian banks to facilitate term wholesale funding.

We're yet to deal with the massive credit default market, which some believe will cause problems greater than those caused by sub-prime. Kohler sees difficult years ahead for the banking, resource and retail sectors, but advises investors to not lose hope. 'These are the times when great fortunes are made, but they are always made at the expense of those who have given up,' he says.

According to Robert Gottliebsen, The Eureka Report columnist, an American downturn will last for at least two years, perhaps three or four. He thinks global banks are still harbouring 'enormous losses' that have not been disclosed to shareholders.

A loss of confidence prompted by further writedowns, plus the need to raise more capital, will see bank shares under pressure for some time, he says. And the removal of the government guarantee on deposits and lending in a few years will also hurt smaller lenders.

Morgan Stanley economist Gerard Minack, who had previously warned the ASX 200 would drop to 3500 and the housing market would fall, is now advocating investors dust themselves off and pick up some bargains.

The 'risk reward now favours buying risk assets,' he says. But Minack too warns of a few troubling years ahead. 'We have a potentially deep recession ahead of us, against the backdrop of unprecedented pressure for the financial sector to deliver.

But, whether fortune favours the brave in times of economic downturn, we are likely to be closely observing the daily unfolding of the current credit crunch for some time to come and picking over the likely ongoing impacts on an unprecedented global scale.


INTHEBLACK
Reference: December 2008, volume 78:11, p. 28-31

Subprime Crisis (who's to blame?)

The number of failing financial institutions and the actions under way for their governmental bailout hit unprecedented levels in recent days. From Fannie Mae and Freddie Mac to AIG and proposed government liquidity pools, actions by the U.S. Treasury, the Bank of England, and other central banks have been broad and monumental. Rarely are we confronted with such important and far-reaching events, and seldom have the stakes been higher.

To a certain extent the following participants are to blame for the creation and magnitude of the subprime crisis ....

• Individual real estate speculators who took out the loans in the first place.
• Mortgage underwriters and their misapplication of loan standards.
  Financial firms that engineered and proliferated highly structured mortgage-backed securities.
• Financial firms that hold these securities—often in off-balance-sheet structures—with inadequate risk and internal control systems.
• Credit rating agencies and careless or negligent ratings on mortgage-backed securities.
• Lax regulators and insufficient regulation of investment and banking institutions.

Zeti: Too early to know impact of fuel price hike

Friday June 13, 2008

KUALA LUMPUR: It is too early to see the impact of the recent fuel price increase on inflation and growth, says Bank Negara governor Tan Sri Dr Zeti Akhtar Aziz.

The central bank would need to study carefully the impact as it was not just the slowing down of the external sector but also involved the effect of stimulus packages being put in place as well as recognising the nature of price increase due to rising costs, she said.

“We have to make a careful assessment whether this is passed on to consumers. When that happens, then you have the inflation when there is a generalised price increase,” Zeti told reporters after the launch of the International Centre for Education in Islamic Finance’s (Inceif) Masters programme in Islamic finance yesterday.

Currently, she said, there were only specified prices rising.

“It is too early to assess whether this is being translated and passed on and whether the producers have the capacity like what they had so far in absorbing part of the increased cost. Then, the consumers’ response, whether they will continue with very strong demand or whether we see some moderation.

“All this will be assessed very carefully in the months to come as we determine our monetary policy response,” she said.

Bank Negara’s interest rate policy would depend on the outlook on inflation and growth, she added.

On slipping into negative interest rate territory, Zeti said Malaysia had some negative real interest rates but as long as it was not fundamental, it would not damage consumer demand and the position of consumers.

Asked if the central bank would consider intervening in the currency market to avoid any instability, she said: “The underlying trend is not something that we try to influence and from time to time, you would see volatility. In fact many times, there will be increased volatility because of the great uncertainty that is occurring in the international financial system.” – Agencies

Zeti: Inflation likely to reach 10-year high

Friday June 6, 2008

KUALA LUMPUR: Bank Negara sees Malaysia's inflation rate rising to a 10-year high following the recent increase in petrol prices but says it will not alter its current interest rate policy.

Governor Tan Sri Dr Zeti Akhtar Aziz said that as a result of rising energy prices, Malaysia’s inflation rate would average 4.2% this year but there was no rush for the central bank to raise the current overnight policy rate of 3.5%.

“We do not consider it of any urgency to call a special meeting of the monetary policy committee and we will make that assessment going forward,” she told reporters after delivering the keynote address at the 12th Malaysian Banking Summit here yesterday.

The central bank had earlier set an inflation target of 2.5% to 3% for this year.

The inflation rate of 4.2% would be the country’s highest since 1998 when it peaked at 5.3%.

“Right now, we don’t see any critical developments. The Government has the capacity to deal with both rising prices and how they impact certain target groups,” Zeti said.
She said the initial price impact would be felt in June during which inflation was expected to be about 5%.

“The increase in prices is expected to peak in the first quarter of 2009 before moderating to less than 3% in the fourth quarter,” she said.

On Wednesday, the Government revised upwards the price of petrol to RM2.70 per litre from RM1.92 per litre previously while the price of diesel was also increased by RM1 to RM2.58 a litre.

Zeti said despite the inflationary pressure, the economy was expected to expand 5% this year. Last year, the economy grew 6.3%.

She also reiterated that the central bank had no plans to use the ringgit as a policy tool. “The foreign exchange would continue to set the currency’s value,” she said.

Financial sector to play vital role in 2020 economic target

Friday June 6, 2008
KUALA LUMPUR: The financial sector has an important role in helping Malaysia develop its economy by 2020 via the channelling of productivity and driving endogenous growth in other economic sectors, Bank Negara governor Tan Sri Dr Zeti Akhtar Aziz said.
In her keynote address at the 12th Malaysian Banking Summit yesterday, Zeti said Malaysia had strong competitive advantages in two areas: Islamic finance and shared services and outsourcing (SS0).

“Malaysia is at the forefront of Islamic finance, housing the world’s largest sukuk market with 65.8% of the global outstanding sukuk as at end-March,” she said at the summit, themed Taking the Leap in Paradigm Shift of Banking - New Wave, New Ventures.

Zeti said the promotion of Malaysia as an international Islamic financial hub was expected to catalyse growth in other economic sectors.

“Positive effects are expected to spill over into the markets and related industries such as property, health, education and business services, spreading the sector’s growth momentum to the economy.

“The Malaysian banking sector on the whole is sound. Domestic banking institutions, in particular, have benefited from the broad-based reforms and capacity building measures that had been undertaken following the Asian financial crisis,” she said.

Zeti said the progress of the financial sector had surpassed initial expectations outlined in the Financial Sector Masterplan.

The financial sector, she said, had maintained a steady growth momentum since the Asian financial crisis, with the profitability of the Malaysian banking system growing by 36.7% to RM17.7bil last year.

Zeti said going forward, the industry’s liberalisation plan aimed to reinforce the role of the financial sector in the next phase of development, capitalising on core comparative advantages while reaping benefits from alliances and partnerships. “An area that will be pursued is increased strategic alliances with foreign partners and greater foreign participation in our financial markets,” she said.

On the regulatory front, Zeti said Bank Negara would continue to direct significant efforts and resources towards strengthening its surveillance capabilities to detect, monitor and to deal pre-emptively with emerging risks in the financial system.

Less painful way to own a house (September 8, 2007)

FROM Jan 1 2008, EPF contributors can make monthly withdrawals from their Account 2 balances to pay off their housing loans.
“For many of us, a house is a very important asset. A house not only appreciates in value over time, but also provides security for our future. Housing repayments, however, are a major financial commitment.
“This move will benefit five million active EPF contributors. It will also enable contributors to own better houses and lessen their monthly financial obligations,” said Prime Minister Datuk Seri Abdullah Ahmad Badawi.
There is also a proposed 50% stamp duty exemption on the transfer of documents for houses costing less than RM250,000.
To promote family values and financial security, full stamp duty exemption will be given on transfer of property from husband to wife.
“In cases where the wife wishes to transfer property to the husband, the same exemption applies,” he said.
To help those without fixed incomes to buy houses, the Government will establish a fund to provide guarantees to banks, which in turn will be asked to give loans to such groups of people.
“These will include farmers and small traders, also those who have the capacity to repay their housing loans but are unable to provide proof of their income stream,” said Abdullah.
For a start, RM50mil will be allocated to Bank Simpanan Naisonal and Bank Islam Berhad to kick-start the scheme, beginning Jan 1.
To help the poor, RM381mil will be given for the implementation of low-cost housing programmes, Abdullah said.
The Syarikat Perumahan Negara Berhad (SPNB) has been directed to rehabilitate 6,000 units of abandoned houses. It will also build 36,000 affordable homes and 4,000 Rumah Mesra Rakyat (homes for the people).
Next year, 13,000 quarters for civil servants are expected to be completed.
The Government has allocated RM887mil in 2008 to build more quarters for civil servants nationwide.
As for the orang asli, from the RM170mil provided to the Department of Orang Asli, RM50mil will go to housing assistance and social amenities for them.


http://thestar.com.my/news/story.asp?file=/2007/9/8/nation/18821072&sec=nation