Credit taps may run dry as US crisis spreads to other regions
By
Matt Smith on Sunday, October 05, 2008
The Washington horror show is over, at least for now, with the United States Congress finally approving the $700 billion (Dh2.26 trillion) rescue of the stricken American financial sector on Thursday.
But readers hoping this will mark the end of the credit crisis are set to be disappointed, with most economists warning its full impact on the wider US economy is yet to come, and that could spell disaster for the buoyant Gulf region.
"The Middle East could be in for a nasty shock," said Dr Venkatraman Anantha-Nageswaran, Julius Baer head of investment research for Asia Pacific and the Middle East.
"It would be realistic to assume that real estate and infrastructure projects relying on foreign funding will be in trouble. If the government steps in to provide funding it will have long-term fiscal implications, most notably a deterioration in the government budget, and wouldn't set a good precedent."
Lending spree
Reckless lending has caused the current credit crisis. US banks gave 100 per cent "sub-prime" mortgages to low-income people in the errant belief that US property prices could only go up and so if these borrowers did default then their debts money could be more than recouped by repossessing their homes. These mortgages were then packaged up and sold to banks across the globe. For a while this plan worked, with historically low interest rates fuelling a US property bubble, but once sub-prime teaser interest rates of one to two per cent expired and borrowers were faced with paying eight per cent or more, defaults shot up and prices fell down.
With no collateral invested, sub-prime borrowers simply walked away from the mortgages, leaving banks with mega losses
that now total $588bn, according to Bloomberg estimates.
Crucially, the banks also failed to make sure they were adequately capitalised to ensure there was enough money to cover potential losses, which is why the US Government has been forced to step in as the country's finance industry teetered on the brink of collapse. US behemoths Lehman Brothers and Bear Stearns have gone bankrupt, while US quasi-government mortgage lenders Fannie Mae and Freddie Mac were also effectively nationalised. Merrill Lynch was taken over by Bank of America and American Insurance Group was the subject of a $85bn rescue by the US Government.
In such a torrid climate, banks are simply refusing to lend to each other because they fear loans will not be repaid. As a result, inter-bank lending rates have shot up, together with credit default swaps, which are essentially insurance policies against corporate borrowers reneging on debts.
This has spread to the cash-rich Gulf, with one-month interbank lending rate rising to 4.19 per cent last week, compared to just 2.01 per cent in mid-June.
The next episode in the Gulf
The prime cause of tight monetary conditions locally is not the sub-prime crisis, but a lack of deposits, with investors having little incentive to save in a negative interest rate environment, while foreign investors have also withdrawn dirham-denominated reserves as hopes for a currency revaluation fade. "Gulf monetary policy has been out of sync with reality and now the chickens are coming home to roost," said Julius Baer's Anantha-Nageswaran.
"The Middle East has a tough time ahead next year, especially since global growth will decline and therefore oil prices will fall further. The Middle East's best days are probably behind it. This is partially linked to the credit crisis. The Gulf has not really saved for a rainy day." He warns the interest rate cycle – the US has slashed its borrowing rates from 5.25 per cent to two per cent in a little over a year, with UAE forced to follow suit because of the dirham peg – has led to a massive credit boom in the Middle East. And like much of Asia, the Gulf has not prepared for when the global economic boom would stall. "This has ended rather abruptly and isn't going to return anytime soon," said Anantha-Nageswaran.
He believes foreign direct investment into the Gulf will decline because of much higher risk aversion from troubled overseas investors. "Capital inflows across the globe will fall. The macroeconomic consequences of the credit crisis have hardly begun," said Anantha-Nageswaran.
He points to the grim statistics from the US Purchasing Managers Index that showed a fall from 50 to 44 points in September 2008, which is its lowest level for seven years and indicates a dramatic decline in US manufacturing. Meanwhile, real personal consumption in the US is forecast to fall quarter-on-quarter in Q3 for the first time since 1991.
"The are question marks over whether this bailout will recapitalise banks," said Anantha-Nageswaran. "Emerging markets have relied heavily on US growth and so the Middle East and Asia are likely to see substantially higher downside risk to growth than currently considered."
Anantha-Nageswaran doubts GCC monetary union will happen in 2010 and believes currency revaluation will return to the political agenda amid worsening economic conditions both regionally and globally.
He said: "A lot of the economic behaviour of the past quarter century will be called into question over the next few years."
Anantha-Nageswaran described current UAE and GCC infrastructure spending as excessive. He added: "Sometimes, cyclical booms can be mistaken for permanent structural improvements [to the economy]. This has led the Gulf states to over invest in many infrastructure and real estate projects. It would be better to space these trophy projects out over a longer period."
Will it work?
Most economists agree that while the $700bn rescue package will stop more banks from going to the wall, it will not revive petrified credit markets.
"The bailout won't immediately ease tight money markets, but will enable institutions to refinance," said Eckart Woertz, economics programme manager at the Gulf Research Centre. "We will have to see whether this will jumpstart lending again or whether we will have to live with continuously high spreads for corporate borrowing. I doubt funding costs will go down overnight. The bailout doesn't address its structural problems and so won't reduce borrowing costs."
Mary Nicola, Standard Chartered economist, describes the bail out as "the least worst option" and says it will restore some confidence in the banking system.
"It's not a cure-all – the very essence of the problem is that US households will have to balance their budgets," said Nicola.
"People will have to stop borrowing and start saving."
If the US does issue new Treasuries to pay for the rescue, then inflation pressures will increase, some analysts warn, because the US will effectively be printing new money.
In some respects, higher inflation could actually be beneficial because it would erode the real value US debts, but the current crisis may be more likely to create deflation of the sort that ravaged Japan in the 1990s.
This was caused by a lending bubble and a bungled rescue of banks. Japanese policy-makers were unable to engineer a credit expansion, despite zero per cent interest rates, which left the Japanese economy in the doldrums for more than a decade. "It would require a staggering degree of incompetence in Washington to make a similar situation happen in the US, but after what we have seen over the past few days this can't be ruled out," said David Wyss, Standard and Poor's chief economist.
He believes the US is already in recession, no matter what GDP figures say, with employment falling for the past three months. Oil prices are likely to fall further because of slackening demand from industrialised countries in throes of recession, before stabilising around the $100 mark, Wyss predicts.
The real cost?
Greedy bankers have made convincing villains for the US public in the ongoing credit crisis, with ordinary Americans incensed that they will be paying the bill for Wall Street excesses. After more than a week of wrangling on Capitol Hill, US lawmakers have finally approved the bailout plan that would see the government buy up "toxic" mortgage assets from the country's banks to enable them to start lending again.
Following brinkmanship that spanned the political divide and saw an unlikely alliance of dissident Republican and Democrat senators defeat the first rescue plan on Monday, a revised version will now at last be implemented. Yet many economists doubt it will provide anything more than emergency relief. "The plan is a stop gap measure and is a way to get the banking sector through to the election," said Wyss.
"The next president is going to have to deal it. Eventually the government will have to tackle the original problem, which is the slump in the housing market and this plan doesn't address that directly – it's a quick fix whereas solving the problems in the mortgage sector is a long term challenge."
Wyss says US house prices must first stabilise to levels that provide a reasonable relationship to personal income.
"We also need to ensure that mortgages aren't so scarce that people can't buy property – we want to keep people in their homes and make mortgages affordable," said Wyss.
This is for the long term. At present, voters are fixated on the headline $700bn cost of the banking rescue. Opinions vary, with some analysts claiming the true cost will run into trillions of dollars, but Wyss is more optimistic. "Ultimately it will be the taxpayer who has to foot the bill, but in the long run I don't think it will cost that much, maybe 20 to 25 per cent of headline $700bn, which is not so large when you consider the US stock markets lost $1.2trn on Monday," said Wyss. "We are buying distressed assets, which will come at quite a discount."
Woertz believes American policy-makers will issue new Treasuries to pay for the plan, saying Asian and Gulf countries were the most likely buyers of such assets.
"What will be full price for the rescue?" said Woertz. "Will $700bn be enough? The US said the Iraq war would cost 'only' $50bn and we have since seen that this figure was way too low. The same could be true of this bailout package."
http://www.business24-7.ae/articles/2008/10/pages/10052008_cdefb9656db64dcdab0bfecedd13d73c.aspx
By
Matt Smith on Sunday, October 05, 2008
The Washington horror show is over, at least for now, with the United States Congress finally approving the $700 billion (Dh2.26 trillion) rescue of the stricken American financial sector on Thursday.
But readers hoping this will mark the end of the credit crisis are set to be disappointed, with most economists warning its full impact on the wider US economy is yet to come, and that could spell disaster for the buoyant Gulf region.
"The Middle East could be in for a nasty shock," said Dr Venkatraman Anantha-Nageswaran, Julius Baer head of investment research for Asia Pacific and the Middle East.
"It would be realistic to assume that real estate and infrastructure projects relying on foreign funding will be in trouble. If the government steps in to provide funding it will have long-term fiscal implications, most notably a deterioration in the government budget, and wouldn't set a good precedent."
Lending spree
Reckless lending has caused the current credit crisis. US banks gave 100 per cent "sub-prime" mortgages to low-income people in the errant belief that US property prices could only go up and so if these borrowers did default then their debts money could be more than recouped by repossessing their homes. These mortgages were then packaged up and sold to banks across the globe. For a while this plan worked, with historically low interest rates fuelling a US property bubble, but once sub-prime teaser interest rates of one to two per cent expired and borrowers were faced with paying eight per cent or more, defaults shot up and prices fell down.
With no collateral invested, sub-prime borrowers simply walked away from the mortgages, leaving banks with mega losses
that now total $588bn, according to Bloomberg estimates.
Crucially, the banks also failed to make sure they were adequately capitalised to ensure there was enough money to cover potential losses, which is why the US Government has been forced to step in as the country's finance industry teetered on the brink of collapse. US behemoths Lehman Brothers and Bear Stearns have gone bankrupt, while US quasi-government mortgage lenders Fannie Mae and Freddie Mac were also effectively nationalised. Merrill Lynch was taken over by Bank of America and American Insurance Group was the subject of a $85bn rescue by the US Government.
In such a torrid climate, banks are simply refusing to lend to each other because they fear loans will not be repaid. As a result, inter-bank lending rates have shot up, together with credit default swaps, which are essentially insurance policies against corporate borrowers reneging on debts.
This has spread to the cash-rich Gulf, with one-month interbank lending rate rising to 4.19 per cent last week, compared to just 2.01 per cent in mid-June.
The next episode in the Gulf
The prime cause of tight monetary conditions locally is not the sub-prime crisis, but a lack of deposits, with investors having little incentive to save in a negative interest rate environment, while foreign investors have also withdrawn dirham-denominated reserves as hopes for a currency revaluation fade. "Gulf monetary policy has been out of sync with reality and now the chickens are coming home to roost," said Julius Baer's Anantha-Nageswaran.
"The Middle East has a tough time ahead next year, especially since global growth will decline and therefore oil prices will fall further. The Middle East's best days are probably behind it. This is partially linked to the credit crisis. The Gulf has not really saved for a rainy day." He warns the interest rate cycle – the US has slashed its borrowing rates from 5.25 per cent to two per cent in a little over a year, with UAE forced to follow suit because of the dirham peg – has led to a massive credit boom in the Middle East. And like much of Asia, the Gulf has not prepared for when the global economic boom would stall. "This has ended rather abruptly and isn't going to return anytime soon," said Anantha-Nageswaran.
He believes foreign direct investment into the Gulf will decline because of much higher risk aversion from troubled overseas investors. "Capital inflows across the globe will fall. The macroeconomic consequences of the credit crisis have hardly begun," said Anantha-Nageswaran.
He points to the grim statistics from the US Purchasing Managers Index that showed a fall from 50 to 44 points in September 2008, which is its lowest level for seven years and indicates a dramatic decline in US manufacturing. Meanwhile, real personal consumption in the US is forecast to fall quarter-on-quarter in Q3 for the first time since 1991.
"The are question marks over whether this bailout will recapitalise banks," said Anantha-Nageswaran. "Emerging markets have relied heavily on US growth and so the Middle East and Asia are likely to see substantially higher downside risk to growth than currently considered."
Anantha-Nageswaran doubts GCC monetary union will happen in 2010 and believes currency revaluation will return to the political agenda amid worsening economic conditions both regionally and globally.
He said: "A lot of the economic behaviour of the past quarter century will be called into question over the next few years."
Anantha-Nageswaran described current UAE and GCC infrastructure spending as excessive. He added: "Sometimes, cyclical booms can be mistaken for permanent structural improvements [to the economy]. This has led the Gulf states to over invest in many infrastructure and real estate projects. It would be better to space these trophy projects out over a longer period."
Will it work?
Most economists agree that while the $700bn rescue package will stop more banks from going to the wall, it will not revive petrified credit markets.
"The bailout won't immediately ease tight money markets, but will enable institutions to refinance," said Eckart Woertz, economics programme manager at the Gulf Research Centre. "We will have to see whether this will jumpstart lending again or whether we will have to live with continuously high spreads for corporate borrowing. I doubt funding costs will go down overnight. The bailout doesn't address its structural problems and so won't reduce borrowing costs."
Mary Nicola, Standard Chartered economist, describes the bail out as "the least worst option" and says it will restore some confidence in the banking system.
"It's not a cure-all – the very essence of the problem is that US households will have to balance their budgets," said Nicola.
"People will have to stop borrowing and start saving."
If the US does issue new Treasuries to pay for the rescue, then inflation pressures will increase, some analysts warn, because the US will effectively be printing new money.
In some respects, higher inflation could actually be beneficial because it would erode the real value US debts, but the current crisis may be more likely to create deflation of the sort that ravaged Japan in the 1990s.
This was caused by a lending bubble and a bungled rescue of banks. Japanese policy-makers were unable to engineer a credit expansion, despite zero per cent interest rates, which left the Japanese economy in the doldrums for more than a decade. "It would require a staggering degree of incompetence in Washington to make a similar situation happen in the US, but after what we have seen over the past few days this can't be ruled out," said David Wyss, Standard and Poor's chief economist.
He believes the US is already in recession, no matter what GDP figures say, with employment falling for the past three months. Oil prices are likely to fall further because of slackening demand from industrialised countries in throes of recession, before stabilising around the $100 mark, Wyss predicts.
The real cost?
Greedy bankers have made convincing villains for the US public in the ongoing credit crisis, with ordinary Americans incensed that they will be paying the bill for Wall Street excesses. After more than a week of wrangling on Capitol Hill, US lawmakers have finally approved the bailout plan that would see the government buy up "toxic" mortgage assets from the country's banks to enable them to start lending again.
Following brinkmanship that spanned the political divide and saw an unlikely alliance of dissident Republican and Democrat senators defeat the first rescue plan on Monday, a revised version will now at last be implemented. Yet many economists doubt it will provide anything more than emergency relief. "The plan is a stop gap measure and is a way to get the banking sector through to the election," said Wyss.
"The next president is going to have to deal it. Eventually the government will have to tackle the original problem, which is the slump in the housing market and this plan doesn't address that directly – it's a quick fix whereas solving the problems in the mortgage sector is a long term challenge."
Wyss says US house prices must first stabilise to levels that provide a reasonable relationship to personal income.
"We also need to ensure that mortgages aren't so scarce that people can't buy property – we want to keep people in their homes and make mortgages affordable," said Wyss.
This is for the long term. At present, voters are fixated on the headline $700bn cost of the banking rescue. Opinions vary, with some analysts claiming the true cost will run into trillions of dollars, but Wyss is more optimistic. "Ultimately it will be the taxpayer who has to foot the bill, but in the long run I don't think it will cost that much, maybe 20 to 25 per cent of headline $700bn, which is not so large when you consider the US stock markets lost $1.2trn on Monday," said Wyss. "We are buying distressed assets, which will come at quite a discount."
Woertz believes American policy-makers will issue new Treasuries to pay for the plan, saying Asian and Gulf countries were the most likely buyers of such assets.
"What will be full price for the rescue?" said Woertz. "Will $700bn be enough? The US said the Iraq war would cost 'only' $50bn and we have since seen that this figure was way too low. The same could be true of this bailout package."
http://www.business24-7.ae/articles/2008/10/pages/10052008_cdefb9656db64dcdab0bfecedd13d73c.aspx