The great global ricochet

MOHSIN HAFEEZ

We’ve come full circle. The great age of globalisation has reversed its trend. For some (coincidental) reason, it seems to have struck us at a time when the global economy has taken a tumble.

What was considered a boon for the world at one time is now identified as a bane, a boomerang of sorts, for the financial world.

What we see in one part of the world has its ripples floating across the map. And if that part happens to be America, then the swell turns out to be more of a dictation, what with the enormousness of everything inextricably intermingled with the rest of the globe.

We have seen the effect of it in the past and, like no other time, are seeing it now. The credit crisis that emanated from the US for reasons of myopia and governmental aloofness has travelled farther than one had first envisaged it would. It seems now as if no one is insulated from this tsunami.

Etymology

The etymology of the current crisis may be traced to the greed to make a killing by lending to less than prime borrowers by charging a higher premium, based on the philosophy of enlarging the number of American homeowners.

Underwriting standards lowered across the board as short-term quarterly financial results started making headlines; violence begets violence just as greed engenders more of the same, unfortunately with disastrous results.

The effect of this crisis in the US has been vast. By some reliable analysis, it will continue to aggravate through 2009 with some respite creeping along in the middle of 2010. As is market tradition, the equity market will show some improvement prior to the actual growth in the economy.

The prognosis is dismal and the world will follow, not precede, this American recovery just as it did its ruin. With some exceptions, like the Middle East with its vast reserves from the oil bonanza to somewhat temper the effects the world will see a series of crises unlike anything since, perhaps, the Great Depression.

All countries have certain primary dynamics instrumental to the growth of their economies. In the US, it is consumer spending which accounts for almost two-thirds of the economy. With free availability of credit, what first seemed like a virtuous circle soon reared its ugly head wrapped around in the worst viciousness of its kind.

The GDP growth has stalled and the country has been in a recession since December 2007, with a negative growth rate of 0.2 per cent for Q4 2007, followed by another negative growth of 0.3 per cent in Q3 of 2008, as reported by the Bureau of Economic Analysis (BEA) Home prices have fallen by as much as 40 to 50 per cent in some parts of the country.

Unemployment has increased to 7.2 per cent. The administration has pumped in hundreds of billions of dollars into the financial system by picking up shareholding interest in banks. Still, credit has had little thawing, if any. To the naked eye, that is a crisis of confidence more than the availability of funds.

Given what we have to deal with, the US must focus on home value stabilisation. It helps in at least two ways: one, it generates consumer self-confidence and, thus, helps bolster spending which we badly need, and, two, it stems bank losses associated with such assets and, thus, generates room in their balance sheets to lend again.

The TARP (acronym for Troubled Assets Relief Programme) was primarily meant to purchase distressed bank mortgages so banks could lend again, starting out with a relatively clean slate. That died its own death as Treasury Secretary Paulson made a flip-flop and bought shares in banks instead.

The Federal Reserve, independently, has provided hundreds of billions of dollars in liquidity by allowing even non-banking financial firms to come to the window for borrowing and at rates never heard of before. Besides, it has subsequently allowed a host of financial services companies to convert to banking corporations, thereby enabling them to help mobilise deposits for liquidity.

The Fed has also started to buy mortgage-backed securities from the now state-sponsored Freddie and Fannie to help reduce the conforming lending rates, and plans to do so to the extent of $500bn in the next six months.

Foreclosure

The foreclosure of homes is reaching an alarming level and is greatly contributing to an inexplicable drop in property prices because of its very characteristic of being contagious.

A couple of things might be in order: one, have syndications, both international and domestic, buy up pieces of properties in the US, and, two, aggressively pursue the mortgage modification programme.

Having syndicated companies buy up in blocks homes left abandoned cleans up the market and offers a promise of excellent returns to the buyers given the current price-levels.

These buyers are in no need to borrow to buy as we ought to be pursuing a certain category of consortiums; for example, let’s interest the Chinese yuan, the Japanese yen, and the Middle Eastern petro-dollar to flow in.

It creates jobs in the related industries. Besides, it serves the main purpose of stabilising home prices.

Granted, there is market risk the investors may be exposed to. Without going into details, and with all the hoopla on the size of the next stimulus à la Obama, surely there could be risk-mitigation measures set aside for investors as a part of the total spending in the backdrop of a trade-off.

Mortgages

Concurrently with this measure, the administration ought to focus on Main Street by being proactive in modifying home mortgages. Mortgages payments can be recalculated based on a reasonable proportion of one’s income, called the debt ratio, by reducing the rate. Another way would be to elongate the term of amortisation so payments are manageable.

Yet another way is to forebear a part of the principal and base the new mortgage on the current asset value, with the condition that the forborne be collected by the sponsor of the scheme at the time of the sale of the home.

Without some really serious help from the administration, no major relief can be expected any time soon. The measures suggested may carry some socialistic undertones but the priority at this time should be to ignore ideology and espouse pragmatism; it’s whatever floats the boat, for America and, consequently, the world.

Courtesy: Dawn