Global financial market crisis
Sunday, 23 September 2007
Shireen Scheik Mainuddin
MOVEMENTS of an earthquake magnitude in what appears to be the most serious event since the stock market crash of 1987, shook the financial markets of the developed world in mid-August, leaving most large international banks reeling. The very best names long regarded as Triple A are assessing their scars -- the 'toxic' assets at stake being the subprime mortgage-backed securities issued by the large international banks and sold to various financial institutions, institutional investors and hedge funds around the world.
Subprime mortgage-backed securities -- risk instruments -- were devised in the U.S. and represent long term home loans to less than credit worthy US borrowers, at above market pricing. Such instruments were then " wholesale packed " into "CMO"s (collateralized mortgage obligation) and turned into debt instruments or ABS (Asset Backed securities). News of defaults in repayments by the US homeowner and mortgage foreclosures led to investor alarm. In turn, this triggered a sell-down of such securities leading to a liquidity crisis with problems in rollover and refinancing when parts of the instruments became due in August. To add to the financial jargon and alphabet soup, the mortgage-backed securities were turned into SIV's or Structured Investment Vehicles allowing the issuing banks to take it off their balance-sheet and freeing capital for other purposes. Given the fact that the instruments have been distributed and sold all over the world, an assessment, of the amount actually under threat, will take time and legal complexities are difficult to comprehend. What is most important is to ascertain if the highly educated hedge and investment fund managers in the world's most sophisticated financial markets overlook any fundamental risk parameters. Or is the crisis the result of a panic response, in no way connected to an underlying weakness in the instrument itself? This is the billion dollar question under review by the global financial authorities.
The response to the crisis so far has been an emergency injection of billions of dollars by the European Central bank, the Bank of England and a rate cut by the Federal Reserve Bank. In the U.S speeches have been made by politicians and regulators intending to calm the homeowners who are most vulnerable to becoming dispossessed. In Europe where a number of institutions had bought the risk, statements denouncing bailouts of reckless borrowers and investors are being made. In London where most of the risk trading is done, there is criticism that the central bank was slow to act. Doubts are also being cast on the rating agencies which assigned a risk category to the instruments and on whom institutional investors rely when making strategic investment decisions.
The crisis is far from over and is expected to worsen when 113 billion dollars of commercial paper comes up for refinancing in the London market. Meanwhile, banks are withholding from further lending and interbank funds are getting scarce.
It is still an early stage to understand the long term implications of this crisis but analysts appear to agree that two of the basis assumptions that have supported the prosperity of global finance have been shaken by the quake.
No longer will mathematical models of past financial behaviour predict the future with sufficient accuracy to support billions of dollars of profitable financial trading, and to turn assets such as mortgages to families with poor credit history into Triple A investment propositions at least some of which are as safe as U.S. and UK government bonds.
Secondly the belief that a global financial market place can be a substitute for the local banks, that dominate every country's financial system, is shattered. It seems that local businesses are best serviced by local institutions who are best aware of local borrowers and their capabilities.
For Bangladesh, the fallout of this crisis may be either positive or negative. It may be time for some of the large institutions to shift risk to emerging markets and to look for viable projects. We have been largely unexplored and the day that we are considered a serious investment destination is overdue. On the other hand, long term risk appetite may be diminished for some time until the international markets return to normaley.
The sad truth of the whole mess is that poor credit risk remains what it is, irrespective whether the country in which it originates is a member of the Group of Eight (G8) that represents industrialised nations or a least developed country (LDC).
MOVEMENTS of an earthquake magnitude in what appears to be the most serious event since the stock market crash of 1987, shook the financial markets of the developed world in mid-August, leaving most large international banks reeling. The very best names long regarded as Triple A are assessing their scars -- the 'toxic' assets at stake being the subprime mortgage-backed securities issued by the large international banks and sold to various financial institutions, institutional investors and hedge funds around the world.
Subprime mortgage-backed securities -- risk instruments -- were devised in the U.S. and represent long term home loans to less than credit worthy US borrowers, at above market pricing. Such instruments were then " wholesale packed " into "CMO"s (collateralized mortgage obligation) and turned into debt instruments or ABS (Asset Backed securities). News of defaults in repayments by the US homeowner and mortgage foreclosures led to investor alarm. In turn, this triggered a sell-down of such securities leading to a liquidity crisis with problems in rollover and refinancing when parts of the instruments became due in August. To add to the financial jargon and alphabet soup, the mortgage-backed securities were turned into SIV's or Structured Investment Vehicles allowing the issuing banks to take it off their balance-sheet and freeing capital for other purposes. Given the fact that the instruments have been distributed and sold all over the world, an assessment, of the amount actually under threat, will take time and legal complexities are difficult to comprehend. What is most important is to ascertain if the highly educated hedge and investment fund managers in the world's most sophisticated financial markets overlook any fundamental risk parameters. Or is the crisis the result of a panic response, in no way connected to an underlying weakness in the instrument itself? This is the billion dollar question under review by the global financial authorities.
The response to the crisis so far has been an emergency injection of billions of dollars by the European Central bank, the Bank of England and a rate cut by the Federal Reserve Bank. In the U.S speeches have been made by politicians and regulators intending to calm the homeowners who are most vulnerable to becoming dispossessed. In Europe where a number of institutions had bought the risk, statements denouncing bailouts of reckless borrowers and investors are being made. In London where most of the risk trading is done, there is criticism that the central bank was slow to act. Doubts are also being cast on the rating agencies which assigned a risk category to the instruments and on whom institutional investors rely when making strategic investment decisions.
The crisis is far from over and is expected to worsen when 113 billion dollars of commercial paper comes up for refinancing in the London market. Meanwhile, banks are withholding from further lending and interbank funds are getting scarce.
It is still an early stage to understand the long term implications of this crisis but analysts appear to agree that two of the basis assumptions that have supported the prosperity of global finance have been shaken by the quake.
No longer will mathematical models of past financial behaviour predict the future with sufficient accuracy to support billions of dollars of profitable financial trading, and to turn assets such as mortgages to families with poor credit history into Triple A investment propositions at least some of which are as safe as U.S. and UK government bonds.
Secondly the belief that a global financial market place can be a substitute for the local banks, that dominate every country's financial system, is shattered. It seems that local businesses are best serviced by local institutions who are best aware of local borrowers and their capabilities.
For Bangladesh, the fallout of this crisis may be either positive or negative. It may be time for some of the large institutions to shift risk to emerging markets and to look for viable projects. We have been largely unexplored and the day that we are considered a serious investment destination is overdue. On the other hand, long term risk appetite may be diminished for some time until the international markets return to normaley.
The sad truth of the whole mess is that poor credit risk remains what it is, irrespective whether the country in which it originates is a member of the Group of Eight (G8) that represents industrialised nations or a least developed country (LDC).