HAMBERGER CRISIS: Financial Tsunami Continues

The 700-billion dollar bailout by US President George W Bush give the US Treasury almost free rein to buy up bad mortgage-related debts crisis. Wall Street stocks sank again after sharp losses in Asia and Europe as markets were again roiled. In the US financial sector pressure intensified with the collapse of Washington Mutual, the nation's biggest bank (with savings and loans) failure ever, and the sale of its assets to IP Morgan Chase. It was the largest bank failure in US history, dwarfing the past collapses. Meanwhile, Goldman Sachs (founded in 1869) and Morgan Stanley (founded in 1935), the last two major independent Wall Street investment banks had already blown their whistles as their shares were under tremendous pressure because of their exposure to real estate and pretty difficult credit conditions. Eventually, they brought down the curtain on a Wall Street era, agreeing to a radical revamp that completes the biggest overhaul and restructuring in high finance at Wall Street since the Great Depression, They become holding companies in a rescue move allowing them to take deposits from investors. On September 21, they had received Fed Reserve approval to convert to commercial banks. This move would hopefully allow them the liquidity through the Fed funding window while also being regulated by the Fed. Bankruptcies of key investment banks and firms one after one, like Bear Stearns, Fannie/Freddie, Lehman Bros and the like.

Here the question as to what is an investment bank can be answered as an investment bank is an intermediary that performs a variety of financial services. This includes underwriting, acting as an intermediary between an issuer of securities and the investing public, facilitating mergers and other corporate reorganisations, and also acting as a broker for institutional clients. The role of an investment bank begins with pre-underwriting counselling and continues after the distribution of securities in the form of advice. Investment banks from Wall Street once rule the world of finance, till hubris and greed drove them to believe they were invincible.

Typically and traditionally, investment banks while acting on behalf of clients take a fee for matching their needs. However, from the 1990s, they changed their role in pursuit of profits. With access to more capital, they essentially turned gamblers and bet on markets with their own money through leveraging their balance sheets. Transitioning from a safe model, where it matched buyers and sellers with little capital at risk, to taking long and short positions on its own balance sheet meant gearing up on its capital. And this is what brought about the disaster.

The final nail in the coffin was struck with the two remaining largest investment banks left - Goldman and Morgan - folding as investment banks and re-emerging as commercial banking institutions, albeit with the Fed's blessing. It is a chance to be quick millionaires driving people into this industry but fundamentally there is nothing wrong with that as monetary incentive is often a key criterion for choice. But when financial compensation leads to greed and moral hazard then society does have a problem with the breed of investment bankers. Curiously, the US Treasury Secretary Henry Paulson himself was an investment banker in Goldman.

How did the moral hazard happen? Investment banks told the mortgage lenders to create as many new mortgages as they could. The mortgage lenders precisely did that, without caring about the ability of the borrowers to repay the loans. The investment banks or the mortgage lenders had no real concern with the quality of the mortgages as default would only affect the investors and not them. They, indeed, looked pretty safe in the beginning. And no one anticipated the torrent of default that followed with the weakening of the US economy. The triple A tranches also turned into junk and ate into the capital of the investment banks, resulting in the demise of an industry. Could all this have been avoided? Yes, of course. The clever investment bankers have known that economies do not always grow.

Business cycle is part and parcel of growth and a little sensitivity analysis of a downturn would have shown the weakness of the structures.

Hopefully, lessons are now learnt but at the cost of the monumental financial apocalypse that has shaken the very edifice of the capitalism the West is so proud of. In final analysis, "Bailout" is back as a buzzword 11 years after the Asian financial crisis, but this time the tables are turned upside down: the US is scrambling to rescue ailing banks while a healthy Asia watches US in turmoil. The ramparts built after the 1997-98 Asian debacle helped blunt the impact of turbulence that ripped through USA's financial heartland this month. However, Asian stock markets plunged after a wide-ranging shakeup on Wall Street that included bankruptcies and take-overs. Asia's exports will take a hit, leading to slower economic growth this year and in 2009.

But the region is now on a stronger footing than in years gone past. ADB economist Young-Park says she did not think the US mayhem can cause a severe crisis in the region similar to 1997. And indeed so far, emerging Asia has been weathering the storm relatively well. That is what the IMP MD Dominique Strauss-Kahn felt as well. According to ADB, Asia's developing countries should grow 7.5 per cent this year and 7.2 per cent in 2009 down from 8.7 per cent in 2007 but still considered respectable. China's growth is likely to come in at 10 per cent this year and 9.5 per cent in 2009.

A currency meltdown plunged Asia into crisis in 1997, sending the region's key economies into recession when US stalwarts came down and lectured a lot on lax monitoring and non-transparency in banking operation. The World Bank, IMF and ADB led multi-billion-dollar bailouts to rescue the stricken economies, and pushed for financial sector reforms that led to stricter financial markets regulation, a thorough clean-up of bad bank loans, greater cooperation among central banks and a swap arrangement that pooled the region's massive foreign exchange reserves to defend against currency speculators. Those reforms, bigger risk management awareness as well as monetary and fiscal prudence have helped cushion the impact of the US-induced turmoil more than a decade later. Now the United States government has proposed its own bailout of up to 700 billion dollars to purchase tainted mortgage-related assets at the heart of the latest crisis. Actually, the huge improvement in economic fundamentals over the past decade has helped Asia sail smoothly in the current crisis. However, countries with large garment and textile sectors that export to the US and European markets will possibly be at risk. Asia's developing countries supply about two-thirds of US clothing imports and 85 per cent of its footwear.

The US government's actions do help address the liquidity crunch for the time being when strains in money market ease but the crux of the crisis remains. Lenders cannot lend while they are laden with underwater, illiquid assets and cannot raise capital. The US government may have put out the fire. The rebuilding lies ahead. We must also be vigilant of the impact of the global events on Bangladesh finance and economy. The commercial banks in Bangladesh have about US $ 500 million worth of foreign currency deposits, which are lying, with various foreign banks overseas, mostly in the US.

In addition to that, the central bank has about US $ 5.5 billion of reserves. Of these reserves, a significant amount is in US dollars or US dollar denominated assets (mostly in US Treasury Bonds). Apart from those, Bangladesh financial sector has very little exposure as the instruments used are mostly deposits and US Treasury bills for central banks.

We do not hold any US corporate bonds. We may not face severe credit exposure, but in case of systemic failure, we would be exposed to liquidity risk. This might dwindle investor confidence and trickle down to our economy mostly through reduction of exports and remittances. Importantly, a long-time recession in the West would cut demand for all consumer items, for which there will be a negative impact on the local RMG export. Interestingly, during the Asian crisis, IMF suggested we should not cut interest rates but this is what the US Fed Reserve is doing right now. That calls for our diversifying products and exploring new export destinations.

The lesson for now is that even the freest economy would require intervention to survive. But the focus ought to be on the risk management process of the banking industry as well as the culture where corporate greed and lack of engaged and forward looking leadership can result in such a catastrophe. At the same time, all these crises have made 'universal banking model' the 'life saving drug' for global financial conglomerates.

Zakia Sultana Tanya
Ref.: http://energybangla.com/index.php?mod=article&cat=SomethingtoSay&article=1067

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HAMBERGER CRISIS

10/09/2008

Financial Tsunami Continues

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