Globalisation-2

GLOBALISATION - PART 2

By S.D.Srinivasan

The international scenario and especially the economies of various countries are not only complex but also complicated. The international events continue to be haunted by the happenings in the United States of America.

The financial crisis that started in 2007 has not reached its zenith yet.  Even though there were early moorings to the recession towards the end of 2006, the signals were not taken in the right earnest to arrest the damages.  The analysts feel that the depth of the recession is yet to be touched.

Now nearly two and half years since the bubble burst in the housing market and the derivatives sector in the stock markets in the United States of America, the world is still reeling under the grip of the economic slowdown.

The financial crisis in the economies of the globe was caused by the fallout caused by the housing mortgages in the United States of America and the defaults in subprime and adjustable mortgages.

Subprime lending is a general term used to the practice of granting loans to borrowers, who do not qualify for the best interest rates because of their deficient credit history.  In India, subprime lending means rate of interest charged below the prime lending interest rate, which is different from what was being resorted to rich economies.

Subprime lending encompasses a variety of credit instruments including subprime mortgages, subprime car loans, subprime credit cards etc. A subprime loan is offered at a rate higher than the normal rate owing to the credit risk involved. The term “subprime” refers to the credit status of the borrower being less than that of the ideal borrower.

Subprime loans are extended to such of persons/borrowers with very poor credit profile including payment defaults and bankruptcies. This means that even if a person/borrower cannot service the debt through his means, the loans will be extended to him but at a higher rate of interest.

The United States Department of Treasury guidelines in 2001 defines “Subprime borrowers typically have weakened credit histories that include payment delinquencies, and possibly more severe problems such as charge-offs, judgments and bankruptcies.  They may also display reduced repayment capacity as measured by credit scores, debt-to-income ratios or other criteria that may encompass borrowers with incomplete credit histories.”

Subprime loans were given to borrowers, who did not have the capacity to repay them (both principal and interest together).  At the height of such lending, the statistics show that these loans were given even to persons belonging to NINJA (No income No Jobs) category.  Another aspect of these sub-prime loans spree was that finance companies lend loans to these NINJA borrowers only to make them default and thereafter to seize the property mortgaged to the loan.  Profits were made a bit later by selling the property as there was housing boom in USA.

Typically, a bank or a mortgage finance company (many of them owned by banks) lent to a sub-prime borrower to finance purchase of a house.  Since the borrower did not have the means to even pay interest in the beginning, the lender adjusts the rate of interest by charging lower rates for the first two years and later on at a rate nearly 5 per cent over London Inter-Bank Offered Rate (LIBOR).

Sub-prime mortgages proliferated in the early part of this century.  The statistics show that 21 per cent of all mortgages from 2004 to 2006 in USA were sub-prime.  Way back in 1996, the sub-prime mortgages were only 9%.  By the year 2006, sub-prime mortgages amounted whopping $600 billions, accounting for one-fifth of the US home loan market.

But, the housing mortgages under subprime category constituted the major delinquency that led to the destruction of majority of the financial companies and banks not only in USA but also in other countries across the globe.

The bankers and financial companies in order to make the loans more attractive to be extended to the subprime borrowers, would charge rates of interest in low terms for the first two/three years and thereafter at a higher rate.  The lender hoped that even if the borrower could not service the loan, there is always a chance for refinance since by then the value of the house property would have gone up.  This assumption that the housing prices would go on increasing has led to the defaults, turmoil, and chaos.

The primary lenders/banks/financial companies of the subprime loans, in order to reduce their risks, pooled such subprime loans into baskets and created new stock market instrument called Collateralised Debt Obligations (CDOs). The baskets were sliced and spliced to make layers of CDOs (derivatives) carrying different risks.  The underlying assumption was that not all borrowers would default at the same time and a percentage of them would be prompt in payment.  The safe portion was sold to investors averse to high risks and the balance to others.  The credit rating agencies, the sister concerns of banks/financial companies who funded these subprime loans, rated these securities/instruments ostensibly to help the original primary lender to sell of their securities.

An analysis of the crisis would reveal that these CDOs were bought by some big investment banks and hedge funds in which the rich invested for high returns.  The investors financed these investments by borrowing from banks against the security of the CDOs, which they intend to purchase from the markets.  The banks’ action in passing on the risk to others boomeranged with the same subprime loans coming back to them as security to the loans extended to the investors to buy these derivatives.  In all, the banks financed the subprime loans not once but twice.

The trigger and the cause of the financial crisis was the bursting of the liquidity crisis in the United States of America’s banking system caused by the overvaluation of the assets.  This has resulted in the collapse of large financial institutions.  It all started with the sub-prime lending resorted to by the banks of the USA and the western countries.

When the housing markets started stagnating in the later part of 2006 and climbing down in 2007 and 2008, the derivatives market crumbled and with it the whole financial sector worldwide due to falling home prices and rising interest rates.  For example, in early 2007, when New Century Financial, a large subprime lender, collapsed, it resulted in Barclays Bank taking the brunt of the hit with its take over of subprime loans of about $900 million.

The whole arrangement crumbled when things turned adverse with falling home prices and rising interest rates.  As a fallout, not only investment banks but also finance companies such as Fannie Mae, Freddie Mac, Washington Mutual (Wa Mu), Wachovia, Lehmann Brothers, Goldman Sachs, Morgan Stanley, started failing and the list seems endless.  It is stated that in the capitalist world every day 2 banks fail and close down their businesses during 2008 and 2009.  Even today, every week at least one bank fails.

The financial crisis is yet to reach its nadir and even though the US and other European countries claim that they are coming out of the crisis, the economists say that it would take years, if not decades, to put the economies of the countries back on rail.

While the economy of the USA suffered initially, the cascading effect was felt thereafter in European countries.  The worst effect was in Iceland with its banking collapse not comparable to in the economic history in any country.  The depth and effect of the economy including the cost on the economy is still not fathomed, while the analysts state that it is more than 75% of Iceland’s GDP.  Even now, the economies of Portugal, Spain and Greece are on the brink of collapse and had to be bailed out by the European Union.

The economic commentators suggest that there could be an extended recession or worse.  This would result in slowing down of developed and developing economies in the years to come.  The global downturn has adversely affected the real economy in the developing world.  The developing countries as a group have been growing at a rate of around seven per cent for the last few years but the growth has declined to 5.9% in 2008.  As per the UN forecasts the growth in developing countries would slump to 2.7%.

As far as the rich countries are concerned, in Europe, the growth forecast is 4.5% and these countries will continue to face high unemployment problems.  The growth rate in United States will be 3.3% in 2010 and is likely to go down to 2.9% in 2011.  In Japan, the growth would be around 2.5% for the current year and would slow down to 2.1% for 2011.

The estimated losses from sub-prime mortgage loans worldwide have touched $950 billion as per the reports of IMF with various financial companies closing down their operations and many others were funded through bailout packages in USA and the Europe.  The effects of the financial crisis still continue to haunt the world with the European Union recently decided on its bailout packages for its member countries.

Losses to financial institutions, bailout packages and job losses

The losses to financial institutions worldwide were huge and the effects of this write-down of sub-prime loans and derivatives are casting their shadows on the functioning of these companies.  The list of financial companies including banks worldwide and the losses suffered by them are given below:

Name of the Financial Company	Losses Suffered
UBS AG (Bank)	$37.7 billion
Citigroup (Bank)	$39.1 billion
Merrill Lynch (Investment Bank)	$29.1 billion
Morgan Stanley (Investment Bank)	$11.5 billion
Credit Agricole (Bank)	$ 4.8 billion
HSBC (Bank)	$ 20.4 billion
Bank of America (Bank)	$ 7.95 billion
CIBC (Bank)	$ 3.2 billion
Deutsche Bank (Bank)	$ 7.7 billion
Mizuho Financial Group (Bank)	$ 5.5 billion
Barclays Capital (Investment Bank)	$ 3.1 billion
Bear Stearns (Investment Bank)	$ 2.6 billion
Royal Bank of Scotland (Bank)	$ 15.2 billion
Washington Mutual (Savings and Loan)	$ 2.4 billion
Swiss Re (Re-insurance)	$ 2.04 billion
Lehmann Brothers (Investment Bank)	$ 3.93 billion
LBBW (Bank)	$ 1.1 billion
JP Morgan Chase (Bank)	$ 5.5 billion
Goldman Sachs (Investment Bank)	$ 1.5 billion
Freddie Mac (Mortgage GSE)	$ 4.3 billion
Credit Suisse (Bank)	$ 9 billion
Wells Fargo (Bank)	$ 2.9 billion
Wachovia (Bank)	$ 11.1 billion
RBC (Bank)	$ 1.2 billion
Fannie Mae (Mortgage GSE)	$ 896 million
MBIA (Bond Insurance)	$ 3.3 billion
Hypo Real Estate (Bank)	$ 580 million
Ambac Financial Group (Bond Insurance)	$ 3.5 billion
Commerzbank (Bank)	$ 1.1 billion
Societe Generale (Bank)	$ 3 billion
BNP Paribas (Bank)	$ 870 million
West LB (Bank)	$ 2.74 billion
American International Group (Insurance)	$ 11.1 billion
Bayern LB (Bank)	$ 6.7 billion
Natixis (Bank)	$ 1.75 billion
Countrywide (Mortgage Bank)	$ 4 billion
DZ Bank (Bank)	$ 2.1 billion
Fortis (Bank)	$ 2.3 billion
ICICI Bank (Bank)	$ 264 million
IKB Deutsche Industriebank (Bank)	$ 3.45 billion
Aozora Bank (Bank)	$ 397 million
Dresdner Bank (Bank)	$ 3.49 billion
HBOS (Bank)	$ 7.06 billion
Lloyds TSB (Bank)	$ 1.32 billion
Bank of China (Bank)	$ 2 billion
ICBC (Bank)	$ 448 million

It is to be noted that the HSBC that suffered huge losses in the sub-prime fiasco is appointed as one of the fund managers by the Government of India to the New Contributory Pension Scheme and Employees’ Provident Fund.  While HSBC’s involvement is quite clear in the sub-prime episode, the Government of India by appointing them as one of the fund managers to the New Pension Scheme and the Employees’ Provident Fund putting the huge hard-earned funds of the workers in the speculative hands thereby jeopardizing and compromising the interests of millions of workers.

The packages announced so far to bail out the companies and financial institutions including banks, investment banks and insurance firms were to the tune of $ 900 billion in United States of America, $ 298.6 billion in Japan.  The European Union has agreed recently to provide $957 billion as rescue package that would help the troubled countries like Greece, Portugal, Spain etc.

In Iceland, the Financial Supervisory Authority of the Government had nationalized all the three major banks.  In USA and other European countries, through bailout packages, the countries Government organizations have taken control of many of the financial sector companies that are nothing but other forms of Nationalisation.

The unemployment rates, as fallout of the economic slowdown, crisis and recession, have hit the capitalist countries pretty badly.  In the United States of America, the number of unemployed persons is a staggering 14.6 million, about 9.7% in percentage terms.  The economists feel that this figure is likely to go up in the months to come.

The percentage of unemployed in Netherlands was 4.1%, Austria 4.9%, Germany 7.3%, Latvia 22.3%, Spain 19.1% and the list is expanding.  In actual terms, more than 15.78 million people in the European Union have lost their jobs since the beginning of the financial crisis.

The effects of the financial crisis have brought about the biggest financial shakeout of banks, insurance and mortgage companies.  The economists feel that it would take years for the global economy to have a face-lift.  The US economy has been spending too much and borrowing too much for years and the rest of the world depended on the US consumer as a source of global demand. With the recession started hitting USA, the countries that depended on the US markets have already started feeling the effects of this financial crisis.  The annualized rate of decline in GDP was 14.4% in Germany, 15.2% in Japan, 7.4% in U.K., 18% in Latvia, 9.8% in the European Union countries and 21.5% for Mexico. 

As far as the economic growth in developing countries is concerned, it has also started slowing down despite strong economic growth in the years preceding global meltdown.  The growth in the economy of Cambodia is almost zero, Kenya 3-4%, for the countries in Euro Zone (France, Germany, Italy etc.) it would be 0.1% and in U.K., Ireland and Spain, the economic growth would be negative.

In all, the countries of the world have been suffering enormously owing to the economic disaster due to financial collapse of the rich countries including USA.  The trio, World Bank, IMF and WTO advocating the neo-liberal reforms of Liberalisation, Privatisation and Globalisation, with its emphasis on markets without any proper supervision and control on the developing countries, has led to the situation where the benefits were derived by the Multinational and Transnational companies of the rich countries and not the people of the developing or under-developed nations.  But, the fallout has hit the rich countries below their belt.  As majority of the countries around the world were dependent on the economy of USA, with the countries keeping up dollar securities enormously, the effects are also felt worldwide.

The developed countries’ governments across the globe have started taking control, either partially or fully, of the ailing financial and banking firms for inducing confidence among the general public and funded bailout packages.  With the crisis into its second year now, many analysts feel that the worst is yet to come and likely to hit the financial sector worldwide with all its tentacles.

It is time the world came together to formulate rules that should be implemented properly by all the players and with proper regulations to ensure that the markets do not take upper hand and that pro-people policies are defined so that the effects of the financial crisis are curtailed and the effects on poorest and the marginalized are reduced drastically. Otherwise, the world would witness a chaos driving more and more people to poverty and penury.

The solutions to the problem lie not in the way the world is going by the dictates of Multinationals, Corporates, Rich Countries, IMF, World Bank and WTO but by carefully designing the policies to uplift the teeming millions below the poverty line.  The financial sector in all the countries should be under the control of the Governments of the respective countries and they should not be allowed to gamble with the people’s money by recklessly investing in equities, stocks, derivatives etc.  The socialistic approach should be followed while framing the policies that would benefit the larger cross-section of the people of the world instead of benefitting a few individuals.  People-centric approach, socialistic model of governance besides policy framework to benefit the common masses alone would be the best solution for the problems that the world is facing today.  This would also avert such kind of disaster happening in future.