Now a year after the onset of the so-called credit crunch and Malta’s financial system seems to go unscathed. The worrying thing about the crunch for us is that there are still people who insist on clinging to the view that it will never hit us much like the famous ostrich example hiding its head in the sand. Many commentators have predicted that it will bypass and not impact Malta. This is swell but then why do we read that Bank of Valletta, last week informed investors it had been effected on a modest scale, by the Lehman Brothers collapse. HSBC ‘s recent interim results also reflected the turmoil in the financial markets so much so that the bank has seen its annual profitability levels being slashed by 21 per cent.
Pundits contend that our closeted economy is resilient mainly since it relies strongly on domestic factors such as the multiplier effect of its property and construction sector. Further concentration in large-scale property investment may continue to earn us a temporary respite in our GDP growth but will the bubble burst as it did in Spain? One does not need to sound as a prophet of doom at this cross-point stage in our development but needless to mention that the 2007 Central bank report also warned of our over-indulgence on the property which started it’s downward trend in prices. Nobody can tell which way the domino effect will proceed and how soon will the process take to trigger price stabilisation. Only then can we calm the fears on values of many local bonds based on extensive property portfolios. If not, the logical question that follows is: Do investors have the inbuilt reserves to mitigate any future negative impact?
On a national level, a lot depends primarily on the level of elasticity of tourism industry combined with effective remedies taken by exporters. Sheltering blindly behind our smallness will not wash since the openness of our economy is directly influenced by outside factors beyond our shores. Notice the drop in tourist arrivals from cash strapped British consumers and others and this effectively shows how the last quarter of this year is expected to show a negative drop in tourist earnings. Back to the global dimension and one meets with a lot of theories postulated as to how the crunch started and financial disasters that it has brought in its wake. Some blame the slowness of regulation particularly where banks are concerned. But of course while regulators were busy implementing Basel 2 rules they must have missed the wood for the trees and not adjusted enough for capital adequacy and solvency ratios ahead of the sub-prime tsunami that hit the US and later on European banks. This problem associated with sub-prime lending had originated in the US, where demand for cheap home loans had resulted in banks leading money to high–risk borrowers based on shaky collateral. To top it up such sub-prime mortgages were neatly repacked into securities and sold on the market to other financial institutions. Then the issue was compounded on default by such sub-prime borrowers and a resulting domino effect had shaken confidence consequently banks stopped lending to each other. One may recall how a year ago in the UK started the phenomena of long queues of depositors snaking on High Street branches of Northern Rock claiming back their deposits. Incidentally, this was the first such situation, when considering that previous runs on a retail bank last occurred in the nineteen century. One appreciates that the European Central bank did react positively to buttress the distress of banks by injecting billions into the money markets but it was too little too late. Hence the downfall and eventual nationalisation of Northern Rock in the UK and others such as the recent troubles faced by HBOS being rescued by Lloyds TSB at a mere £12 billion after its shares plummeted. On 14 September, Lehman Brothers, the 158-year old US investment bank, saw its shares plunge more than 40 per cent when the state-owned Korea Development Bank pulled out of negotiations about a capital infusion. Lehman’s share price had already dropped from a high of $67.73 last February to a close of $16.20. It further collapsed to $3.74.
Lehman sealed its fate on 15 September when it filed for Chapter 11 bankruptcy protection. Within the week, we note how Barclays plc., announced its agreement to purchase, subject to regulatory approval, Lehman’s investment-banking and trading divisions along with its New York headquarters building.
How can we omit from the list the sudden occurrence of Merrill Lynch’s troubles which led them to a swift sale to Bank of America? True to its financial cataclysm we notice how oil price dropped by over 4 percent to a seven-month low on the news of Lehman ‘ collapse. Dealers were concerned the credit crisis will hurt the economy and undermine fuel demand. So now, one year later, the next question on the lips of many was about when it will all end. The answer came shockingly clear with the collapse of Lehman Brothers and the takeover of Bear Stearns by J.P Morgan, followed by the huge bailout by the US government of Freddie Mac and Fannie Mae alongside AIG.
Of unbelievable proportions was the bailout of $85 billion of AIG as a major American insurance company. It is a well run company which suffered badly in its financial–products section and was pre-eminent for the insuring US banking credit risks that it had to be rescued by the US government by a 24-month credit-liquidity facility. This facility has been severely criticized for its heavy interest charge of LIBOR plus 8.5 per cent. In exchange for the credit facility, the US government is entitled for a 79.9 per cent equity stake. This was the largest government bailout of a private company in US history, though smaller than the handout via a $200 billion equity facility offered to the two moribund mortgage houses Fannie Mae and Freddie Mac. Why is AIG so important that has change the attitude of the US treasury to single it out? The answer is not difficult when one contemplates the importance of this international insurer and the contagion that will ensue if it went belly-up. AIG has operations in more than 130 countries and jurisdictions and employs circa 116,000 employees. It’s history dates back to 1919, when its founder established an insurance agency in China, being the first to introduce insurance at an international level in China. AIG later expanded to other markets, including Latin America, Europe, and the Middle East. By the mid-2000 AIG had unfortunately been tainted in a series of fraud investigations conducted by the Securities and Exchange Commission (SEC) and the New York State attorney. This led finally to a stiff fine of $1.6 billion and criminal charges on some of its executives. Due to the above-mentioned sub-prime cancerous exposure it lost heavily since 2007 and in the first six months of 2008 it reported over $13 billion in losses. To conclude what started as the aftermath of mortgage madness in the US has progressed into a domino effect exposing the fragility of the European banking sectors. On a local front, we have been assured that the government is reviewing, with the collaboration of foreign supervisors, crisis prevention mechanisms while an investigation by the MFSA and Central bank concluded that the impact of the collapse of Lehman Brothers and Merrill Lynch calamities will have a minimal effect on us. Let us hope that the tide is turning in our favour and destiny will spare us an austere winter.
George Mangion
Partner at PKF – an audit and business advisory firm [email protected]
