US crisis may damage Shipyards privatisation, economist warns
Charlot Zahra
Economists and bankers contacted by Business Today offered different interpretations of the extent to which local economy might be impacted in the wake of the crisis hitting Wall Street recently.
The situation in the US last week led to the declaration of bankruptcy of Lehman Brothers, the purchase of Merrill Lynch by the Bank of America, as well as to the US government going to the rescue of various US financial institutions including AIG.
On a local front, veteran economist Karmenu Farrugia said that in this scenario, there might even be a psychological effect on the privatisation process of Malta Shipyards, which depends on a lot of bank credit to survive.
Asked whether the Maltese economy will be hit as a result of the crisis that hit Wall Street, former Labour Finance Minister and economist Lino Spiteri said Maltese exports may be negatively impacted.
“If as a result of the financial crisis there is further pressure on an already weak global economy, Maltese exports will be affected through the slowdown,” Spiteri said.
He also mentioned that there were local investors who were indeed hit by the meltdown of the US financial system. “No doubt there are investors who have placed funds in foreign financial assets. They are obviously being hit by the decline in the market value of such assets,” he said.
Finally, when asked whether he agreed with those who maintain that the US slowdown was the result of under-regulation, Spiteri said: “Largely, yes. Greed was allowed to take a free ride. The contagion of greed is inevitably followed by the contagions of loss of confidence and panic.”
On the other hand, veteran economist Karm Farrugia told Business Today that it was inevitable that the Maltese economy would be impacted in some way or another by the crisis in the US financial markets.
“No economy is totally immune to the Wall Street crisis: not even the Russian one,” he insisted.
However, Farrugia said that the Maltese economy “will chiefly be hit only indirectly” by the crisis in the US financial markets.
He explained how the crisis will “plunge the world into a recession, hitting hard other economies with which we trade in goods, but especially in services, mainly tourism.
Farrugia added that “although BoV has already hinted that it could be a ‘modest’ casualty, I don’t believe this is serious.
“More frightening, perhaps, is the psychological impact the crisis will have on potential bidders for the Shipyards which depend a lot on bank credit,” the veteran economist warned.
Farrugia said that there might have been some Maltese investors, “the usual speculative ones,” who may have been hurt as a result of the Wall Street crisis, “but I don’t consider this as a problem of national proportions.”
Questioning the use of the term “meltdown” to describe the crisis of the US financial system, Farrugia added: “The Federal Reserve has been quite ‘choosy’ with regard to whom it is prepared to bail out: AIG yes, Lehman Brothers no, for instance. In a ‘meltdown ‘ none is attempted to rescue. “Whereas the USA has always been the strictest regulator in the financial services system, this has been allowed too much leeway in branching out into untested highly-profitable terrain, with regulation not following suit,” Farrugia told Business Today.
On his part, former banker and University lecturer John Consiglio said: “I do not think that Maltese financial institutions are in any way likely to have any large fallout from the Lehman crisis.”
He explained that the way that inter-bank markets worked, and the level of assessments that financial institutions all over the world made of each other in deciding to what extent they should do business with each other or with each other’s paper, varied extensively among countries and institutions.
“So in such circumstances it does not automatically follow that if - for example, there’s a big fallout from Lehman in the US or in the United Kingdom (UK) or elsewhere, then in Malta the same should be the situation,” Consiglio insisted.
“Ours is after all a small economy – and this is a factor that has its own particular psychological connotations – and often, but not always, small is beautiful in such situations,” he told Business Today.
All economists agreed on the need for further regulation of the US banking sector in view of the deregulation regime adopted by the Bush administration in the past few years.
Finally, when asked about the impact on the Maltese economy of the Wall Street crisis, senior economist and University lecturer Gordon Cordina said that the Maltese economy was “small” and “very open to international business”.
“Its smallness may induce it to avoid the direct impacts through significant exposures to ailing banks, although we have had news of some direct impact in this sense,” Cordina told Business Today.
However, he added, its openness to international business would imply that slowdown or recessionary environments in the global economy would impact on local business, particularly in sectors which are not sufficiently competitive.
“We might also witness a declining wealth effect affecting Maltese consumers through reductions in portfolio of investments by Maltese residents overseas.
“Expectations of further declines in overseas investment values might then trigger a return to real estate investment in Malta, with potential effects on the value of land,” the senior economist told Business Today.
Asked about what lessons for the Maltese economy should one learn from the crisis that has hit Wall Street, Cordina said that “the entire basis of applied economics as a science is being shaken these days, with the massive government intervention to prevent a large crisis that is taking place in what is perhaps the world’s most free-market oriented economy.
“We are seeing that Keynesian thinking remains very much applicable, that markets can fail on a massive scale and that government intervention remains an important support to economic development.
“Whereas the first best situation would be one where markets operate properly, the second best probably entails government intervention rather than allowing a massive financial meltdown with the potential for a deep and prolonged recession,” he concluded.
On September 13, 2008, Timothy F. Geithner, the president of the Federal Reserve Bank of New York called a meeting on the future of Lehman, which included the possibility of an emergency liquidation of its assets. Lehman reported that it had been in talks with Bank of America and Barclays for the company’s possible sale. The New York Times reported on September 14, 2008, that Barclays had ended its bid to purchase all or part of Lehman and a deal to rescue the bank from liquidation collapsed. Leaders of major Wall Street banks continued to meet late that day to prevent the bank’s rapid failure. Bank of America’s rumured involvement also appeared to end as federal regulators resisted its request for government involvement in Lehman’s sale.
The International Swaps and Derivatives Association (ISDA) offered an exceptional trading session on Sunday, September 14, 2008, to allow market participants to offset positions in various derivatives on the condition of a Lehman bankruptcy later that day.
Although the bankruptcy filing missed the deadline, many dealers are honuring the trades they made in the special session.
In New York, shortly before 1 a.m. the next morning, Lehman Brothers Holdings announced it would file for Chapter 11 bankruptcy protection citing bank debt of $613 billion, $155 billion in bond debt, and assets worth $639 billion. It further announced that its subsidiaries will continue to operate as normal. A group of Wall Street firms agreed to provide capital and financial assistance for the bank’s orderly liquidation and the Federal Reserve, in turn, agreed to a swap of lower-quality assets in exchange for loans and other assistance from the government.
Merrill Lynch
Andrew Cuomo, New York Attorney General, threatened to sue Merrill Lynch in August 2008, over their misrepresentation of the risk on mortgage-back securities. A week earlier, Merrill Lynch had offered to buy back $12 billion in auction-rate debt and said they were surprised by the lawsuit. Three days later, the company froze hiring and revealed that they had charged almost $30 billion in losses to their subsidiary in the United Kingdom, exempting them from taxes in that country. On August 22, 2008, CEO John Thain announced an agreement with the Massachusetts Secretary of State to buy back all auction-rate securities from customers with less than $100 million in deposit with the firm, beginning in October 2008 and expanding in January 2009. On September 5, 2008 Goldman Sachs downgraded Merrill Lynch’s stock to “conviction sell” and warned of further losses from the company. Bloomberg reported in September 2008 that Merrill Lynch had lost $51.8 billion in mortgage-backed securities as part of the subprime mortgage crisis.
On September 14, 2008, Bank of America announced it was in talks to purchase Merrill Lynch for $38.25 billion in stock. The Wall Street Journal reported later that day that Merrill Lynch was sold to Bank of America for 0.8595 shares of Bank of America common stock for each Merrill Lynch common share, or about US$50 billion or $29 per share. This price represented a 70.1 per cent premium over the September 12 closing price or a 38 per cent premium over Merrill’s book value of $21 a share, but that also meant a discount of 61 per cent from September 2007.
AIG
On the evening of September 16, 2008, the Federal Reserve Bank’s Board of Governors announced that the Federal Reserve Bank of New York had been authorised to create a 24-month credit-liquidity facility from which AIG may draw up to $85 billion. The loan is collateralised by the assets of AIG, including its non-regulated subsidiaries and the stock of “substantially all” its regulated subsidiaries, and has an interest rate of 850 basis points over the three-month London Interbank Offered Rate (LIBOR) (i.e., LIBOR plus 8.5 per cent). In exchange for the credit facility, the U.S. government will receive warrants for a 79.9 per cent equity stake in AIG, and has the right to suspend the payment of dividends to AIG common and preferred shareholders. The credit facility was created under the auspices of Section 13(3) of the Federal Reserve Act. AIG’s board of directors announced approval of the loan transaction in a press release the same day. The announcement did not comment on the issuance of a warrant for 79.9 per cent of AIG’s equity, but the AIG September 18, 2008 8-K filing reporting the transaction to the Securities and Exchange Commission stated that a warrant for 79.9 per cent of AIG shares had been issued to the Board of Governors of the Federal Reserve. AIG drew down US$ 28 billion of the credit-liquidity facility on September 17, 2008.
