The on-going global financial crisis has generated debates about the extent to which the Nigerian economy is at risk of contagion which is spreading all over the world. To sensibly answer this question, we must carefully diagnose the causes and critical elements of the US and European financial meltdown which have now degenerated into a cause for global concern. The root of the problem was the housing bubble which led to unrealistic property prices in the US. This led banks to lower lending standards and grant mortgages to borrowers who would otherwise not be qualified to access them. Those borrowers on their part were enticed to procure those mortgages because of easy initial terms and the presumed availability of refinancing options on more favourable terms.
Remember this all made sense because interest rates were low, and property values were rising dramatically on a seemingly sustained basis. However once housing prices started to stagnate or drop, and interest rates began to tighten, refinancing became more difficult, and defaults and foreclosures began to increase. Once that cycle was broken, the wheel would naturally turn in the opposite direction, and property prices began to plunge just as easy initial terms began to expire and adjustable rate mortgages were reset to higher interest rates leading to more defaults and foreclosures. Gradually concerns about the value of portfolios of financial institutions and corporates with exposure to housing and mortgage markets began to spread and credit to such institutions dried up.
That led consecutively to the failure of Northern Rock, INDYMAC and Bear Sterns a major US investment bank with exposure to securitized mortgages. Fears began to spread about Fannie Mae and Freddie Mac and American capital markets plunged leading to a government “bail out” of the two mortgage behemoths. By this time, a credit crisis had developed which eventually spread beyond mortgage and housing related businesses to the entire financial markets as no one knew which institution would follow. Huge veritable firms were threatened-Lehman Brothers, Merrill Lynch, AIG, HBOS, Washington Mutual and the top two investment banks, Morgan Stanley and Goldman Sachs had to convert to bank holding companies (essentially seeking access to retail deposits and FDIC insurance) to survive. In September everything hit the fan, leading to Henry Paulson’s famous $700billion bail-out plan as the credit squeeze now threatened a wider recession.
What were the critical elements that combined to produce this spectacular market failure? There were six major ones- weak macroeconomic conditions produced by an irresponsible US government under George Bush that incurred huge budget deficits and unsustainable debts while fighting two major wars; asset price bubbles (housing); excess capital in financial markets; imprudent lending by banks and the financial sector; “irrational exuberance” in capital and financial markets; and weak financial market regulation. With the exception of our very strong macroeconomics (huge foreign currency reserves and low external debt), each one of the other elements in present in the Nigerian case!
We have asset price bubbles (recently busted share prices and perhaps a developing property bubble as well); banks have been encouraged to amass capital in excess of their requirements (clearly there is an over-supply of bank stocks on the capital market and the talk about share buy-backs is an admission of over-capitalisation); there has been a wave of imprudent lending most notably (but not limited to) margin lending to purchase over-valued stocks; there has been a mass hysteria in the capital market with wholesale, institutional and retail investors alike rushing in and expecting 100 percent annual returns! I also believe there has not been sufficient or appropriate regulation in the financial sector as everyone focused on banking sector growth and capital market regulators did not display sufficient understanding of the underlying market risks.
It does seem that the major insulation from a domestic financial crisis is not the financial sector itself, but our very strong macroeconomic conditions. We must thank God for Ngozi Okonjo-Iweala (and debt forgiveness) and Olusegun Obasanjo (for leaving us $50billion in reserves). And even our macroeconomics while sound, are headed in the wrong direction-oil prices are plunging, spending is rising, infrastructure remains weak, and policy is stagnant or reversing. The outlook for Nigeria will depend on the answer to some critical questions-will government curtail spending and revise its oil price benchmark downwards in the face of plummeting oil prices? Will government put in play a more effective policy for power, transport and other infrastructure, as well as overall economic management? How large are the margin lending related (and other loan) losses in the banking sector? How significant are Nigerian bank exposures to international banks? Finally will regulatory capacity in the capital market be rapidly overhauled? opeyemiagbaje.blogspot.com
Agbaje is CEO of Resources and Trust Company Ltd-a strategy, consultancy and business advisory firm. RTC POLICY is the policy, government and political consultancy division while RTC Strategy and Advisory offers private sector advisory services.
2 comments:
I waited earnestly for the second part of this write up but it never came.
The 5 questions raised at the end of the article has been a source of worry.
I work in the financial sector, a bank to be precise, and the question of Nigerian bank's exposure to international banks is not in doubt. The attempt at cover up is what alarms me.
Hello Dare!Our exposure to this crisis is about 5 percent! Thats not what you should worry about. Our financial sector is largely funded by revenues from Crude sales. Apart from the fluctuating prices and lack of apparent transparency in the sector, nothing should worry you. It is imperative to note that if there were any exposures, you'd have known by now! look at Countries that had exposure, Iceland, Engalnd. Their financial sector is already in chaos and responding likewise to the meltdown!
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