In the aftermath of our domestic stock market collapse and the global financial crisis last year, a friend and former student of mine sent me an e-mail. The story reproduced hereunder with my comments in bold teach all anyone needs to know about financial crisis.
“Tamedu is the proprietor of a Foo-Foo and Isi-Ewu Shop… in Lagos, Nigeria. Sales are low and, in order to increase them, he comes up with a plan to allow his customers to eat now and pay later. (In effect, Tamedu stops being a food seller and becomes a financial institution engaged in lending. Unfortunately he has not acquired any credit risk management skills) He keeps track of the meals consumed on a ledger. Word gets around and as a result increasing numbers of customers flock to Tamedu's shop. (If credit is freely available, borrowers will flock to any lender; the test is whether he can collect the debts on due date) His suppliers are delighted and are very willing to sell more and more raw materials for the meals he prepares. Tamedu shows them his ledger of receivables and they extend him credit (a financial system develops)
“A young and dynamic Customer Service Consultant at the local Nairaland bank recognizes these customer debts as valuable future assets and gives Tamedu a credit line and then increases Tamedu's borrowing limit (In AIG’s financial products division, they would have called it financial innovation). Taking advantage of his customers' freedom from immediate payment constraints, Tamedu jacks up the prices of his Foo-Foo and Isi-Ewu. Customers don't mind as they are not required to pay on the spot (A borrower who has no intention of repaying doesn’t care what the interest rate is!). Sales volume increases massively; Banks and suppliers lend more (the bubble begins); Tamedu opens more outlets in Abuja, Kaduna, Port Harcourt and Ibadan (In effect he becomes a mega-food seller!). He sees no reason for undue concern since he has the debts of the customers as collateral. At the bank's corporate headquarters, expert bankers recognize Tamedu's customer loans as assets and transform these customer assets into Bonds (that is called securitisation. Unfortunately a securitized instrument is only as good as the underlying asset, which in the US sub-prime market were bad mortgages based on over-valued houses; in the Nigerian margin loan transactions, the underlying stock prices were determined by Peter Ololo!) .
“These negotiable instruments are given exotic names such as FoofooBond, IsiBond, EwuBond AND EgusiBond (that’s what they call derivatives). These securities are then listed on the Stock Exchange and traded on markets worldwide (globalisation of financial markets, which guarantees that like global pandemics, modern financial crisis infect the whole world). No one really understands what the names mean and how the securities are guaranteed (In the US crisis, the CEO thought the COO knew, the COO thought the risk manager did, the risk manager thought the investment bankers did, they thought the product managers did, the investors assumed all these Harvard MBAs in the bank did, and the regulators assumed that the bankers knew-apparently no one knew anything) but, nevertheless, as their prices continuously climb (a bull market celebrated by the NSE DG) , the securities become top-selling items One day, although the prices are still climbing, a credit risk manager of the Nairaland bank decides that the time has come to demand payment of one of the debts incurred by Tamedu(He in effect puts a pin to the balloon).
“Tamedu in turn asks his clients to pay up. One by one they refuse; the clients cannot pay back the debts. Tamedu refuses to serve them anymore. The clients stop coming. Tamedu is really screwed now. (And the bubble bursts) He cannot fulfil his loan obligations and therefore claims bankruptcy. All bonds drop in price by between 80 to 95% (meltdown). The suppliers of Tamedu, having granted generous payment due dates and having invested in the securities (bad debts, toxic assets) are faced with similar problems. The goat-meat supplier defaults on payment to the Mallam who sells goats to him and to the cattle supplier and claims bankruptcy. The yam supplier is taken over by a competitor; Tamedu lays off the cook and staff. Bankruptcies soar, unemployment mushrooms (Recession, unemployment, corporate bankruptcies, credit crunch etc). The Nairaland bank that lent the money in the first place is set to collapse (Lehman Brothers, AIG, Freddie Mac, Fannie Mae, and the local examples) It is saved by the Government following dramatic round-the-clock consultations by leaders from the …(ruling) Party with Tamedu commuting back and forth in his Executive jet and Mercedes 500SEL, brokering the deal. The funds required to save the economic collapse are obtained by a tax levied on the citizens, most of whom do not eat Foo-Foo or Isi-Ewu. (Privatised profits and socialised losses-the people always end up paying!)
The meltdown was not caused by the credit risk manager who asked Tamedu to pay up his debts. He in fact probably prevented a bigger collapse in future if the bubble was allowed to get bigger…and bigger…blaming Lamido Sanusi for the current credit crunch amounts to blaming the surgeon, who undertook the corrective surgery, rather than the patient who made wrong lifestyle choices, and the doctor who delayed treatment. But then the surgeon must also be calm and careful to ensure the patient does not die after a “successful” surgery!
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