Wednesday, October 15, 2008 Osmeña: US sub-prime crisis and the Philipine housing sector By Antonio V. Osmeña Estatements
THE economic meltdown in the United States started with housing sub-prime mortgages, which is the Wall Street’s euphemism for junk.
But while this is true, problems have spread way beyond the sub-prime sector. Those who predicted that the housing hiccup wouldn’t be a big deal failed to grasp that possibility. It turned out that Wall Street’s greed – and by Wall Street, we mean worldwide money and investment sector not a geographic area in downtown Manhattan-was supplemented by ignorance.
People in the world of finance created, bought, sold and traded securities that were too complex for them to fully understand. Try analyzing collaterized debt obligations (CDOs) – squared. Good luck!
Lehman’s fall shows the downside of using borrowed money. Even though Lehman has a 158-year old name, it’s actually a 14-year old company that was spun off by American Express (AmEx) in 1994. AmEx had gobbled it up 10 years earlier, and it wasn’t in prime shape when AmEx spat it out. To compensate for its relatively small size and skimpy capital base, Lehman took risks that proved too large.
To keep profits growing, Lehman borrowed huge sums relative to its size. Its debts were about 35 times its capital, far higher that its peer group’s ratio. And it plunged heavily into real estate ventures that cratered.
The world lost faith in American International Group (AIG)—the world’s leading insurer—too. A major reason is that AIG is one of the creators of the aforementioned credit-default swaps.
What are those, you ask? They’re pixie-dust securities that supposedly offer insurance against a company defaulting on its obligations. Assume you buy $20 million of Ford bonds. You might hedge your bet by buying $20 million CDs from AIG. In return for the premium, AIG agrees to give you $20 million should Ford have an “event of default” on its obligations. But as a way to make sure that swap can make good on its obligations, AIG has to post collateral. If its credit is downgraded, as was the case with AIG, the company has to post more collateral.
What put AIG on the brink was that it had to post $14 billion overnight which, of course, it didn’t have lying around. What doomed AIG was the rating agencies’ decision – they had suddenly awakened to AIG’s problems – to sharply downgrade the firm’s securities.
Since AIG is in a much scarier situation than Lehman – the insurer has assets of $1 trillion, more than 70 million customers and intimate back-and-forth dealings with many of the world’s biggest and most important financial firms—the US Government felt that it had no choice but to intervene.
There is no question that the crisis has gone so deep that it cannot be halted by government bailout. Banks and other financial companies around the globe are struggling to pull themselves out of this mess. Rebuilding will take time, vast amounts of money and constant attention to stop greed. Sooner or later, the trillions of dollars that the Federal Reserve and other central bankers are throwing into the markets will stabilize things.
When this happens, the housing prices will stabilize because no financial trend continues forever. The effect of lost of credibility with foreigners, specifically of Wall Street and fund insurers, is that the shift of investment will benefit the real estate industry.
The sub-prime mortgage fiasco in the US will never happen in the Philippines because credit capabilities of the borrowers are strictly observed by our financial and bank institutions. Our central bank have the just-right measure of regulation.
Of course, there are only a few Filipino greedy bank CEOs who were drawn to the AIG’s fundamentally flawed business model.
The root of the problem is that many borrowers showed no fear at all, and Wall Streeters didn’t have to worry about regulation, which was in disrepute. They didn’t worry about risk, which had supposedly been magically whisked away by all sorts of smart new products—derivatives like credit-default swaps. This lack of fear became a hothouse of greed and ignorance on Wall Street—and on Main Street as well.
When greed exceeds fear, trouble follows. Wall Street has always been a greedy place and every decade or so it suffers a blow resulting in a bout of hand-wringing and regret, which always seems to be quickly forgotten.
Analysts argue that real estate investments in our country, specifically residential condos, will not be affected by the US economy meltdown and, on the contrary, many expect more investors to come in because it is the safest investment until confidence is restored in the US security market.
