Monday, November 03, 2008 What the ‘R’ word means for Cebu By Romeo R. Briones Contributor
(Last of 2 parts)
THE losses keep on rising.
As of October 2008, the International Monetary Fund (IMF) estimated that worldwide losses on debt sourced from America (principally from mortgage-backed securities or MBS) will reach $1.4 trillion.
Banks, insurance companies, hedge funds and institutional investors that own the debt have written down some $760 billion so far. The global banking sector alone accounts for about $600 billion of credit-related losses. Its ability to continue functioning as a viable entity is increasingly being questioned.
This creeping loss of confidence in banks produced troubling developments.Time was when the banking sector in the developed world depended on individual depositors for funding their assets.
Now, practically everyone relies on wholesale sources—money market funds, investment funds and other banks. However, during these times when nobody knows the real state of banks and other financial institutions, i.e. nobody really knows who is holding the toxic MBS-related debt and how much, the wholesale providers prefer to put their money in US treasuries and bonds.
In financial parlance, the decision by fund providers to invest in lower-yielding yet safe government securities rather than placing their money in bank bonds and commercial paper is called “flight to quality.”
In addition, banks avoid lending to other banks in the inter-bank market, afraid that they may be lending to the next Bear Stearns or Lehman Brothers, two failed banks. If they do lend, they charge much higher interest than what would be normally quoted in the inter-bank market. Otherwise, they deposit their money with the Federal Reserve banks. The stage was set for one of the severest credit crisis to hit the financial system.
The credit crunch and recession
The financial press has heralded the onset of a global credit crunch for some time now. What is a credit crunch?
Essentially, it occurs when the credit markets (the system that binds lenders and borrowers of funds together) stop being their robust selves and start to function at a grindingly slow pace.
Suddenly, borrowers—firms as well as households—can no longer get funding from their regular creditors and even if they are able to, the borrowing will have to be at a much higher cost.
Why is this all happening? Blame the subprime mess in the US.The humongous losses suffered by the global banking and financial sectors on account of their subprime-related holdings practically drained their capital to levels where they could not effectively carry out their principal function of providing finance to oil economic activity.
The amount of loans and investments that banks can make is a direct function of the size of their capital. The smaller the capital, the smaller loan and investment volumes will be. Also, a bank that is capital-challenged will have a hard time attracting deposits and placements – additional money that otherwise could be re-lent.
This diminished lending capacity inevitably leads to an economic slowdown. Businesses are unable to borrow to meet payroll, replenish inventories and build new facilities. Individual households can no longer rely on credit to finance the kids’ college education and to buy that new car or HDTV set. That long-planned Caribbean cruise will have to be postponed.
The IMF reckons that the assets of American and European banks will contract by some $10 trillion in 2009. Overall credit growth in the US will slow to below one percent, compared to a post-war annual average of nine percent, a development that can reduce the growth rates of the US and the European Union (EU) by 1.5 percentage points. The “R” word (for recession) is now heard in the politest of circles. Stock exchanges all over the world have reacted to the looming, if not ongoing recession, by free-falling to record lows in the past few weeks.
Unemployment figures have started to climb in the US and the EU. To stave off a protracted and deep recession, the US and EU governments instituted dramatic moves in concert, designed to get credit markets working normally again. The primary goal is to remedy the capital inadequacy of their banking sectors by giving them fresh funds directly. For instance, out of the $700-billion bailout package passed by the US Congress, $250 billion was injected into the country’s five largest banks.
The US Government also funneled a separate tranche of $85 billion to AIG, one of the world’s largest insurers. The UK, France, Germany, Holland and Belgium also carried out similar measures, investing hundreds of billions in their troubled banks.
The impact on ordinary Cebuanos
Despite these drastic measures adopted by governments, the global financial crisis continues. More losses from the toxic subprime assets are expected.
Experts agree that it will take time to restore confidence in the financial system and to allow the cure provided by the bailout packages to filter through the economy.
The economic turmoil that has gripped the global economy may seem distant to many in Cebu so far. Philippine banks remain solid capital-wise, having no direct exposure to subprime mortgages.A number of banks, though, experienced problems with loans extended to the local subsidiary of Lehman Brothers, the Wall Street investment bank that went bankrupt.
Philamlife, the Philippines’ largest insurer, is now on the selling block even though it is financially stable. Its American parent, AIG, included it in the list of global assets to dispose of as AIG struggles to reduce its $85-billion loan from the US Government. Stakeholders in Philamlife, including its policyholders, face the prospect of new owners and managers.
Other than these indirect effects, the Philippine financial system has been little affected by the global financial crisis.
On the other hand, the country could start feeling the recessionary ripples sweeping the world.
Over the years, Cebu’s economy, unlike economies of other regions in the country, has developed a base that increasingly looks to external markets for growth. Witness the electronic firms and other export manufacturers in the Mactan Export Processing Zone, the shipbuilding sector in Balamban, the small and medium enterprises (SMEs) producing furniture and fashion accessories, the business process outsourcing (BPO) firms and the local tourism industry.
Recession in the main markets of Cebu exporters means dampened demand and declining orders.
Companies may start to lay off employees or work shorter hours. They may also have to shelve expansion plans. In the case of the BPOs such as the call centers that have mushroomed in Cebu, a case has been made that a recession in the West would pressure operators to transfer more activities offshore in order to cut costs. There is, however, a counter-argument which says that the recession may cut so deep and last so long that demand for call center services may just drop or disappear altogether.
As far as tourism is concerned, the large contingents of Korean visitors may stop coming as the Korean economy, which is even more dependent on world trade, starts to shrink. The same can be said for the Japanese tourists. Furthermore, tourism normally slackens during hard times. Foreign travel is an optional expenditure for many and is usually the first to be scrapped from people’s budgets.
As the local export and tourism sectors reel from the effects of worldwide recession, the other pieces of Cebu’s economy such as construction, retail and services are also bound to suffer. Malls, restaurants and watering places could experience a drop in custom.
Not everything is bad about recession, however.
The rapid rise in commodity prices that has accompanied global economic expansion in recent years is set to go in reverse.
The price of oil, for instance, has already dropped to around $63 per barrel from a high of $147. The prices of other commodities are expected to follow suit in response to falling world demand.
Unpleasant news about the global economy will continue to dominate the headlines and indeed, we Cebuanos have reasons to worry. Cebu’s economy has become so outward-looking that we cannot insulate ourselves from the effects of a global recession. The governments of the hard-hit countries have already reacted forcefully and decisively by throwing lots of money at the problem, a measure that majority of economists agree is the appropriate response.
Restoring faith in the financial system and getting the credit markets back to speed again will be a gradual process, however. Meantime, the crisis continues and we just hope that it will not last long and that it will inflict minimum damage to the world economy and to our own.
(Romeo Briones is a retired investment banker and worked at the Saudi Industrial Development Fund in Riyadh and at the Kuwait-based Gulf Investment Corp. [GIC] for 25 years. In his last position as head of alternative investments with GIC, he managed the firm’s $1.4-billion portfolio of structured investment vehicles, hedge funds, MBS, CDOs and private equity funds. Mr. Briones has a postgraduate degree in Finance from the University of London and earned his BSBA in Accountancy from UP-Diliman. He also holds a CPA certificate.)
