THE SUB-PRIME CRISIS...
In the US, bailouts are perfectly fine
By Tion Kwa, Senior Writer (The Straits Times)
NOT SO UNFORTUNATE: Sub-prime borrowers are not unfortunate victims so much as complicit in an arrangement that has profited them as much as mortgage lenders.
IN FINANCIAL talk, haircuts and workouts have nothing to do with looking smart. Instead, they're a result of doing something really dumb.
So a decade ago, anyone with an ounce of sense was saying Asia needed a clipping, as bad lending decisions were revealed in their awfulness during the Asian financial crisis. Banks that made bad calls with loans needed to pay the price for underestimating risk, and write down those lendings with a haircut. Meanwhile, borrowers had to work their way out of high levels of leverage. This parcelled out responsibility for reckless behaviour.
Now replace 'Asian crisis' with 'sub-prime' and you get another kind of recklessness. But this time, instead of divvying out responsibility, markets are clamouring for a bailout. To call this an irony is to put it charitably. Try hypocrisy. For when it finds its back against the wall, America, the world's most advanced capitalist economy most of the time, can look, feel and react like a dinky Third World market.
Ten years ago, the argument was rightly made in Asia that bailouts would encourage moral hazard, meaning that if people are saved from the pain of risky decisions when these go splat, they'll continue making risky choices. It worked. Asia now is more sensitive about bailouts. Although the temptation remains, when bailouts do occur, they are not without a dose of embarrassment.
But in America, there is no shyness. Maybe it is because it has a long tradition of bailing out its own deadbeats and people in trouble. Start with sweetheart protection for uncompetitive industries. Then, move to Chrysler and the savings and loan crisis in the late 1970s and 1980s, and Long-Term Capital Management in 1998.
As odd as it might seem at first, Americans are used to government intervention. Indeed, the US addiction to moral hazard partly is the reason its financial industry has been encouraged to think up ever more complex securities, and why these exotic instruments are willingly bought by investors.
At the most basic level today, there is talk of helping out homeowners facing foreclosure. Who can argue? Surely people in danger of losing their homes deserve sympathy and a helping hand.
Maybe. Let's be clear - it isn't as though sub-prime borrowers are in danger of losing much, and maybe even nothing. In many cases, these borrowers bought their homes with no downpayment and at most very little upfront money. Bailing them out would be like bailing out renters.
But then again, if only. For unlike real renters, sub-prime borrowers have benefited from mortgage interest deductions on their taxes and, until a year ago, could even have leveraged rising home values into second mortgages. A good many did.
Rather than unfortunate victims, sub-prime borrowers were complicit in an arrangement that profited them as much as mortgage lenders. And people who gain from the risk they take should also have to pay up when things unravel. That was what was expected and demanded of Asia in the 1990s, and it applies just as much to America in 2007.
Over in the financial markets, another kind of bailout is taking place, as a 25-basis-point cut in the benchmark federal funds rate to 5 per cent is being priced in, for a start, awaiting confirmation from the Sept 18 Fed meeting.
But while the Federal Reserve was right to pump liquidity into the market to prevent seizure and to lower the discount rate, a reduction in the Fed funds rate is another thing. The first two are market operations, while the latter is an instrument of monetary policy that should be wielded only if economic indicators demand it.
Right now, it is not entirely clear how badly affected the United States economy will be from the sub-prime panic. It's been a rollercoaster ride, but it's also only been about a month and a half. Markets tend to overreact, and certainly the credit crunch has given them reasons to react wildly. But again, it's only been about a month and a half.
There is no basis yet to assume the worst in the real economy, which until recently was doing well enough. US second-quarter GDP growth was adjusted up to an annualised 4 per cent. Corporate profits have been respectable. Third-quarter earnings will start to come in around the second week of October, and that is when we'll begin to judge sub-prime's effect on the US economy.
Certainly, there is every reason for the Fed to monitor the twitches in the economy. But there is not yet enough grounds for it to adjust monetary policy.
For all that, the likelihood is that the Fed will lower rates. And Washington will bail out everyone else. Both will do what's expected, as each has done before. Neither action will be without cost, but this won't be a concern.
The US has always been refreshingly willing to let the market set its currency value. The dollar exchange rate perhaps is the best example of how the free market operates. While most of the world tinkers with currency values to varying degrees, America lets the dollar go wherever it might. Senator Charles Schumer may huff and puff about the Chinese yuan, but it will never occur to him instead to try to influence the value of the US currency.
On the other hand, that willingness to let the dollar settle anywhere also means one less restraint on politicians to print money and spend. And this is a reason why a bailout was on the cards the moment troubles looked serious, when retirement investors, banks, hedge funds and the next-door neighbour all got squeezed.
When emerging markets tried the same thing during the Asian crisis, global capital swiftly showed its disapproval. But when it is America's turn, Wall Street and Main Street are begging to be Uncle Sam's cronies.
tionkwa@sph.com.sg
..AND ITS IMPACT ON WORLD MARKETS
Fear not, China's quite resilient
By Chi Lo, For The Straits Times
THE sub-prime woes of the United States have spread to world markets. Recently, there have been even worries, exaggerated by some China critics, that the country's foreign reserves and financial system could be at risk due to their sub-prime exposure.
The Industrial and Commercial Bank of China, Bank of China and China Construction Bank said recently they had US$12 billion (S$18.3 billion) in sub-prime-related investment as of June. US data shows China held US$107.5 billion in US mortgage- backed securities in June last year, and the sum would likely be higher now.
Some critics (including regional media) have said - rather irresponsibly in my view - that China's foreign reserves would be significantly affected by the sub-prime debts if the experience of its state banks were extrapolated. But such extrapolation is nonsense, since there is very little sub-prime exposure in the rest of the financial system due to the strict control of Chinese financial institutions' overseas investments under the closed capital account.
Thus, the US sub-prime mortgage crisis should have little impact on China's financial system. The bulk of China's holding of US mortgage-backed securities is in the AAA category. The resilient stock price performance of Chinese state banks, which are also listed overseas, after their revelation of sub-prime holdings confirms that the problem was firmly under control and would not pose any threat to the stability of these firms and China's financial system.
However, the crisis will have some impact on China's real economy through the export channel. The sub-prime crisis will inevitably slow global economic growth in the short term. In particular, US growth is expected to be below its potential 2.5 per cent rate for a while. This slower growth will cut demand for Chinese exports.
China's exports are vulnerable to a US economic slowdown because they are being hit by a triple whammy. First, a slowdown in global demand for Chinese goods, due to a moderation in world economic growth even without the sub-prime crisis. Second, the impact of China's self-imposed export restraint measures, such as the cut in export tax rebates and the introduction of export tariffs and quotas, will become more evident soon. Third, the appreciation of the yuan will inevitably hurt competitiveness and profitability of Chinese exports.
As a result, China's export boom is likely to moderate in coming months. Since net exports have been a major contributor to its GDP growth in recent years, an export slowdown will also drag down overall economic growth.
But there are offset factors, so a growth slump is unlikely. The central government has room for fiscal expansion to boost economic growth, if needed. Beijing has been reducing its fiscal stimulus to the economy since 2002, when falling spending and rising fiscal revenue growth cut the fiscal deficit from 3 per cent of GDP to a surplus of over 0.5 per cent recently. With an improved fiscal balance, Beijing can restore fiscal stimulus by raising spending, especially on much-needed social programmes such as medical, pension and education initiatives.
Second, domestic consumption growth has been steady, averaging over 10 per cent of late. The trend is going to speed up due to the government's policy of boosting private spending as a GDP growth driver, rising income growth, accelerating urbanisation and better social security coverage.
Finally, domestic capital spending will likely remain strong, and this will offset some of the negative impact of slowing exports on manufacturing capacity expansion. Fast income growth and urbanisation will create demand for housing and, hence, property investment.
The immediate implication from all this is that slowing exports are likely to reduce the need for more policy tightening because the economy is expected to slow under the weight of slower external demand. Meanwhile, massive manufacturing capacity expansion in recent years and slowing exports will combine to increase the risk of more job losses and deflation. These issues will again dominate Beijing's economic policy decision-making in the coming year.
On a positive note, the sub-prime crisis is not expected to derail the world's solid economic fundamentals. It is a market problem, not an economic-fundamental problem. The world's central banks have shown a common front and great determination in preventing the sub-prime crisis from damaging still-benign economic fundamentals. In fact, the current asset market turmoil could well be an opportunity to buy quality, under-valued assets once the dust settles.
The writer is director of investment research at Ping An of China Asset Management (Hong Kong).
Source: The Straits Times, Singapore
No comments:
Post a Comment