Few see US financial fiasco ending soon
Written by changthai11 on Tuesday, September 23rd, 2008
WALL STREET CRISIS
Few see US financial fiasco ending soon
US conditions echo Japan’s fall in 1990s
DARANA CHUDASRI
Even as the US government prepares to spend up to $700 billion to buy up dud assets from ailing banks, few expect the problems that led to last week’s near-meltdown of Wall Street and the global financial markets to disappear.
Local economists and financial experts said the crisis, which was rooted in the sharp asset price declines in the US housing sector, could take three or four years to fully shake out.
Somphop Manarungsan, an economist with Chulalongkorn University, said the US economy mirrored that of Japan in the 1990s.
Public debt in Japan soared to as much as 160% of gross domestic product as the government moved to bail out ailing financial institutions. The high cost of intervention led to a decade of deflation, declining asset prices and falling salaries.
Dr Somphop, addressing a conference yesterday at Chulalongkorn University, said one key difference between the US and Japan, however, was that Japan at the time had a huge pool of savings and no foreign debt.
Borrowings were financed domestically at relatively low cost by the Japanese authorities. In contrast, the US is already a massive debtor to the world markets, with foreign debt now up to $11.4 trillion or 80% of GDP, a figure that excludes the potential future cost of bailing out ailing banks today.
“What is quite ironic is the fact that the formula that the US government is following is quite the opposite from that which the International Monetary Fund gave to Thailand a decade ago,” Dr Somphop remarked.
The US Treasury Department and Federal Reserve have defended their intervention in the insurer AIG as necessary to prevent a meltdown of the world’s credit markets and a spillover from Wall Street to “Main Street”.
But critics say it is incomprehensible why AIG, Bear Sterns and home mortgage institutions Fannie Mae and Freddie Mac were able to receive government assistance even as Lehman Brothers was allowed to enter bankruptcy.
Dr Somphop said asset values were likely to fall 30% to 40% in the US before markets corrected. With prices now down only 10%, this implied that more turmoil was possibly ahead for the US economy and financial markets.
“Basically, we are seeing the problems occur in the US because of five ‘overs’: overconsumption, overinvestment, overborrowing, overspeculation and overinflated asset prices,” he said.
Dr Somphop noted that over the past cycle, US housing prices had risen three-fold to $12 trillion. Assets for US pension funds rose from up to $10 trillion in 1999 to $29 trillion before the bubble burst.
The bubble came at a time when the global financial sector over the past several decades shifted from their role as servicing the “real sector”, or extending loans to individual and corporate borrowers, to a form of financial alchemy through derivatives and complicated structured products.
Sovereign wealth funds have also played an increasing role in the markets, as countries leverage their foreign reserves to buy up physical assets and securities in the markets.
Sukanda Lewis, another Chulalongkorn economist, said the crisis would be over once asset prices and private sector debt declined and the financial sector realised its losses and recapitalised.
“The risk today is that the financial institutions have not fully grasped the extent of their losses, while the recapitalisation process is only just beginning,” she said.
For the rest of the world, the problems in the US will inevitably have a spillover effect on their own economies, considering the interconnections in the global economy and markets.
Vachira Aromdee, director of international economics for the Bank of Thailand, said the crisis would lead regulators and financial institutions to rethink the business model of originating loans for securitisation to mobilise additional capital for new loans.
The crisis first emerged in mid-2007 with the collapse of the sub-prime mortgage market, a class of loans made to the riskiest borrowers.
Hundreds of billions of dollars worth of mortgage-backed securities have been issued in markets and purchased by institutional investors, including banks in Thailand. As default rates rise on mortgages, the value of these securities falls due to higher credit risk.
Ms Vachira said for the Thai economy, some impact on exports would be felt from the US downturn.
But the resiliency of Thai exporters and increasing importance of “new” markets in East Asia, the Middle East and Africa would help buffer the impact of an economic slowdown in Japan, Europe and the US.
“For the money markets, short-term volatility will continue. Risk aversion has increased, and this could lead to a credit crunch,” Ms Vachira said.
