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Date: 09 Oct 2008
Title: The ins-and-outs of the global economic crisis
The causes and effects of the US mortgage crisis on world markets is often lost in financial jargon and economic terminology, with many South Africans left wondering whether they are being directly affected by it, writes Michael Appel.
Put plainly, the economic woes in the Unites States began a few years back when banks and other financial institutions - not acting within the confines of good lending practices - extended home loans to almost every person walking through their doors.
No proper credit checks were done on prospective lenders and financial institutions continued lending in the face of a diminishing housing market in which the value of assets began dropping sharply.
Econometrix economist Russell Lamberti explained to BuaNews that when, for example, a bank has $500 million in housing mortgages on its balance sheets, but the value of houses has dropped by 20 percent, the bank can no longer extend as much credit as it did.
"If you have $500 million on your balance sheets as a bank, but the assets have lost 20 percent in value, it needs to be reflected in the books," he said.
How much a bank lends needs to be proportionate to the value of its assets, Mr Lamberti explained.
With banks over extending credit and debt-burdened Americans struggling to repay their mortgages, the US market plummeted, requiring all major world banks to inject billions of dollars into world markets.
"These banks now either have to recapitalise or recall all their loans," Mr Lamberti said.
The US government's $700 billion bail-out plan passed by Washington last Friday is hoped to be the saving grace for world markets as the US government will effectively payoff financial institutions' bad debt.
Problem being, however, that nobody seems to know the amount that needs to be paid off by the US government, with Mr Lamberti arguing that $700 billion could simply not be enough.
"There are many reasons for the markets not reacting more positively to the news of the US government bail-out plan being passed. Firstly, there is a deep worry that the bail-out package will simply scratch the surface of debt.
"[And secondly] that long term consequences of the bail-out plan will further indebt US taxpayers," Mr Lamberti said.
The US government is raising the $700 billion through the issuing of bonds to anyone who will buy them, and will then use the funds to inject much needed liquidity into world markets.
The $700 billion will basically be used to buy the assets from the bank at a discounted rate, manage the assets and restore them to some sense of financial health, said Mr Lamberti.
He also believes that the US government could possibly make a profit out of the whole bail-out plan, as the bought assets would later be sold back to the private sector, quite possibly yielding a profit.
In terms of South Africa, despite a high inflationary environment currently with annual inflation in August hitting 13.6 percent, South African consumers are still in a much better position than their American counterparts.
"South Africa's banks are properly capitalised and are in pretty good shape.
"Absa and Standard Bank are the big banks in home loans, but our credit policies have always been rather strict.
"The price of property in South Africa has remained pretty flat for the past year, but if it drops by another 10 to 15 percent in the future we could see our own credit crunch in South Africa," he highlighted.
While many doomsayers have witnessed the recent All Share index drop to recent all time lows as the beginning of a local market collapse, Mr Lamberti explained that among developing countries, South Africa's not doing all too badly.
The local currencies of other developing markets like Turkey and Brazil saw greater weakening than the South African Rand, he said.
"The Australian Dollar was actually the hardest hit on Monday losing more than the Rand, so in comparison we're not doing that badly.
"Emerging markets fell 10 percent on Monday, while we fell 7 percent. We're holding up somewhat better with the Rand acting as a shock absorber," Mr Lamberti said. - BuaNews