Despite all the complexities of financial markets and financial products, when there is a crisis the problem can often be broken down to simple economic issues. The parallels between the 1997 Asian Financial Crisis and the current US Financial market meltdown are so staggering, chief central bankers in Asia can be sent now to US to lecture Bernanke and Paulson.
Here are the similarities:
1. Overexposure to real estate
Awash with foreign earnings, Asian banks started lending heavily to companies. Since it was very easy to obtain credit, private companies invested heavily in real estate, even if their main business has very little to do with property. Even fly-by-night companies can get a loan to build a subdivision or condominium.
In the US, the mortgage market kept on expanding since China's appetite for American securities seem insatiable. Small mortgage companies provided housing loans to everybody, including NINJAs (people with No Income, No Jobs, no Assets).
2. Lack of regulation
The expansion of the financial market in Asia in the 1980s and early 1990s was so fast, regulators (Central Banks, SECs and finance departments/ ministries) were caught flat-footed. Institutions for monitoring and regulating real estate markets were either missing or ill-equipped. In the Philippines, the alphabet soup of regulatory agencies (McCain's favorite term, until recently) dealing with the housing market is still in disarray. The agencies with housing in its name include HLURB, HUDCC, HMF (Pag-ibig Fund), NHMF, NHA, HGC, and SHFC (with so many homeless people in the Philippines, I am not sure what do they all do).
In the US, the regulations put in place after the Great Depression were gradually removed by the government. Hence, there is a call for greater regulation and oversight in the current US elections. (Actually after the US$70 billion bailout package, they don't need to regulate anything anymore since they'll end up partially owning the entire financial industry.)
3. Corruption
Companies owned by government officials, their families and cronies benefited a lot from the housing and lending booms in Asia before the crisis struck. And when the government injected money to revive the industry, they benefited once more (I think we have a very rich senator who made a lot of money from banking and real estate).
In the US, the corruption is not that obvious... they call it lobbying. Lobbyists push congress and the government to loosen regulations and to look the other way. Worse, they actually use economic studies to push their corrupt cause.
4. Politics
In several countries in Asia, the financial crisis led to a change in leadership. Populists with a pro-poor agenda won in South Korea, Indonesia, Thailand and the Philippines. On whether they fulfilled their campaign promises is another matter.
In the US, the economic mess by the Republican Bush administration seem to benefit the Democrats led by Barrack Obama.
5. Bailout
With the economy in a mess, it needs bailing out. In Asia, the IMF, ADB and World Bank contributed for bailout funds for the Asian economies.
In the US, they are bailing out themselves probably by borrowing internationally. If they were in Zimbabwe, they would simply print more money until everybody becomes a trillionaire.
Friday, September 26, 2008
Tuesday, September 16, 2008
Is the worst yet to come?
The financial market is in a mess. The 158 year old investment bank, Lehman Brothers went bankrupt. The US government bailed out Freddie Mac and Fannie Mae, America's mortgage giants. Bank of America, the largest commercial bank in the US, swallowed Merrill Lynch. Bear Stearns was swallowed by JP Morgan Chase, with the help of the Fed. The Fed is about to swallow AIG.
As Bush tried to explain the crisis in July, "Wall Street got drunk... It got drunk and now it's got a hangover." Two months later, it seems Wall Street is not just sobering up, it is detoxifying. It got high while authorities are watching investors take drugs.
When I was researching about the US mortgage market a year ago, I was surprised and baffled by their system. When interest rates are falling, borrowers can refinance their loan, i.e. adjust the conditions of the loan to bring down the interest rate. In most cases, refinancing also include increasing the loan amount to reflect the increase in property value.
Most loans are fixed for 20 or more years. So when interest rates are rising, borrowers would simply hold to the loans. Borrowers can also choose from a wide array of mortgage options. In one mortgage option, borrowers don't have to pay anything for the first five years.
The system is almost risk free for borrowers. It seems too good to be true... and it was too good to be true. After a mortgage lender has released the loan, mortgages are bundled together and sold as mortgage-backed securities (MBS). A big chunk of these securities were bought by Freddie mac and Fannie Mae. The rest are bought by commercial banks, investments banks, mutual fund companies, trust funds and different financial institutions.
When property values started falling, the value of MBS fall. When borrowers started defaulting on their mortgages, these MBS became worthless. And this is why all these financial institutions are in trouble. Well, there are other reasons why they are in trouble including higher interest rates, higher inflation and weaker economy but the sub-prime mortgage crisis is the main root of the current financial crisis.
One problem in Wall Street is that there was a lack of transparency, something heard more referring to governments. Financial institutions refuse to divulge how much they invested in these troubled assets. For an investment bank to disclose how much it invested in a particular sector is like telling other companies their investment strategy.
The financial market is not as efficient as economists hope it should be, it is prone to the influence of animal spirits, self-fulfilling prophecies and voodoo dolls and feng-shui. If everybody expects markets to crash and pull out their investments and then the market will surely crash. These financial institutions think that if they keep their losses until the worst is over then they might survive the crisis.
And now here are the problems. Monetary and fiscal authorities failed to exercise their supervisory and regulatory power. The US government bailed the Freddie Mac and Fannie Mae this year that should have been done last year. The Fed helped JP Morgan buy Bear Stearns, by lending it money. If Bear Stearns was allowed to fall, Lehman would not have hoped that the Fed would also help them.
The problem is called in economics as moral hazard problem. As authorities give explicit or implicit guarantees to institutions that are "too big to fall" they become reckless. In a market-based economy characterized by competition, there are always winners and losers. There are No too-big-to-fall winners and no too-big-to-fall losers.
Inefficient and under-capitalized banks and financial institutions must be allowed to collapse before the market can get better. More banks should be allowed to fall. More financial institutions should be allowed to collapse. They took high risks and their investments failed. And no matter what happens, it is small investors like me who will pay eventually.
As Bush tried to explain the crisis in July, "Wall Street got drunk... It got drunk and now it's got a hangover." Two months later, it seems Wall Street is not just sobering up, it is detoxifying. It got high while authorities are watching investors take drugs.
When I was researching about the US mortgage market a year ago, I was surprised and baffled by their system. When interest rates are falling, borrowers can refinance their loan, i.e. adjust the conditions of the loan to bring down the interest rate. In most cases, refinancing also include increasing the loan amount to reflect the increase in property value.
Most loans are fixed for 20 or more years. So when interest rates are rising, borrowers would simply hold to the loans. Borrowers can also choose from a wide array of mortgage options. In one mortgage option, borrowers don't have to pay anything for the first five years.
The system is almost risk free for borrowers. It seems too good to be true... and it was too good to be true. After a mortgage lender has released the loan, mortgages are bundled together and sold as mortgage-backed securities (MBS). A big chunk of these securities were bought by Freddie mac and Fannie Mae. The rest are bought by commercial banks, investments banks, mutual fund companies, trust funds and different financial institutions.
When property values started falling, the value of MBS fall. When borrowers started defaulting on their mortgages, these MBS became worthless. And this is why all these financial institutions are in trouble. Well, there are other reasons why they are in trouble including higher interest rates, higher inflation and weaker economy but the sub-prime mortgage crisis is the main root of the current financial crisis.
One problem in Wall Street is that there was a lack of transparency, something heard more referring to governments. Financial institutions refuse to divulge how much they invested in these troubled assets. For an investment bank to disclose how much it invested in a particular sector is like telling other companies their investment strategy.
The financial market is not as efficient as economists hope it should be, it is prone to the influence of animal spirits, self-fulfilling prophecies and voodoo dolls and feng-shui. If everybody expects markets to crash and pull out their investments and then the market will surely crash. These financial institutions think that if they keep their losses until the worst is over then they might survive the crisis.
And now here are the problems. Monetary and fiscal authorities failed to exercise their supervisory and regulatory power. The US government bailed the Freddie Mac and Fannie Mae this year that should have been done last year. The Fed helped JP Morgan buy Bear Stearns, by lending it money. If Bear Stearns was allowed to fall, Lehman would not have hoped that the Fed would also help them.
The problem is called in economics as moral hazard problem. As authorities give explicit or implicit guarantees to institutions that are "too big to fall" they become reckless. In a market-based economy characterized by competition, there are always winners and losers. There are No too-big-to-fall winners and no too-big-to-fall losers.
Inefficient and under-capitalized banks and financial institutions must be allowed to collapse before the market can get better. More banks should be allowed to fall. More financial institutions should be allowed to collapse. They took high risks and their investments failed. And no matter what happens, it is small investors like me who will pay eventually.
Thursday, September 4, 2008
Obama in, GMA out. McCain in, GMA stays?
Iraq War. Historic high oil prices. Sub-prime mortgage crisis. Philippine occupation.
What do they have in common? They all happened while a Republican is in the White House.
Flashback: 1901
US is an emerging US power. US President William McKinley, a Republican, annexed the Philippines, Puerto Rico and Guam after winning the Spanish-American War.
As a colony, the highest government offices in the Philippine Islands were all held by Americans. This continued to the next decade as Republicans continue to rule the US. While the Philippine-American War was ongoing, the government implemented "Benevolent Assimilation", intended to teach "brown monkeys" civility.
Things changed in 1913, when Woodrow Wilson, a Democrat became president. The US government changed its track in dealing with their colonies, a series of policy changes which eventually led to Philippine independence. Why the shift in policy? The Democrats realized that it was too costly to maintain the Philippine Islands as a colony.
In 1933, a Democrat-led US Congress passed the Hares-Hawes-Cutting Law overriding a veto by Pres. Herbert Hoover, a Republican. It was the first law dealing with the decolonization of the Philippines. However, the Philippine Senate led by Manuel Quezon rejected the law.
In 1934, a revised version of the law was passed, the Tydings-McDuffie Law or the Philippine Independence Act. It was signed by Pres. Franklin Roosevelt, a Democrat. It led to the creation of the Commonwealth of the Philippines in 1935 with a ten-year transition period before full independence.
Interrupted by World War 2, there were talks that the Philippines should not be independent in 1945. But with a Democrat US president, Harry Truman, the Philippines became independent in 1946.
When Ferdinand Marcos declared Martial Law in 1971, the White House was occupied by Republican Richard Nixon. When Martial Law was lifted in January 1981, the White House was occupied by Democrat Jimmy Carter.
The ousting of Marcos might have happened earlier if Democrats continued to occupy the White House. However, because Republican Ronald Reagan was president from 1981-1989, we had to endure more of Marcos. Marcos was ousted by People Power in 1986, but Reagan allowed Marcos to live in exile in Hawaii.
Back to the present:
Iraq is the new Philippines (remember that Macario Sakay, the last Filipino general to surrender to Americans, was called an Insurgent). Republican John McCain is against pull-out from Iraq. Democrat Obama is calling for an end to American occupation of Iraq.
Republicans have a long history of keeping loyal dictators in power as long as they support the US against whatever it is fighting... communism then and terrorism now.
GMA supported the War in Iraq and she was elected in May 2004. In July 2004, sure that she "won" the election, she ordered a pull-out of Philippine troops from Iraq so that kidnap victim Angelo delaCruz can be released.
Now, here is where the conspiracy theorist in me gets excited. Remember when GMA went to the US and tried to meet both US candidates... she was able to talk in person to McCain but not to Obama (he called her instead)...
What are the chances... Obama in White House in 2008, GMA out of Malacanang in 2010. McCain in White House, GMA stays...
Historical Sources:
Corpuz, O.D. (1997). An Economic History of the Philippines. Quezon City, UP Press.
Constantino, R. (1996). Ang Bagong Lumipas. Quezon City, UP Press.
What do they have in common? They all happened while a Republican is in the White House.
Flashback: 1901
US is an emerging US power. US President William McKinley, a Republican, annexed the Philippines, Puerto Rico and Guam after winning the Spanish-American War.
As a colony, the highest government offices in the Philippine Islands were all held by Americans. This continued to the next decade as Republicans continue to rule the US. While the Philippine-American War was ongoing, the government implemented "Benevolent Assimilation", intended to teach "brown monkeys" civility.
Things changed in 1913, when Woodrow Wilson, a Democrat became president. The US government changed its track in dealing with their colonies, a series of policy changes which eventually led to Philippine independence. Why the shift in policy? The Democrats realized that it was too costly to maintain the Philippine Islands as a colony.
In 1933, a Democrat-led US Congress passed the Hares-Hawes-Cutting Law overriding a veto by Pres. Herbert Hoover, a Republican. It was the first law dealing with the decolonization of the Philippines. However, the Philippine Senate led by Manuel Quezon rejected the law.
In 1934, a revised version of the law was passed, the Tydings-McDuffie Law or the Philippine Independence Act. It was signed by Pres. Franklin Roosevelt, a Democrat. It led to the creation of the Commonwealth of the Philippines in 1935 with a ten-year transition period before full independence.
Interrupted by World War 2, there were talks that the Philippines should not be independent in 1945. But with a Democrat US president, Harry Truman, the Philippines became independent in 1946.
When Ferdinand Marcos declared Martial Law in 1971, the White House was occupied by Republican Richard Nixon. When Martial Law was lifted in January 1981, the White House was occupied by Democrat Jimmy Carter.
The ousting of Marcos might have happened earlier if Democrats continued to occupy the White House. However, because Republican Ronald Reagan was president from 1981-1989, we had to endure more of Marcos. Marcos was ousted by People Power in 1986, but Reagan allowed Marcos to live in exile in Hawaii.
Back to the present:
Iraq is the new Philippines (remember that Macario Sakay, the last Filipino general to surrender to Americans, was called an Insurgent). Republican John McCain is against pull-out from Iraq. Democrat Obama is calling for an end to American occupation of Iraq.
Republicans have a long history of keeping loyal dictators in power as long as they support the US against whatever it is fighting... communism then and terrorism now.
GMA supported the War in Iraq and she was elected in May 2004. In July 2004, sure that she "won" the election, she ordered a pull-out of Philippine troops from Iraq so that kidnap victim Angelo delaCruz can be released.
Now, here is where the conspiracy theorist in me gets excited. Remember when GMA went to the US and tried to meet both US candidates... she was able to talk in person to McCain but not to Obama (he called her instead)...
What are the chances... Obama in White House in 2008, GMA out of Malacanang in 2010. McCain in White House, GMA stays...
Historical Sources:
Corpuz, O.D. (1997). An Economic History of the Philippines. Quezon City, UP Press.
Constantino, R. (1996). Ang Bagong Lumipas. Quezon City, UP Press.
Tuesday, September 2, 2008
Why change (and poverty alleviation) is difficult?
Change is good... and so is poverty alleviation... but even if everybody agrees that poverty must be eradicated (or reduced at the least), it is not easy, it never was and never will be.
One reason is that poverty alleviation involves change, and change involves uncertainty... and everything in between is complicated. From an individual point of view, change may be desired generally but the fear of uncertainty is too great that (s)he would rather settle for the current status... no matter how mediocre or how pitiful the current situation is.
For instance, the government intends to relocate people living under bridges or next to esteros and canals. There are several reasons for their relocation, it is dangerous for those living there, especially when there are storms and floods. The informal settlers impede the flow of water, worsening flooding. They throw their waste directly into the water, leading to pollution.
Relocating them might be good for the general public and to them as well. They can be provided temporary housing or permanent relocation site or a fare back to their province. But all the options involve uncertainty for them. The relocation site might be far and inaccessible. They might not be able to find jobs there. They might not be able to find people to look after their children when they work. All these uncertainties may be enough to convince them that they are better off looking for a nearby bridge or estero to live at.
There is another problem... with great changes come much greater expectations. You hope for changes and improvements... But what if you get disappointed... During elections, we here politicians promise change, some old politicians promise the same things they promised the previous election. Some people vote for the dismal current state simply because they don't want to be disappointed.
The secret to happiness... says one joke... lowered expectations. This is probably the reason why poverty is easier to escape than to eradicate.
There are other problems with change... sometimes, the road to hell is littered with good intentions. Proposals intended to protect or help the people in the short run, might be disastrous in the long run. These might include legislated across the board wage increases, rent control, VAT abolition, and zero-rated loans.
And sometimes, it boils down to implementation... The devil is in the details. A hydroelectric dam that will provide renewable source of energy, irrigation and drinking water involves the destruction of villages and relocation of thousands of people. The Clean Air Act prohibited incinerators, instead of burning we are burying our garbage, including dangerous, contaminated hospital wastes.
Some people might call me a pessimist, for me, I think I am a "realist". Realizing that poverty alleviation is difficult puts into context why so many great ideas failed and will continue to fail. Change involves everybody, everybody (or at least the majority) must agree that they want change.
Poverty alleviation involves everybody, but not everybody agrees how to reduce poverty.
One reason is that poverty alleviation involves change, and change involves uncertainty... and everything in between is complicated. From an individual point of view, change may be desired generally but the fear of uncertainty is too great that (s)he would rather settle for the current status... no matter how mediocre or how pitiful the current situation is.
For instance, the government intends to relocate people living under bridges or next to esteros and canals. There are several reasons for their relocation, it is dangerous for those living there, especially when there are storms and floods. The informal settlers impede the flow of water, worsening flooding. They throw their waste directly into the water, leading to pollution.
Relocating them might be good for the general public and to them as well. They can be provided temporary housing or permanent relocation site or a fare back to their province. But all the options involve uncertainty for them. The relocation site might be far and inaccessible. They might not be able to find jobs there. They might not be able to find people to look after their children when they work. All these uncertainties may be enough to convince them that they are better off looking for a nearby bridge or estero to live at.
There is another problem... with great changes come much greater expectations. You hope for changes and improvements... But what if you get disappointed... During elections, we here politicians promise change, some old politicians promise the same things they promised the previous election. Some people vote for the dismal current state simply because they don't want to be disappointed.
The secret to happiness... says one joke... lowered expectations. This is probably the reason why poverty is easier to escape than to eradicate.
There are other problems with change... sometimes, the road to hell is littered with good intentions. Proposals intended to protect or help the people in the short run, might be disastrous in the long run. These might include legislated across the board wage increases, rent control, VAT abolition, and zero-rated loans.
And sometimes, it boils down to implementation... The devil is in the details. A hydroelectric dam that will provide renewable source of energy, irrigation and drinking water involves the destruction of villages and relocation of thousands of people. The Clean Air Act prohibited incinerators, instead of burning we are burying our garbage, including dangerous, contaminated hospital wastes.
Some people might call me a pessimist, for me, I think I am a "realist". Realizing that poverty alleviation is difficult puts into context why so many great ideas failed and will continue to fail. Change involves everybody, everybody (or at least the majority) must agree that they want change.
Poverty alleviation involves everybody, but not everybody agrees how to reduce poverty.
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