Monday, November 11, 2013 / By Abimbola Hakeem Omotola / Proshare
It was H2 2007; the global economy and financial system was riding on a bubble, this is despite the ominous signs of financial distress which economic managers and policy makers were too eager to pass it off as a slight blip. The Nigerian economy was also in an upbeat mood then, the nation had just conducted expensive but controversial general elections, and the elected officials were just settling to tackle the developmental issues at hand. Confidence was gradually returning to the economy as oil prices were trending up, which was reflected in the positive macroeconomic indicators and market indexes recorded during the period. Fast-forward to 2009 when all hell and been let loose after the near collapse of financial markets globally and an economic recession and you get a different picture. Not only were the markets indices in the red, other macroeconomic indicators were also negative.
It is not as if the global economy was new to experiencing financial crises and economic recessions. Infact, an IMF working paper in 2008 put the number of economic crises that have occurred in the developing world between 1970 and 2007 at 124 and several countries and regions have spent the better part of the last four decades managing one crisis or the other. Business cycles are just meant to fluctuate, and they cannot all be cyclical.
The Global economic crisis or the 2008 financial meltdown as some prefer to call it was however different in many respects from the crises the global economy has been experiencing for the past five decades. Markets and economies are now more interlinked than ever which made the crisis different in scale and scope; it was a classic textbook contagion crisis which started from the world’s largest economy; the United States, gathering steam as it crossed the Pacific and Atlantic, ravaging economies that were exposed.
The crisis would provide reasons for commentators and public affairs analysts to pass a damning verdict on the economist and banking profession and equally force a rethink of the market fundamentalism cum liberalization principles that had been shaping economic policies for the past four decades. Not only did just few economists predict the crisis, those that did could not even properly capture the scale and scope. The crisis however did not just emerge out of thin air as series of event and activities precipitated it. The next segment of this write up which was inspired by a chapter in Joseph Stiglitz, “Freefall; Free Markets and the Sinking of the Global Economy” will examine that.
2008 Financial Crisis; a Crisis in the Making
The crisis came on the back of the Clinton era deregulation of the financial markets which was globalized, and the low interest rates in the US between 2001-2007 that was first introduced to ease the US economy and boost consumer confidence following the 9/11 attacks, but later used as an economic palliative to stimulate growth. Several non-credits worthy individuals and households would then obtain mortgages which they don’t have the means to pay back. Some might wonder why and how financial intermediaries saddled with the responsibility of solving the asymmetric information problems associated with financial markets which could lead to adverse selection in granting mortgages to potential bad credit risks with were unable to stop the bad mortgages from going to people with no income, no jobs and no assets (NINJAs). The answer is not farfetched.
First, the markets was filled with ample liquidity since the federal fund rates was low; this led to excessive risk taking and under a weak regulatory system purposely designed in order not to stifle innovation in the markets, this went unnoticed or perhaps ignored. Second, the incentive structure on Wall Street was skewed towards short term returns; which made highly liquid but risky securitized assets very attractive. Mortgages firms did less thorough jobs in screening out bad credit risks since the aim here is to securitize and package the mortgages; toxic or not, and sell in the secondary market to earn high short term return. This clearly worsened the moral hazard problem in the markets.
The seeds of the financial crisis that was sowed In the US housing bubble would later pop when interest rates started rising and prices of mortgaged assets moved in the opposite direction and home owners were defaulting on their sub-prime mortgage loans. The toxic assets had already been securitized into a derivate known as the Mortgage-Backed Securities and repackaged with other debts assets which were then sliced and diced into tranches by Wall Street’s financial wizards and sold to unsuspecting investors worldwide through the Collaterized Bond Obligation (CBO) instruments which later went burst on account of defaults in sub-prime mortgage loans. The loss accumulated by the “too big to fail” financial institutions that were exposed to the CBO instrument was estimated to be in the hundreds of billions of dollars, which led to many going into financial distress.
As financial institutions started going under in the US while others were in distress, houses foreclosed and the financial markets equally tumbling; confidence was quickly drained out of the US economy and consumption dropped.
What was initially a financial crisis quickly turned into an economic recession. In a globalized world with interlinked economies and financial markets where the US plays a major role, it was not surprising to see the crisis quickly gathering steam as it spreads to other economies of the world. Triggering the Sovereign debts crisis in Europe and crossing the Atlantic to set back economic progresses made in Africa and Asia the past few years.
The Nigerian Economy was not spared; contrary to the assertion made by the then CBN boss, Charles Soludo, who in a bid to restore confidence in the economy and markets pronounced that the Nigerian Economy will not suffer adverse effects since the economy has low integration with the global economy (Vanguard, October 20, 2008). He even went a step further to pronounce all Nigerian banks safe.
He would have been right if the Nigerian Capital market was also not in a bubble; engineered by the banks themselves who had granted margin loans to their customers to buy their shares in the stock exchange which made their stocks quickly appreciate, even without any corresponding improvement in fundamentals.
Soludo would also have been right if the Nigerian economy was (and still is) not overly dependent on crude oil exports for foreign exchange earnings and revenue; thus making the economy vulnerable to “oil shocks”. As the global demand for crude oil retreated and prices succumbed to speculative pressures, the economy started caving and Soludo’s statement ended up being only a damp squib.
Impact on the Nigerian Economy
The impact was spectrum wide and was felt in various sectors of the economy. Fiscal authorities; both at the state and federal level were faced with revenue constraints during the period as revenue and foreign exchange earnings dropped significantly after oil prices succumbed to speculative pressures during the crisis. Oil price, which peaked at $147 per barrel in July 2008, consequently fell to $50 a barrel in November, which is below the $58 per barrel benchmark oil price for the 2008 budget. The government had to look to the Excess Crude Account to make up for the revenue shortfall in the 2008 and 2009 fiscal years.
The Nigerian capital market which was on a bubble before the global financial crisis hit the shores of Nigeria was the first financial institution to show signs of distress in the Economy. Like every other capital markets in the world, the Nigerian economy was a target of speculative pressures from investors who were selling off assets in response to the crisis. Prior to 2008, the market enjoyed a decade of unprecedented growth, driven principally by the banking sector reform. Market Capitalization (MC) rose by 318.3 per cent, from N2.90 trillion in December 2005 to N12.13 trillion in March 2008, while the All-Share Index (ASI) also rose by 161.6 per cent with the index rising from 24,085.8 in December 2005 to 63,016.56 in March 2008 (NSE, 2008; cited in Sanusi, 2011). As the crisis bit harder however, the NSE ASI and Market Capitalization inched southward, shedding 67.2% and 61.7% respectively between April 2008 and March 2009.
Foreign portfolio investors play a significant role in the Nigerian capital markets and on account of the selloff in the markets triggered by the financial crisis, started repatriating funds, leading to massive capital flight. Net outflow from the NSE alone spiked to #480 billion in 2008 from #104 billion in 2007. The import dependent economy witnessing both portfolio and direct investments capital flight proved too much for the economy, and the impact was felt at the foreign exchange markets, forcing the CBN to adjust the exchange rate to a more realistic band. The Naira which was exchanging at #117 per US dollar at the official market in 2007 depreciated to #135 per US dollar in December 2008 before depreciating further to #146 to a dollar in May 2009. The demand for forex at the official and parallel BDC segment spiked from $17 billion in 2007 to $32 billion in 2008; mainly due to capital flight, a demand which the CBN cannot satisfy if it does not want to deplete the reserve. Faced with mounting foreign exchange demand, the Naira’s value had to be sacrificed.
Exchange rate and reserve were not the only macroeconomic aggregates impacted by the crisis. Inflation also spike from 6% in 2007 to 15.1% in 2008 and remained at double digit till January 2013 when it returned to single digit.
The stability of banks and other financial institutions in the country were also threatened by the crisis. Many of the banks were already exposed to the oil and gas sector when it was booming and were left counting their losses when oil prices fell. Others had also placed huge bets on the stock market and it was estimated that the banks lost over #900 billion to the stock market crash. Huge loans had also been granted to firms and individuals who defaulted on payment and to make matters worse, the loans were not backed by adequate collateral. The Non Performing Loan (NPL) ratio of the banks rose to 20.7% in 2009, which is close to the 22% NPL that preceded the banking consolidation of 2007. The banks were already filled toxic assets and facing serious liquidity challenges, which impaired their ability to give credits to the real sector. Many of the banks even had to downsize on staffs and tighten expenditure to scale through the challenges; thus increasing the number of the unemployed in the country.
After the CBN; now being headed by Lamido Sanusi, and NDIC conducted a stress test on the banks in the country; only fourteen scaled through, while ten were adjudged to be in distress, with substantial non-performing loans; weak capital adequacy; poor corporate governance and illiquidity (Sanusi 2011). This necessitated the establishment of the Nigerian “bad bank”, the Asset Management Company of Nigeria (AMCON), which acquired the toxic assets from banks balance sheets and supplied liquidity to the banking system to avoid bank runs and systemic banking failures.
Relative to countries in Europe and even some in Asia, the global financial crisis had limited impact on the Nigerian economy. This is probably because the country is still developing and the financial system was relatively less connected to the global economy.
The economy has since returned to a path of stable growth. Major macroeconomic indicators are now positive and the capital market has been bullish for the past two years.
The impact, though limited was however still substantial and the lessons from the global economic and financial crisis should not be quickly forgotten. The factors that exposed the Nigerian economy to the crisis can be summarised into three;
1. The nation’s over-dependence on crude oil for foreign exchange earnings and revenue
2. Poor cooperate governance and risk management practices in the private financial institutions
3. Weak regulatory oversight of financial institutions and capital markets by the Central Bank of Nigeria, Nigerian Deposit Insurance Cooperation and the Securities and Exchange Commission
This should give us a cue on actions to take to limit the impact of future financial and economic crisis on the Nigerian economy. Fiscal authorities should be more committed to providing necessary infrastructures’ and also formulate economic policies that will aid the diversification of the economic base; which would make the country less vulnerable to oil shocks. The NDIC, CBN and SEC should also keep a close eye on happenings in the financial markets and financial institutions. Deregulation should not be taken too far nor taken to mean weak regulation of the financial system. As the crisis later proved in the end, markets are not entirely self regulating and cannot be left on their own. Balanced government intervention is needed to regulate the markets and ensure it does not fail.
You can also take part in the “The next CBN governor; whom the cap fit?” discourse. Send your contributions to firstname.lastname@example.org .
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