- Rapid growth in the Real Estate sectors in the US, UK, Spain and other parts of the world (minus the usual exceptions such as Somalia, Iraq, Japan, etc), fueled by cheap mortgage financing. In the US in particular, re-financing activities involving 'sub-prime' mortgaging and loans created an economic bubble driving consumption.
- US and other heightened OECD consumption drove growth in countries that have recovered from the Asian Crises of the late nineties and more significantly, provided the burgeoning market to fuel China's economic growth through manufacturing of exports. China's economic fairy-tale came into its own in the new century with double digit growth from rapidly evolving industries and a middle-class expansion occuring simultaneously. Soon China was not just a beneficiary, but became a new engine for the global economy.
- China's manufacturing growth and shift in role in the global economy spurred a strong upwards trend in commodities prices. Commodity driven economies, not just the oil producing Gulf States but also Russia, South Africa and smaller players like Malaysia benefitted and also found a rejuvenated anchor for growth. In the Middle East, this fueled its own local construction boom, soon to (proportionately) rival that of China. Even India began to awake from decades-long slumber.
But it all began to unravel where it began, in the US. What was bound to happen happened, sub-prime mortgages and loans, i.e. those given to individuals otherwise deemed unworthy of credit and at higher interest exposure, began to fail! Surprise, surprise, especially with many of such sub-prime borrowers typically choosing to use the re-financing gains for consumption, not investment! In a sense, sub-prime lenders are a bit like alongs la, but with lower interest and without the parangs.
So these sub-prime mortgages in the US failed. But get this, the reason why the sub-prime lenders didn't need parangs was because they covered some of their risk of losing by hedging using financial instruments. Hedging is a bit like insuring, only you're not really insuring, but trying to play the direction of the market against itself. I know, confusing, but never mind. Suffice to say, when the sub-prime lenders failed, they didn't fail alone. They actually put the institutions that they hedged their risks with at risk.
And so we had the beginning of the financial crisis from this bursting of the sub-prime 'bubble', with banks that were hedging failing, and surprise-surprise, it wasn't just smaller banks, but bigger institutions that were involved, and not just US investment banks like Merryl Lynch and financial giants like Citigroup, but from across the globe, such as mortgage specialist Northern Rock in the UK and Swiss institution UBS both hit hard. (Northern Rock actually failed). Following that:
- The bursting of the sub-prime bubble affected confidence in the real estate market worldwide, which then led to the collapse of real estate bubbles in the UK and Spain. Soon, all the OECD nations were affected, including most critically Japan, which had its fragile economic re-emergence scuppered.
- Now that there wasn't any sub-prime lending available, and in fact with many home-owners losing their houses, consumption also dropped in the US (also followed by others). This directly impacted China's export growth.
- China was at least still going strong for a while, but all this was because of the Olympics. But then the Olympics started, and all the economic activity due to the build-up to the Olympics seized.
- And with reduced consumption, there was less need for commodities as raw materials for manufacturing. So guess what, oil, palm-oil, iron et al prices all began collapsing.
- Now suddenly the Middle Eastern and other commodities dependent economies are finding their cash cow producing less cash!
With 5, we see merchants banks like Lehman Brothers and Merryl Linch (that barely survived the first round) now being hit by the collapse of the commodities bubble! Serves them right, they were SPECULATING on commodities, which contributed to much higher prices of such materials worldwide in the first place, especially over the course of the past year. They also came in later in the game and seemed to focus on paper only, with higher risk, unlike Goldman Sachs and Morgan Stanley, which began speculating earlier and with physical trading support.
Lehman is now dead and Merryl has gotten itself 'saved', or rather 'eaten up' by Bank of America. But now comes the interesting part, which will really 'rock the world'. The sub-prime lenders had hedged their bets with these investment banks etc, but these investment banks etc. in turn actually INSURED themselves against losses. And this is where AIG comes into the picture.
I know it's Ramadhan, but to understand the whole AIG thing, I would have to recommend that people check out this posting at Malaysia-Finance Blogspot, remembering that the blog is about finance and just HAPPENS to have some nice pictures of naughty people... or is it naughty pictures of nice people...
Anyway, here's some exerpts of what the blog says to encourage you to check it out:
If AIG is to fail, it poses a much larger threat to the financial system than Lehman Brothers ever did because it plays an integral role in several key markets: credit derivatives, mortgages, corporate loans and hedge funds. AIG touches every single sector of the financial spectrum. Funds and investors who bought these CDS, who thought they had insurance (and now needs it because the chances of these mortgage-backed securities failing is very high), will now be faced themselves with no insurance.
Its like insuring your home fo fire, paying the premium and your house getting burnt down and the insurance firm went belly up. So if AIG collapses, which means their assets cannot serve their overall liabilities, you'd be staring at getting only a small fraction of what was covered.
If A.I.G. collapsed, its hundreds of billions of dollars of mortgage-related assets would be added to those being sold by other financial institutions. This would just depress values further. The counterparties around the world to A.I.G.’s credit default swaps may be unable to collect on their trades. More failures, particularly of hedge funds, could follow.
The full posting does offer some hope, but with an assortment of ifs.
Now, back to the Malaysian socio-political context. The last time we survived the Asian Crisis, we had Tun Dr M at the helm of a pretty strong team steering the economy back to health. Now we have Pak Lah... and as an alternative, we have Anwar Ibrahim, who was killing the economy before Tun Dr M had him sacked...
Tun Dr M and Tun Daim would likely help anyone who asks for assistance in saving the country from disaster. Pak Lah and Anwar are two of the most unlikeliest persons to ask for their help. We have an alternative genius in the form of KuLi (of Petronas, PNB, etc. fame), but he also will never be asked by Pak Lah and Anwar. We need a leader who is either a genius or can call on the strength of exprience of these aging geniuses to help us survive the coming storm. Let's hope Najib, Muhyiddin or indeed KuLi himself can get into the hot-seat ahead of the storm-front.