Dealing with the fallout of the global financial crisis, April 2008
What started as turbulence in segments of the U.S. subprime mortgage market has become a global financial crisis, which some analysts deem the biggest challenge to the international financial system since the Great Depression. As an organisation trading internationally you are likely to feel the effects of this and will need to understand the challenges to be overcome and the opportunities which are being presented.
Current Situation
Market-to-market losses on mortgage-backed securities, collateralized debt obligations, and related assets through March 2008 amounted to approximately $945 billion. In absolute terms this represents the largest financial loss in history.
The damage extends across a wide range of investor classes. Commercial banks stand to lose $440-510 billion, insurance companies $105-130 billion, pension funds $90-160 billion, governments $40-140 billion, and other financial institutions $110-160.
Global Effects
Innovations in mortgage securitization in the early and mid 2000s enabled loan originators to sell high-risk assets to downstream financial institutions around the world, thereby globalizing the American subprime crisis. Against U.S. bank losses of $144 billion, European financial entities stand to incur $123 billion in mortgage-related losses. Within the latter group, British institutions face $40 billion in asset write offs, nearly matching the combined losses of the Euro area ($45 billion). Financial institutions in Asia and other regions are far less exposed.
Industry Effects
The imprudent lending practices that precipitated the American subprime collapse are not confined to the United States. The IMF estimates that housing prices in Ireland, Netherlands, and United Kingdom are 30 percent higher than justified by economic fundamentals. British housing prices fell by 2.5 percent in March, the sharpest monthly fall in that country since 1992. Australia, Belgium, Denmark, France, Norway, Spain, and Sweden also face sizable housing bubbles.
Housing prices in OECD countries with more conservative lending practices (Austria, Canada, Finland, and Germany) are more closely aligned with market fundamentals, underscoring wide country variations in mortgage markets.
A surge in corporate defaults and debt downgrades in the U.S. and Europe indicates spillover of the subprime crisis to non-financial companies, as commercial lenders re-price their risks and de-leverage their portfolios.
The Global Economy
Together with the contraction of household spending resulting from the mortgage crisis, the tightening of corporate credit portends a slowing of economic growth worldwide. The IMF forecasts global economic growth to fall from 4.9 percent in 2007 to 3.7 percent in 2008. The U.S. faces a steep decline from 2.2 to 0.5 percent, with a non-trivial possibility of a prolonged and deep recession. GDP growth in the Euro zone, U.K, Canada, and Japan is expected to fall to the 1.2-1.6 percent range in 2008-2009.
The U.S. Federal Reserve and the Bank of England have slashed interest rates in an attempt to stimulate economic growth. Meanwhile, rising inflation has dissuaded the European Central Bank from deploying its interest rate weapon to spur growth.
Growth Opportunities Amid the Downturn
While the deterioration of international financial markets presages slower growth and heightened uncertainty, globally active mid-sized companies enjoy strong commercial prospects in coming years. Indeed, the dislocations arising from the current crisis offer unique opportunities to strategically agile middle enterprises, as follows:
- Financially stressed companies face mounting difficulties obtaining credit. However, companies with healthy balance sheets are holding their own in the global downturn.
- The April 1 report of the Institute for Supply Management confirms persistent sluggishness in the U.S. manufacturing sector. But the dollar’s fall is proving a boon to American exporters, particularly manufacturers of electrical equipment, machinery, appliances, paper products, primary metals, and transportation goods.
- Dollar devaluation also creates opportunities for middle enterprises to launch mergers and acquisitions in the United States. Foreign investors from Europe and other regions are in fact exploiting currency shifts to expand their U.S. positions.
- The financial crisis has not derailed the large emerging markets from their robust economic growth paths. Nor has the West’s subprime problem endangered the financial systems of those countries. Indeed, sovereign wealth funds based in China and other emerging economies are serving as liquidity buffers by injecting capital into beleaguered Western financial institutions.
- Profitable growth opportunities abound in global market niches that play to the strengths of technologically nimble middle enterprises
More broadly, previous economic downturns have proven excellent opportunities for middle enterprises to undertake counter-cyclical moves that strengthen their competitive position for the inevitable rebound: Lean enterprise campaigns; strategic acquisitions; discounted purchases of advanced equipment on secondary liquidation markets; hiring of talented employees released by downsizing companies. The present financial crisis offers similar possibilities for mid-sized companies taking a long view of their global growth trajectories.
To discuss how your organisation can counter the effects and continue to develop, contact the author of this article, David Bartlett an RSM International Economic Advisor.