By Omoh Gabriel
Last month the United States of America, the hub of capitalism and the high priest and chief advocate of free market economy announced a $200bn (¬£100bn) bail out for two mortgage lender and on Friday the US congress passed the $700billion bailout for the credit crunch rocking the global financial market. In announcing the earlier bail out for the two mortgage firms President Bush said the firms had posed “an unacceptable risk” to the economy. In a dramatic move, US Treasury Secretary Henry Paulson announced the rescue plan on before markets opened. The rescue of the two firms cost the US Federal government $200bn (¬£100bn) as it invests fresh capital into the stricken mortgage giants to keep them solvent.
But a collapse of the two lenders would have frozen US mortgage lending for years, and would likely have lead to even steeper declines in house prices. What Nigerians must understand however is the difference between systemic failure and the failure of a single bank or company. In a systemic failure as was the threat in the Nigeria financial system before consolidation, the entire economy is at risk. This is what had happen in the mortgage sector in the US. The move is intended to keep the two companies afloat, amid fears that either could go bankrupt as borrowers default on their home loans. Together, Freddie Mac and Fannie Mae own or guarantee about $5.3 trillion (¬£3 trillion) of mortgages. But they have made a combined loss of about $14bn in the past year and officials were worried that they would no longer be able to continue functioning if such losses continued.
Banks around the world are highly exposed to the two companies and therefore, given the febrile state of markets across the world, it had become dangerous for doubts to persist about whether they were viable and would be able to keep up the payments on their massive liabilities.
A single bank or company failure on the other hand merely result in loses to the shareholders and customers of the bank/company. Global shares have rallied after the US government said it was taking over troubled mortgage lenders Freddie Mac and Fannie Mae. The decision of the US government stem from the under standing that market forces are not always efficient in resource management. In pure economics the invisible hand of supply and demand gives signal to economic agents and household as to the direction of the economy. A rising demand trend signal to producer the incentive to invest more while a downward price and demand trend signal the opposite. Very often, the invisible hand of demand and supply result in market failure nationally or globally. In recent times the signal from the invisible hand of market forces of demand and supply had tended to give a downward price trend to investors who inturn withheld investment funds. This had resulted in stock market melt down in almost all free market economies.
Investors hoped the largest bail-out in US history would prop up the country’s housing market and ultimately help to end the credit crunch, analysts said. What is clear however is the fact that the US government knows when to apply the brake. There have been several bank failure but the mortgage was an exception because of the danger it portend for the entire US economy whose engine of growth is the credit and mortgage systems.
Nigeria has had its own fair share of market failure. In recent time the capital market was experiencing a hull and regulator rallied round to save the market. Also the banking consolidation was conducted to address the financial inadequacies in the banking system. A total of N72.692billion was the deposit trapped in 10 of the 14 banks that could not meet the minimum N25billion during consolidation. This amount would have been lost if the banks had been allowed to fail ordinarily but with the intervention of government private sector depositors in these banks were able to recover their deposit. The failed banks in liquidation which liquidation have been concluded are Allstate Trust, Trade Bank, Lead Bank, Assurance and Metropolitan. Others are City Express, Hallmark, African Express, Eagle and Gulf. Three of the four failed banks still have cases pending in court while SGBN has won its case and is preparing to return.
Analysis of the available data for 10 of the 14 banks showed that the assumed private sector deposit trapped in these banks was N72.692billion, value of assets cherry picked by four banks amounted to N20.513billion, premium paid by NDIC on the insured deposits in the 10 banks was N2.688billion, promissory notes issued by CBN amounted to N25.764billion thus giving a total of N47.856billion of total deposits equivalent accessed by depositors in these 10 banks.
It is not just the financial sector in Nigeria that there has been market failure. In the oil sector the deregulation of diesel has experienced some form of market failure that require government intervention. Prices of the product has gone to the roof thus posing a threat to the fragile manufacturing sector which depend on generators to power their production yet nothing has been done. The failure of oil companies to address the externalities in oil exploration and exploitation has become a sour spot in the national economy resulting the militancy in the Niger Delta. What the recent US action has demonstrated is the known fact that there is no perfect market any where in the world. Markets have to be guided to achieve national goals.
When the bailout of the two could not solve the credit crunch, the US government proposed a $700billion bailout for the economy. The US Senate and Congress approved the revised $700 billion U.S. plan to stabilise the financial industry and kick-start credit, after the House defied President Bush and leaders of both political parties to reject the original package. The financial revival plan is expected to calm the financial market and restore confidence in both mortgage and credit system in the US, Europe and other markets.
Despite US senate approval of the bail out plan, most Asian markets ended down Thursday as the U.S. Senate’s approval for a $700 billion financial-rescue package failed to ease fears about a slowing global economy, while Japanese automakers such as Toyota Motor Corp. were hit especially hard by a dismal U.S. sales report for September.
European stocks have risen in Thursday trading following the US Senate’s decision overnight to back the revised American financial rescue plan. Analysts said investors were hopeful the US House of Representatives will now back the revised scheme this week. The UK’s FTSE 100 index was up 1.3 per cent in lunchtime trading in London, while Germany’s Dax had gained 0.7 per cent. The share gains also came after France confirmed that it will host a summit on the financial crisis on Saturday.
French President Sarkozy’s office said the special meeting would discuss a co-ordinated response to the financial turmoil amongst European members of the G8 ahead of a meeting of world finance leaders in Washington next week. UK Prime Minister Gordon Brown is due to attend, together with German Chancellor Angela Merkel, Italian Prime Minister Silvio Berlusconi, and European Central Bank President Jean-Claude Trichet.
Investors are still concerned about the efficiency of this rescue plan and how it can help the global economy But with just two days to go before the talks start, EU members are deeply divided.
France and Holland favour a European response to help banks hit by the credit crisis while Germany and Luxembourg believe a joint rescue plan isn’t necessary. European leaders have denied speculation that they wanted to establish a unified 300bn euro ($418.4bn; ¬£236bn) banking rescue deal along the same lines as the US plan.
In Hong Kong stocks advanced after a volatile session, with Ping An Insurance (Group) Co. of China soaring more than 17 per cent after the insurer said it won’t proceed with plans to buy a 50 per cent stake in Fortis’s asset-management arm for $3 billion. Japan’s Nikkei 225 Average ended the day 1.9 per cent lower at 11,154.76, its lowest finish in more than three years, while the broader Topix index lost 2.2 per cent to 1,076.97. Both benchmarks had advanced earlier in the day. Masanaga Kono, a strategist at SG Asset Management in Tokyo, said the decline probably stemmed from liquidation by some hedge funds, which affected the demand-supply equation of shares and hammered down valuations of even fundamentally strong companies.
Australia’s S&P/ASX 200 index fell 0.7 per cent to 4,761.10, South Korea’s Kospi lost 1.4 per cent to 1,419.65 and Taiwan’s Taiex gave up 1.1 per cent to 5,703.72. Singapore’s Straits Times Index also wavered between gains and losses, and was recently up 0.3% at 2,364.79. The decline came despite the U.S. Senate’s approval to the U.S. government’s plan to stabilise the financial industry and kick-start credit. See full story.
“It is perhaps too early for celebrations, as the bill still needs to be approved by the House of Representatives, which is potentially the biggest hurdle to overcome,” Moody’s economist Sherman Chan wrote in a note.
President Bush, Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke pressed lawmakers hard to approve the bill, and members of both parties huddled earlier in the week to hammer out a compromise plan after the failure of the vote in the House on Monday.
Sens. John McCain, R-Ariz., and Barack Obama, D-Ill., left the presidential campaign trail to cast their votes for the plan. Sen. Judd Gregg, R-N.H., a key participant in negotiation, said failure by the Senate to act would result in “a great period of trauma for our nation, especially for just everyday Americans who don’t deserve it.”
A massive plan to bail out the faltering U.S. financial system has been approved by Congress. Officially called the Emergency Economic Stabilisation Act of 2008, here are the bill’s major actions:
‚Ä¢ Authorises Treasury Secretary to buy $700 billion of troubled assets from financial companies.
‚Ä¢ Increases deposit insurance at banks to $250,000 from $100,000.
‚Ä¢ Limits executive pay and “golden parachutes” at participating firms.
‚Ä¢ Requires government agencies to modify troubled mortgages.
‚Ä¢ Includes tax relief measures and tax credits for business.
The revamped Senate bill sticks to the core plan developed by Paulson and Bernanke to have the government buy and hold toxic mortgage assets, freeing up funds for banks to begin lending again. It gives Paulson the $700 billion in phases, with $250 billion up front, then $100 billion pending presidential approval and another $350 billion pending congressional approval.
The most sweeping change is language to raise the limit for insured bank deposits sought by the FDIC, which asked to raise the cap temporarily to $250,000 from $100,000. This was designed to attract votes of some members of Congress who said that little was being done for Main Street.
Regional banks had lobbied hard for increasing the deposit-insurance limit, as they said that the government-backed sales of Washington Mutual Inc. had given consumers the impression that bigger banks were a safer place to hold their savings.
Separately, the bill also temporarily would allow the FDIC to borrow unlimited amounts of money from the Treasury, up from the current limit of $30 billion. The unlimited borrowing ability would expire in 2009. Executive pay would also be limited in some cases under the bill, as would “golden parachutes” for some corporate chiefs. Government agencies would also be required to modify some troubled mortgages as part of the legislation. Read a summary.
The bill also includes tax relief such as an extension of the fix for the alternative minimum tax and extensions of R&D credits. The big question is what lesson is there for Nigeria government which has left things in the hands of market force