2009 LECTURE :
“GLOBAL FINANCIAL MELTDOWN: CAUSES AND EFFECTS”
– by Alhaji Abubakar Abdulkadir (B.1162)
INTRODUCTION

It started small, then it went global. Now this financial crisis is forcing the entire world into deep recession which is also threatening to develop into a depression. This last prospect is sending jitters into the spine of everyone. Nobody is looking forward to it. It is a phenomenon which was last experienced between 1929 and 1933. It was economically and socially, devastating. But we have not reached that ugly situation yet. We are currently in a state of deep recession. This is one step better than a depression.

Recession occurs more often and has a pattern which policy makers recognize and learn to manage as it occurs periodically. Therefore, if that is the case, then why should the current recession cause so much panic reactions which we are witnessing all around the world? The answer lies in the fact that this recession was caused by the systematic breaking down of the world financial system thereby shaking things abruptly up. Economists and bankers are calling the process ‘financial meltdown’; whatever is the outcome of this process, the financial world will never be the same again. The recession, when it ends, will throw up a challenge behind it for a new and hopefully a stronger and a more purposeful system than what we have at the moment But how did this crisis all begin and from where? It all began in the United States of America and therefore can be correctly labeled “MADE IN AMERICA” wherever and whenever its effects are felt around the globe. The adage that when America sneezes the rest of the world catches cold is, on this occasion, demonstratively and painfully correct; much as we dislike the idea.

It was America which invented and developed what it called “Assets-
backed securities” in the mortgage banking industry, it was America which developed and exported to the rest of the world the philosophy of extreme deregulation in the free market system which has now been proved to be a mistake. Unfortunately, the philosophy has already been adopted by many countries but which are now happily trying to reverse themselves. It was America which exported its corporate irresponsibility through dubious accounting methods which tended to hide many weak areas of its management style and ultimately resulted in quite a handful of failures. Many countries are now reversing themselves and going back to a more conventional system which they were used to.

It has to be understood that the American economy is largely resting on its four key sectors, namely:
a. Housing growth and development;
b. Transportation industry (i.e. the growth of such manufacturers as General Motors, Ford, Chrysler, Boeing, etc.) railways, housing, airways and many others of such kind. They were all privatized and their operations completely deregulated.
c. Military industrial complex; and
d. Information Technology.

If there is any trouble in any of these sectors, the effect will translate negatively in the overall growth of the GDP of the country. It is in this light that we should understand the concern of the American policymakers when the housing sector started experiencing trouble through mortgage defaults by the end of 2005 and the beginning of 2006. But even at that time, not many people could imagine the trouble to be of crisis proportion and in fact a global “wild fire. There was however a little difference between the situation obtained in the U .S.A. and the situation existing elsewhere. This is with respect to the fact that there was no privatization exercise to be undertaken there. Most economic projects and business were already in the hands of the private sector. The main area of decision therefore, was for the Reagan administration to determine the role of his government in the smooth operation of these strictly private enterprises by their own operators.

Like his counterpart in the U.K., Mr. Reagan, as said earlier, believed in the strict non-interference in the activities of the private sector both of his country and the world at large. As a result of this attitude, the Wall Street financial operators were left alone with only the derelict regulations which were in no way abreast with the changing items. Nor were they adequate in providing the necessary restraints on the operators.
They were on the contrary, regulatory systems which enthroned market extremism that saw mortgage and other lending institutions extending loan facilities to unfit and improper persons and corporate entities. This eventually plunged the American economy into an unprecedented recession leading to the loss of jobs by at least five million Americans by the current account and still counting. Apart from the irresponsible behaviour of the Wall Street operators, there is also the American government tendency of consistently incurring budget deficits and the high consumption levels of the American people to consider. It should be appreciated that these two tendencies have also contributed in no small measure to the downturn of the global economy.

Over the last eight years, for example, the American federal government’s budgets have gone through annual deficits on an average of $450 billion. In fact, the present 2008/2009 budget will incur a deficit of approximately $ 1.2 trillion. The reason for this significant increase in fiscal recklessness is not far to find. The American government under President Bush has plunged the country into two costly wars, one in Iraq and the other in Mghanistan. The Iraqi war alone has so far cost America S1.02 trillion. We have not yet seen the end of these two wars. Maybe the new president, Mr. Barrack Obama, will have to be financed, as in fact they do, through borrowings from both internal and external sources. America today is the world’s largest borrower with a total national debt profile of well over $9 trillion. China alone is claiming $500 billion from this total debt. And yet the world did not seem to be worried, not to speak of expressing anger over this matter until now when it realized the nature of the disaster which these reckless actions would lead us into.

The American people also cannot be free from this blame. Even though they constitute only 5% of the total world population, and contributing only 22% of the global economy, yet they consume about 67% of the world’s total economic output. It therefore adds up to the fact that America today siphons up most of the world’s total savings to address its various problems which include wars and its insatiable level of consumption. In so doings it leads the world into serious drought in the availability of loanable funds for productive business.

From these accounts therefore, one could see that the failure of the mortgage banks in America only triggered the already simmering crisis of the finance and banking sectors into explosion. When it did last year, it took everybody unawares and unprepared. The policy makers were very reluctant to admit the serious nature of the problem. When Fannie Mae and Freddie Mac, two of the US mortgage banks, declared themselves insolvent, most operators at the Wall Street did not pay much attention to the issue until after the giant financial institutions like Lehman Brothers, Merrill Lynch, AIG (American International Group), Goldman Sachs, CitiGroup, Wells Fargo Bank etc. started on one-by-one basis to declare the same insolvency position that these operators and the rest of America began to panic. The White House at first played down the serious nature of the problem. Mr. Bush would not want to expose the already broken down scenario at the Wall Street After all, it is part of his failure and the failure of his party’s philosophy too.

The world is now a global village. Banks and other financial institutions now establish links with each other across the globe. Whatever happens in the U. S.A has direct bearing on the rest of the world. The global banking and finance systems are now a single entity and they are seriously breaking down. When the crisis surfaced in Europe, it was in Great Britain that it first appeared. Northern Rock, a once thriving mortgage bank, declared itself in distress. There was a run on its operations. The operators of the financial district in the city of London were practically left alone with few or no adequate regulation to help the government in providing them with effective supervision. As a result, banks were unintentionally allowed inordinate leeway to extend credit to weak or even undeserving borrowers. The net result was naturally heavy defaults which ultimately rendered the banks themselves insolvent. The aggregate of these insolvencies was to usher in the general nationwide credit crunch which the government is now, in later years, trying to solve through bailouts with funds from the public treasury.

In the United States of America, the situation was the same. In fact, it was from there that the deregulation of free market philosophy originated and was exported across to Europe (principally Great Britain, France and Germany), to south-east Asia and to the Far East, principally to Japan and South Korea. The main proponents of this philosophy were of course, Milton Friedman, the economic advisor to Mrs. Thatcher and Alan Greenspan, the former chairman of the US Federa1 Reserve Board.

B. THE GENESIS
A new financial product called “mortgage backed securities (MBS)” was introduced in the mortgage payments in America several years ago. They were readily accepted by all financial institutions in both the U.S.A. and the rest of the world, more particularly in Europe and the Far East. These papers were seen as very dependable assets by all financial security institutions and even by the other groups of corporate investors and individuals across the globe. Through them these investors invested heavily in the United States of America’s housing market; in fact, the trust in the MBS had attracted major banks and other financial institutions like insurance companies to even borrow and invest so heavily in them. Every indication showed that it was a wise decision until the time when the bubble burst in the year 2007. It all started manifesting itself with the high default rates in the America’s housing market.

This was as a result of the earlier government policies which encouraged higher risk sub-prime lending practices. There was also already an additional incentive like that of easy initial terms which also encouraged borrowers to get more and more involved in the venture until when in the long run the interest rates began to rise and until housing prices started to fall. The borrowers began to default as a result. Foreclosures increased dramatically because the initial easy terms have expired. To make matters worse, the home prices still refused to go up because of glut. Foreclosures therefore accelerated. This was what triggered the world. By 2007, nearly 1.3 million housings in the country were up for foreclosures. That was 79% of the total. For the rest of the financial world, the total collapse of the MBS had resulted in the colossal loss of approximately $435 billion (four hundred and thirty five billion dollars) by the middle of July 2008. This was the clear indication that all was not well in our financial world. It signaled the commencement of the global financial crisis which led us to our present recession which most countries in Europe and North America were reluctant to admit until lately.

THE DEVELOPMENT AND THE IMPLICATIONS ON THE WORLD ECONOMY
Meanwhile, as could be expected, the colossal losses incurred by the financial institutions worldwide as a result of their decision to patronize on a large scale, the American-invented and now collapsed MBS, has seriously affected their liquidity positions. It is needless to say that this development has therefore curtailed their ability to grant loans to their potential borrowers. In short, a worldwide credit crunch is what would follow, and is what is now happening. If banks and other financial institutions could not be in a position to grant loans to manufacturers, traders and farmers, then these sectors, unless somebody comes to their rescue, would also be in a difficult position leading to their total collapse. There would therefore be only one institution left to do so under the circumstance; and that is their individual governments. It is no surprise therefore that most governments, particularly those in the industrialized countries, are now seriously inclined and in fact determined to assist by extending public funds to them as a bailout.

However, it is clear that these governments have a long way to go because the crisis is very deep and very widespread. It would take a lot more effort and time before any positive turn around of the world economy could be achieved. Nevertheless, it must be admitted that the initial responses of these governments that have the problem required some urgent action. They must have also realized by now that the crisis is imposing the greatest challenge to the world since the end of the period of the Great Depression, between 1920 and 1933. The recent convening of meeting of the leaders of the industrially advanced countries, the now G20, so urgently attested to this realization.

However, it is very simplistic to suppose that the main cause of the crisis was just the mortgage payment defaults in the housing market in the United States of America. At best, it could be described as only a trigger to a disaster waiting to happen. To understand the roots and the origin of this potential disaster, one should go back to the early nineteen-eighties when Mr. Ronald Reagan was the President of the United States of America and Mrs. Margaret Thatcher was the Prime Minister of the United Kingdom. Both of these leaders strongly shared the same belief. They believed that the less the governments interfered in the private-sector activities the better for such activities to grow and prosper.

Nobody in a free democratic environment with a free market economy would argue against this belief. However, this environment must be strictly controlled with adequate regulations to ensure that the operators of this free market do not act against the necessary norms because of greed and selfishness. If that is allowed to happen their entire society suffers.
But even this basic requirement was strongly opposed by these two leaders. They passionately believed in the free and the deregulated economy with little or no government intervention whatsoever. In Britain in particular, Mrs. Thatcher had embarked upon a massive privatization of enterprises which were hitherto under the ownership and control of the government. These include telecommunication facilities. Government, wanting to calm down the nerves of the depositors, declared that it was taking over the banks and would meet all its obligations to them. There was peace but only for a short while. Soon other banks joined the line in the distress declaration exercise.

They included HSBC, Standard Bank, Lloyds Banking Group and few others. Even the Royal Bank of Scotland did not escape the crisis. It was after this declaration that the people of Britain came to the grip of what was really happening. It was really a global financial breakdown and it was then that the government started treating it in that manner. It decided to vote some 48 billion pounds sterling as bailout money to several of these financial institutions.

Back in the U.SA, President Bush went to Congress and secured bailout money of $700 billion. This was also to be distributed to these financial institutions to keep them in operation. He was however able to distribute only $350 billion before he left office. The big question however is the manner in which to treat this bailout money. While Britain wanted to use it to buy equities with loans in these institutions, the American government preferred to use it as short to medium term loans. It would however consider buying equities (35%) on a very few occasions. And even at that it would be in a form of preference shares.
In Germany, the government decided to extend $13.5 billion to Commerce Bank to help it out of its distress situation. Other European banks have also received the same treatment from their respective governments. So also were those in South East Asia and the Far East.

All these measures appear to be steps in the right direction. Banks and other financial institutions must be assisted to survive and operate in a healthy situation. The first step therefore is to make sure that they have adequate capital base and adequate liquidity to function satisfactorily. But there is a far more serious work to be done in both the medium and long term period in order to ensure their permanent survival.
The Wall Street regulation must, for a start, be seriously reviewed and modernized to help the government to supervise it properly. A laxity that allows people like Bernard Madoff to swindle investors to the tune of a staggering $50 billion (fifty billion dollars) cannot be allowed to continue all in the name of keeping the government away from private sector activities.

While the government should encourage private sector participation and even helping it to take a leading role in most instances of business activities, it should at the same time exert upon it proper supervision based on up-to-date laws and regulations. In this respect however, the government must emphasize harmony in all its dealings with the private sector. More will be said on this issue later on in this paper.
Meanwhile, it should be noted that there are other two areas of financing to pay attention to if we are to see the process of recovery take off in the proper direction. The first one is the bailout fund for the other sectors of the economy especially the manufacturing sector. In a period of credit crunch, the banks cannot be in a position to help with the required loans, and unless credit fund can come from outside the banking sector, these enterprises will surely collapse. Already, some important manufacturing ventures like the General Motors (GM), Chrysler and others in America are now either in the process of being assisted or have already been assisted. In fact, the government of Mr. Bush had already extended $13.4 billion to the automakers like GM and Chrysler. More of this kind of assistance is expected to be made by the Obama Administration.

In whatever form the bailout money was given to these strictly private enterprises, the message is now clear. It is that the days when the individual governments (whether in the countries of Europe, Asia, Africa or America) will stay away from private sector business activities are now over. This is not however to say that the days of capitalism are also now over. However, what led us to this sorry situation was our absolute trust that the private sector could operate independently, free from the overbearing supervision of the government and expect it to contribute meaningfully to the economic growth and development of their individual nations. In short, we expected them to operate in a completely deregulated environment as envisaged by Mrs. Thatcher and Mr. Reagan. The development from the early nineteen eighties to the present day has however shown that these two leaders as well as their economic advisors were absolutely wrong. The capital market operators at the Wall Street in New York, the operators in the city of London as well as those operating in Tokyo, Zurich and in few other market centers around the world (including Lagos) have found out that the freedom to operate freely and unsupervised was a license to misbehave and manipulate the practice to their own greedy inclinations. The end result is what we now see around us; a total breakdown of the system leading to a deep recession the like of which was last seen since seventy odd years ago.
But still, capitalism remains the best option for mankind. This is because it is the one among all other options which gives optimum reward to personal initiatives and encourages human drives for excellence. Capitalism has its ugly face of course, but those negative aspects can be contained and be converted into positive concrete codes for the benefit of all of us rich and poor.

The present financial crisis should therefore be seen as an opportunity for us to take a second look at capitalism again with a view to making it more acceptable to all of us in our future endeavours. The end of this recession will show us the way to reach there. Meanwhile, the second area of assistance is the stimulus plan which perhaps requires more money and whose full impact will be felt only in the long run. It will, hopefully, help to take the economy out of the recession into normal growth. The Obama administration understands the importance of this scheme that it is sparing no effort to get the Congress to approve adequate funds necessary for its execution. So far, the following monies have been lined up:
A. $350 billion part of the fund already approved by the former President Bush.
B. $750 billion already approved by both the House of Represen tatives and the Senate.
Total : USD l.00 Trillion

Details of the plan have not been released but President Obama has indicated that the scheme will principally cover new projects in the transportation, education and health sectors. Nothing more was revealed apart from this short statement It is evident that the President, with the assistance of his aides, is working at the details pending the final execution.
Stimulus package is not a new scheme which is invented and introduced only at this time. It was first introduced during the Great Depression of 1929 to 1933. It was also introduced again immediately after World War Il. The advice for this was made by the great economist, Mr. John Meynard Keynes. He stated in his two books “General Theory on Employment, Interest and Money” and “The Consequences of Peace” that in a depressed economy with high level of unemployment, government should discard its aloof stand and engage itself more in the construction of public works and also in those projects which were hitherto regarded as private sector affair.

By so doing, many unemployed people will go back to work and earn income. This in turn will induce them to spend on goods which will have to be supplied by the manufacturers who will naturally bring back their industrial plants into operation again. This multiplier effect is the surest process which will most likely revive the economy. It is the process which the Obama administration is apparently going to adopt to get the American economy working again; and by extension, the rest of the world also. It remains to be seen.

D. THE NIGERIA CONNECTION
So many questions have been asked and divergent answers have been given as to whether the current financial crisis has affected Nigeria’s economic fortunes. The truth of the matter is that this financial crisis is worldwide in nature. It has caused a global economic activity worldwide as the demand for energy, principally crude oil, has drastically fallen in volume and also in price level. Nigeria, being a major world crude oil producer and exporter will certainly experience a fall in revenue; more particularly so because oil revenue constitutes over 90% of the country’s foreign exchange earnings. This fall in revenue is therefore bound to be reflected in the national budgeting process and hence affecting the overall economic well-being of its citizens. The only solution is to have a second look at the size of the budget itself and contract it up to a certain limit. In a situation of this kind, budget deficit is almost inevitable despite the contraction. In Nigeria’s case, the government will have to contend with a deficit of well over N500 billion. To make up this gap, the money market is bound to come under pressure because the government is sure to borrow from there if it wants to avoid resorting to “ways and means”. This in turn will affect the liquidity position of the money and the capital market themselves. The final victim will be the private sector which will have difficulty in securing loanable funds.

There is no foreign bank in Nigeria today, neither do we have many joint ownerships between foreign and the indigenous interests in our local banks. The question of foreign bank withdrawing its participation in order to consolidate at home does not therefore seriously arise. The amount of money owned by foreign banks in the custody of the Nigerian banks is not very significant as to affect the business life of Nigerians in the event of withdrawal. This is not however to say that the interconnection between the Nigerian and the foreign banks are not affected. In fact there are evidences showing that they are really affected because this crisis is a global phenomenon. The foreign partner banks are bound to experience business slow down which is sure to affect their relationship with Nigeria’s partner banks during the downturn. But all the same, it has to be admitted that Nigeria’s bank linkages with the rest of the world are limited.

The recent banking consolidation has left banks in Nigeria with a much stronger balance sheet than they have ever been. First of all, the banks’ capital adequacy of 18.8% is much higher than their peers elsewhere. Also, the total banks’ non-performing loans have drastically come down to only 7.7%. Even at the height of the consolidation exercise in 2006, Nigerian bankers have avoided borrowing from the Organization of Economic Cooperation and Development (OECD) to fund growth. They mostly raise capital domestically.

In short, the consolidation exercise has strengthened their basic foundations. If any local bank is showing any sign of crisis then it has nothing to do with the global financial melt-down. Rather, it has everything to do with the internal management incompetence or lack of integrity thereof. The global economic slowdown has, on the other hand, affected the overall foreign currency receipts into the country. This has affected the exchange rate of the naira from its stable position of N116 to the dollar to the current rate of N165. Private foreign currency receipts have virtually dried up leaving the CBN as the only main provider of foreign currencies. The measure so far taken by the apex bank seems to arrest a further deterioration of the local Currency, it remains to be seen whether it will hold on or even go up to at least N125 to the dollar. This is the best that could be expected in the presented circumstances.

Our foreign reserve is now about $45 billion. It had at one time risen to over $60 billion, but it systematically fell to the present level. It may fall further down because of the serious instability in our finance and banking world. Foreign reserve is like any other money saved. It is an income not spent. It is used to give confidence to our trading and investing partners that we have the money to meet our obligations in any event. We also have the money to allow for the repatriation of the investor in the event of a take-over of his initial investment. In short, we are a viable nation. With the present reserve of $45 billion it is generally believed that $20
billion can adequately meet all the above mentioned purposes and that the remaining $25 billion can be used for local investment. The Nigerian capital market operators i.e. the Securities and Exchange Commission (SEC) and the Nigerian Stock Exchange, have of late and been trying to link their serious troubles at the market with the present worldwide financial crisis, but generally to no avail. This is because every stakeholder knows that the operators have been mismanaging the market well before the outbreak of the present global financial crisis.

Again, as every stakeholder knows, the behaviour of these operators of the two institutions of the Nigerian capital market is anything but ethical. The banks, the shareholders and the potential shareholders connive together with the operators of these powerful institutions to manipulate the otherwise orderly and transparent process of buying and selling legitimate stocks, bonds and shares in the market, all because of their greed and selfishness. Their manipulations of share prices to go up and down in unethical manner are very much well-known. It is not surprising therefore that when the financial “meltdown” arrived at our shores the foreign stakeholders decided to dump their millions of shares.

THE FUTURE
The financial crisis and the economic downturn are still in process. It is doubtful whether we have reached the very bottom of our misery yet, not to mention the expected upturn. Up till now, we are still assessing the damage which is also on-going. But with the determined effort of Western leaders, mostly those in North America and Europe (particularly the United States of America and the United Kingdom), there is a good chance the trend downward may be arrested and a turn round upward will begin very soon. It is only then that we can begin to determine what shape our future financial system will take. From what has been said so far in this paper, the present deep recession has been caused by the system breaking down of world’s financial system. This was caused by important factors.

The first one is that the system has been creaking under the weight of the world’s modem demand. It has now become a global village sewn together by easy telecommunications and other well established technological advancements. Financial products are now traded across the borders on-line. A good example is how the Mortgage Backed Securities (MBS) on the American housing market move across to Europe and Asia thus enabling the Europeans and the Asians to participate in the market without any apparent hindrance. This easy movement, as we have seen, is what contributed to making this crisis a global affair. Certainly, the present world financial system was not really designed to cope with this kind of demand, hence its systematic breaking down.

The other causative factor is the general misbehaviour of the operators of the capital markets, in America, Europe and Asia. The philosophy of free market deregulation has virtually removed the governments’ supervisory powers from the market thereby allowing these operators to behave in an outlaw fashion so as to satisfy their selfish and greedy instinct; and in so doing plunged the world into this financial meltdown. All of these issues will have to be addressed by the world leaders and experts who must fashion out a new system which will reflect the demand of the twenty - first century.
The former U.S President, George W. Bush took the initiative, last November by inviting to Washington twenty major world leaders among whom were the traditional G8 nations, that is the leaders of the eight world topmost industrial nations. These were to brainstorm on what then appeared to be a major world economic and financial problem.

Mr. Bush knew perfectly well that this particular problem was beyond the ability of the G8 to tackle and solve all by themselves alone with the rest of the world trailing along and accepting whatever decision they have taken. The centers of the world economic powers are now more in number and scattered all over the globe. It is now no longer the affairs of Europe and North America as was the case in say, 1948 No economic decision could for example be enduring without the active participation of such major countries as China, India, Brazil, and few others outside the G8 nations; hence his decision to cast his net wider to include more nations to what isnowG20.

Mr. Bush is also aware that no final decision could be taken through one session alone. In fact, the November meeting was simply to identify the problem and set the agenda for tackling it through series of future sessions at different date. The next meeting was therefore set to take place in April, 2009. This meeting took place in London on schedule and it was well attended. Most of the leaders of the G 20 were present. It was clear that the main items on the agenda were those connected with the world’s economic recovery rather than on what measures to be taken in order to usher in a new financial system to replace current failed ones. Perhaps they were putting that assignment aside until after the end of the current recession.

It was the opinion of everyone at the meeting that it was a resounding success. Everyone was satisfied with the decisions taken and was of the firm belief that, if properly implemented, the approved measures could hasten the realization of the eagerly awaited world economic recovery. For example, it was decided among other decisions, that, the developed world should in aggregate contribute no less than $3.3 trillion to the bailout fund across the globe. It was also agreed that the Bretton Woods institutions i.e. the IMF and World Bank should receive at least $25 billion to assist in the simulation of the world trade and investment especially in the developing countries. It was also agreed that leaders should revise their laws governing the operations of the capital markets in their respective countries in order to improve on their general supervision. By and large, these decisions are being faithfully implemented and already the impact is now clearly noticeable by this June; two months after the historic meeting. There is now much optimism that the recession could end by the end of this year and that full recovery could start by the beginning of the year 2010.

F. THE LAST WORD
When the last Great Depression (1929-1933) ran its course and tapered off, recoveries began. This led to eventual prosperity which the world had never seen before. Then came the World War IT and misery descended again on the world. Again, we worked hard and achieved recovery. This also led to unimaginable prosperity.
With the world advancement in science and technology, nobody thought that we would experience the very deep recession which we are experiencing today. Ironically, it is the same very high technology which made it possible for the present recession to occur so easily.

Even though technology has made the world a small place with information so easily obtained, we tend to forget about the human negative instinct which renders all else unimportant. The result is now serious financial problem which is threatening to destroy all our gains of many years and to throw us into deep misery. God forbid.
We have learnt very valuable lessons from this sad episode and we hope to use the experience to guide us as we embark upon a new global financial system which will definitely be established immediately after the end of this recession.

Thank you and God bless.