IMPACT OF GLOBAL FINANCIAL CRISIS ON NIGERIAN STOCK MARKET
CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND OF THE STUDY
The current global economic meltdown which started in late 2007 was as a result of a liquidity shortfall in the United States banking system. The immediate cause or trigger of the current crisis was the bursting of the United States housing bubble which peaked in approximately 2005–2006. Already-rising default rates on “subprime” and adjustable rate mortgages (ARM) began to increase quickly thereafter. An increase in loan packaging, marketing and incentives such as easy initial terms, and a long-term trend of rising housing prices had encouraged borrowers to take on difficult mortgages in the belief they would be able to quickly refinance at more favorable terms. However, once interest rates began to rise and housing prices started to drop moderately in 2006–2007 in many parts of the U.S., refinancing became more difficult. Defaults and foreclosure activity increased dramatically as easy initial terms expired, home prices failed to go up as anticipated, and ARM interest rates reset higher.
Low interest rates and large inflows of foreign funds created easy credit conditions for a number of years prior to the crisis, fueling a housing construction boom and encouraging debt-financed consumption. The combination of easy credit and money inflow contributed to the United States housing bubble. Loans of various types (e.g., mortgage, credit card, and auto) were easy to obtain and consumers assumed an unprecedented debt load. As part of the housing and credit booms, the number of financial agreements called mortgage-backed securities (MBS) and collateralized debt obligations (CDO), which derived their value from mortgage payments and housing prices, greatly increased. Such financial innovation enabled institutions and investors around the world to invest in the U.S. housing market.
As housing prices declined, major global financial institutions that had borrowed and invested heavily in subprime MBS reported significant losses. Falling prices also resulted in homes worth less than the mortgage loan, providing a financial incentive to enter foreclosure. The ongoing foreclosure epidemic that began in late 2006 in the U.S. continues to drain wealth from consumers and erodes the financial strength of banking institutions. Defaults and losses on other loan types also increased significantly as the crisis expanded from the housing market to other parts of the economy. Total losses are estimated in the trillions of U.S. dollars globally.
While the housing and credit bubbles built, a series of factors caused the financial system to both expand and become increasingly fragile, a process called financialisation. Policymakers did not recognize the increasingly important role played by financial institutions such as investment banks and hedge funds, also known as the shadow banking system. Some experts believe these institutions had become as important as commercial (depository) banks in providing credit to the U.S. economy, but they were not subject to the same regulations. These institutions as well as certain regulated banks had also assumed significant debt burdens while providing the loans described above and did not have a financial cushion sufficient to absorb large loan defaults or MBS losses. These losses impacted the ability of financial institutions to lend, slowing economic activity. Concerns regarding the stability of key financial institutions drove central banks to provide funds to encourage lending and restore faith in the commercial paper markets, which are integral to funding business operations. Governments also bailed out key financial institutions and implemented economic stimulus programs, assuming significant additional financial commitments.
Financial booms and busts are not a new phenomenon. What is disquieting about the current meltdown is that it is in the nature of a seismic tremor of earth-shaking proportions. Within a few months, some of the biggest financial giants have gone belly-up, while several more were in serious trouble. How indeed are the mighty fallen! Bear Stearns, AIG, Fannie Mae and Freddie Mac, Lehman Brothers and Merill Lynch.
The automobile giants are virtually on their deathbeds while a good number of industrials are surviving only by the skin of their teeth. A rather prosperous central European nation, Iceland, has virtually sued for bankruptcy, resorting to an IMF standby arrangement – the first since the British ‘humiliation’ of 1967.
The contagion has spread to Europe, Japan, Asia, Africa and Latin America. An estimated US$1.7 trillion in bailout funds has already been committed by OECD countries, but we are yet to see the end of the tunnel, not to talk of any light in it. According to a recent report, the world stands in need of a staggering US$4 trillion to fully resolve this crisis.
In Nigeria, the former CBN Governor Professor Chukwuma Soludo was credited as saying that Nigeria was not going to be affected by the Global economic recession. After much dithering, the Federal Government decided to take some steps towards insulating the nation’s economy against the effects of the global economic recession. President Umaru Yar’Adua, acknowledged that the impact of the crisis was already taking its toll on the economy and set up a new economic team to monitor the crisis and advise the government accordingly. The team, with the President himself as chairman, will assess the impact of the global economic crisis on the country, recommend appropriate macro-economic policy responses and identify other practical measures aimed at shoring up investors’ confidence.