By Nhlanhla Nyathi/Precious Mhlandhla
WHILE the Zimbabwean financial sector experienced difficulties initially through severe cash shortages in 2007 and later through a
banking sector wide liquidity crunch in January 2008, global financial markets were in turmoil from the contagion effect of the US sub-prime market crisis.
Although this occurred simultaneously in the later stages of 2007 and spilling over into 2008, the timing of the incidents was purely coincidental.
The US sub-prime market crisis emanated from banks capitalising on the housing boom by advancing mortgage finance to borrowers with high credit risk and generally low scores from credit rating agencies.
Subsequent rising home foreclosures or repossessions due to high default rates from sub-prime borrowers resulted initially in a US financial crisis and then spread into global financial turmoil.
The impact on global financial markets was so severe that all major central banks including the US Federal Reserve, Bank of Canada, Bank of England, Swiss Central Bank and European Central Bank intervened to stabilise financial markets in 2007 by injecting more than US$200 billion in liquidity support.
The extent to which global markets subsequently hemorrhaged due to the effects of the sub-prime crisis is a clear indication of the internationalisation of financial instruments and the systemic risk passed on from the US to the rest of the world.
From the intervention initiatives undertaken by the various central banks to stabilise financial markets, it is apparent that Africa was the least affected with South Africa and Egypt being the only countries to record some minor disturbances.
With the current crop of African leaders pushing for Africa’s integration into the global village, one would have expected the continent to resonate with global trends in tandem.
Why has Africa remained so detached from the sub prime crisis?
To answer that question, people need to understand the concept of the sub-prime market, what caused the crisis, and how the contagion spread to other markets.
Global financial markets have undergone a major evolution with synthetic financial instruments being introduced by banks primarily in well developed markets over the years.
The sub-prime mortgage market was one such evolution which sought to push home ownership in the US to record levels, making it possible for previously disadvantaged minorities and about one third of Americans that could not access home loans from prime or main stream markets to own their own homes.
The sub-prime market was established to provide mortgage loans to borrowers with poor credit ratings and previously could not access home loans through traditional low interest rate or prime markets.
Higher interest rates and fees were charged to compensate for the higher perceived risk assumed by lenders.
Over the 1998-2001 period, the sub-prime mortgage rate exceeded the prime mortgage rate by an average 3,7% points.
Lenders in the sub-prime market view borrowers as presenting high levels of risk if their credit history is impaired or not very long, or because they carry a large amount of debt relative to income.
These and other borrower characteristics go into credit rating scoring models that statistically analyse the historical relationship between these characteristics and defaults.
Data from the Mortgage Information Corporation shows that borrowers with credit scores of 620 or below normally fall in sub-prime territory and represent unacceptable levels of credit risk for lenders in the prime mortgage market.
Another risk reduction characteristic of the sub-prime mortgage market, which also incidentally caused other markets outside the US to have exposure to the US sub-prime was securitisation of sub-prime mortgage loans into tradable instruments on bond markets and other liquid secondary markets where a number of investors were subsequently exposed.
The majority of sub-prime mortgages are now sold by the initial lenders or mortgage originators, bundled into mortgage based securities and offered to individual and institutional investors in secondary markets.
Sub prime mortgage activity grew an average 25% a year from 1994 to 2003, outpacing the rate of growth for prime mortgages.
The industry accounted for about US$330 billion, or 9%, of US mortgages in 2003, up from US$35 billion a decade earlier.
In 1994, US$11 billion of sub-prime mortgages were securitised and sold on the secondary market; in 2003, the figure had gone up to US$200 billion.
Securitisation of the sub-prime mortgages was the major reason for the globalisation of the instrument.
Consequently when the sub-prime market collapsed in 2007 due to high interest rates, rising home foreclosures caused by defaults from borrowers resulted in a contagion effect that spread to all investors and secondary markets that had sub-prime mortgage based securities on their books.
The sharp increase in home repossessions caused a glut in the market with no buyers which subsequently caused home values to decline and consequently wiped out the “equity” values from of houses held by investors in the sub-prime market.
Due to the securitisation characteristic of the sub-prime market, major investment banks such as Citigroup, Merrill Lynch, USB AG, Morgan Stanley, Credit Agricole France, and HSBC had combined write-downs of US$84 billion due to exposure to the non-performing sub-prime mortgage based on secondary markets.
The write-downs were more pronounced in the developed markets because of their fluidity and free flow of international capital unhindered by exchange control regulations unlike in most African states.
South Africa and Egypt were the only countries within Africa to experience minor irritations from the sub-prime crisis.
Looking at the size of the write-downs from the major investment banks, South Africa’s Investec which had a total write-down of US$70 million was rather insignificant.
These write-downs left most banks requiring immediate capital injections and this has seen an influx of “Sovereign Funds” especially from the oil rich Middle East countries which have benefited from the commodity price boom, snapping stakes in Western banks at a huge discount as the share prices took a “pounding”.
Securitisation is still a fairly new phenomenon in South Africa. African financial markets have been developing with renewed interest from the international community due to the improving political climate with most countries that were once haunted by wars moving towards democracy and good governance.
This has resulted in new investor inflows.
The main reason why Africa has not felt the full effect of the sub-prime crisis which has since culminated in the slowdown of the US economy is that most African financial markets still lag behind in terms of financial market sophistication in terms of products on offer as well as information asymmetry.
This is evident in the fact that most of the capital markets in Africa are still being developed with the exception of the two advanced ones which are South Africa and Egypt.
Some African countries still have exchange controls which restrict the flow of international capital thus limiting the contagion effect from foreign financial markets.
Some African countries have just established Stock Exchanges which by and large lack liquidity and market depth with a case in point being Swaziland which has six listed counters and an inactive bond market.
Other established exchanges are illiquid and in a way limit Africa’s exposure to the global village.
The Zimbabwean economic recession has also had a severe impact on foreign currency flows and there are strict foreign exchange regulations administered by the central bank further limiting flow of capital.
According to the African Development Bank, the African economy is expected to grow by 6,5% in 2008 driven by increased demand for resources from the booming Chinese and Indian Economies which will offset the decline in demand from the US and Europe.
The Chinese economy is expected to grow by 9,6% in 2008 which is still high enough to benefit African economies despite the threat of a US recession. The indirect effect on African economies of a global slowdown emanating from the sub-prime crisis will be felt nevertheless through reduced demand for African goods and services.
The Chinese economy which is expected to grow by 9,6% down from the initial forecast 11,7% will insulate Africa and ensure some growth going forward despite a slowdown in the US.
* Nyathi is a director of a private equity firm and Precious Mhlandhla is an Equities Trader (African Markets) based in Johannesburg, South Africa. They can be contacted on firstname.lastname@example.org and pmhlandhla@gmail.