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Saturday, October 25, 2008

Who’s to blame for financial tsunami?

WHEN we read about the financial tsunami in the United States, we all must be wondering how it all happened? How can big companies like American International Group Inc (AIG) go bankrupt and need US$85bil bailout or how did the world’s fourth largest investment bank Lehman Brothers end up with US$660bil in debts?

To me, this is only possible when financial institutions use other people’s money to invest and need prices to go up so that they can make a profit and pay themselves 20% bonus on top of the 2% management fees.

A lot of financial institutions have employed the best graduates, pay them hefty salaries to configure financial derivatives and mechanism that pushes the price of things so that they can make a killing as speculators.

From the beginning of the 21st century, these financial institutions have reigned supreme. First was the currency crisis, which we experienced in 1998. Then came the subprime loans when people mortgage and re-mortgage their houses to banks, financial institutions and insurance companies.

Oil speculators then pushed up the price of crude oil to US$147 per barrel based on demand for cars, weather forecast and 2 billion consumers in China and India entering the new market. Lately, we have had the credit crunch and financial institutions going bankrupt.

I remember, about 6 months ago, a friend of mine wanted to buy a terminal in the US for US$300mil. While the debate was going on, a financial institution armed with provident fund resources, bought it for US$1.2bil. The justification was the land could be used for property development and not container facility. Such an investment can only be made by people managing other people’s money and getting a fee for their efforts.

Another story I am familiar with is that a piece of land that was worth RM20mil was sold within months at double the price. The second buyer sold it to the third guy for RM80mil. The fourth buyer got a loan from the bank for RM120mil based on his proposed plans. However, when the plans did not materialise, the last guy declared himself bankrupt and the bank has classified that as a non-performing loan. (The four guys than shared the RM120mil.)

Such is the wisdom of the new financial wizard and the current banking system. This is how you get a credit crunch. On the local front, already there are signs of mounting consumer debts and pretty soon, the credit crunch could hit us. Who will be responsible for this financial turmoil?

A straightforward example: Just take a look at the number of credit card offers we receive in our mail boxes, either marked pre-approved for RM10,000 or RM20,000, or have a fake cheque that can actually be used. All of which hook gullible consumers into a world of painful “interest only” loans.

I am not surprised to hear one of my staff actually hold six credit cards, a number that is considered low compared to the average 13 cards held by a US citizen.

Bankruptcy expert and investor Wilbur Ross feels that in some ways, the US financial crisis could be blamed on the American consumer for wanting to improve their standard of living without having the wages and means to do so. Foreclosures, mortgage delinquencies and late payments, repossessions are all up because loans were issued to people who clearly could not afford them.

Is the same thing happening here in Malaysia? Are many of us taking out credit that we cannot afford to finance, or home and personal loans at terms that no reasonable person could afford to repay, including the very desperate ones going for the “Ah Long” services? Have most of us been living well above our collective means for far too long, and now the piper is calling to be paid?

For borrowers, surely you must have heard the term “Buyer Beware. If you are taking out a multi hundred thousand ringgit home loan, then certainly you must understand the terms as well. Because ultimately, you are responsible for your own actions.

It is a known fact that 65% of current banking loans are given for property financing and credit card transactions. Only 11% is provided for economic development of the country such as infrastructure and other amenities.

Daily, there are people buying properties at higher prices based on the fact that the asset value will appreciate and they can get a better return within a year or two. But when there is a property glut, then all becomes NPL. Only the guys who had the staying power will see any benefits in their property investments. Speculators and borrowers will be caught out when they can’t pay the loans or there is a property slump.

In the US, manufacturing was transferred to China and IT was transferred to India. In the last 10 years, US investors engaged themselves in property development.

When there is a property slump and fewer buyers, then the people who took out credit and re-mortgaged their properties to financial institutions and giant insurers like AIG are actually using funds two or three times the value of the property. And when they cannot pay, all the financial institutions become bankrupt.

Former US Federal Reserve chief Alan Greenspan called this the “once-in-a-century” financial crisis. He should know, since he was the one who helped inflate the housing bubble in the first place, which has led to reckless lending and borrowing in the US housing market.

Creditor institutions, on the other hand, should always apply the number one rule: When you lend money, do not lose it. When you loan money professionally, you are at a big advantage because you have systems in place to make sure every borrower has the desire and ability to repay you, and the collateral in case they do not.

The problem arises when you do not bother checking anything before you make a loan. When the problem becomes insurmountable, will you just wait until the government comes and bails you out (with tax payers’ money, nonetheless)? Remember, just like the borrowers, you too are responsible for your own actions at the end of the day.

Ultimately, it all boils down to this: Irresponsibility on the part of financial institutions AND the public at large can have a massive and terrible economic price. Judging from the current situation, it looks inevitable that we will all be paying for it.

When we talk about the 1929 depression, history will tell you that it started in 1927. What is worrying is that this financial tsunami in the world is just the beginning. The years 2009 and 2010 are when economic activities will be hampered because of lack of funds. Or beware of the traditional Year of the Tiger in 2010. (The previous Years of the Tiger were in 1998, 1986 and 1974)


Gnanalingam is executive chairman of Westports.

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