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. The Committee’s other responsibilities are to examine other related issues such as unemployment and make recommendations on any other matters or actions required to forestall adverse consequences of the global economic meltdown on the nation.
Many Nigerian households invested in the Global Depository receipts (GDRs) operated by some Nigerian banks. Indeed the value of these GDRs has fallen to an abysmally unacceptable level since the first quarter of 2008 when the global Stock Market was hit by tumbling prices and dwindling investor confidence.
The situation is so bad that some of the GDRs purchased at $11.20 have fallen to an all-time low of $3.50. Back home, in Nigeria, the stock market is in shambles, with all efforts put forward by the Nigerian Stock Exchange (NSE) producing no substantial results.
The global financial crisis has resulted in foreign portfolio investment withdrawals from the Nigerian Capital Market in order to service financial obligations. A total financial inflow to Nigeria between 2007 and 2008 increased by 21%, but is estimated to have reduced by 38.6% between 2008 and 2009.
Nigeria’s own stock market index is the Nigerian Stock Exchange’s All-Share Index (NSE-ASI, or simply ASI), and currently provides a composite picture of the financial health of 233 listed equities. Starting with an index value of 100 in 1984, with increased listings and financial activity, it attained a value of 57,990 at the end of year 2007. It started the year 2008 at 58,580 (with a market capitalization of N10.284 trillion), and went on to achieve its highest value ever of 66,371 on March 5, 2008,with a market capitalization of about N12.640 trillion.
However, ever since that high, the ASI has inexorably declined, exhibiting a secular bear posture since July 17, 2008 when, at ASI=52,910, the index fell below 20% of its all-time high, and has continued to fall, closing on October 22, 2008 at 42,207 (a 36.4% loss from the high within just seven months, and a year-to-date decline of 27.9%), The decline continued into 2009 and was 25,065 as at October 26, 2010, with a market capitalization of N6.141 trillion. In terms of capital decline, the Nigerian capital market has since the March 5, 2008 lost to date about N6.5 trillion, or about 52%.
I doubt if there is any reasonable Nigerian who did not jump on the bandwagon in the crazy days of share boom. Even petty traders and other low-income earners saw stocks as the new way to financial freedom. Some invested all their life savings and end of service benefits.
How wrong they were; because less than one year after the bonanza started prices crashed throwing them into the cesspit of hopelessness and indebtedness.