Easy credit in the US led to rapid expansion. Now some banks are worried about unpaid loans

Easy credit in the US led to rapid expansion. Now some banks are worried about unpaid loans

Are we approaching ‘the great unwind’?

The economy, stock and property markets are all doing fine. But something feels wrong.

For one thing, stock market volatility has increased. Last week, the Straits Times Index rose and fell more than 100 points.

It was the same for the US Dow index with swings of 200 points.

In the past 30 years, the world’s economy has taken three big hits. We will check them out and then ask: ‘Are we headed for hit number four?’

3 + 1 ECONOMIC DOWNTURNS

Crisis #1: The US Savings and Loan (S&L) crisis of the 1980s.

S&Ls are like banks but specialise in US home loans. Many took in deposits costing 3 per cent and used the money to make risky real estate investments earning more than 15 per cent.

Investors didn’t care about the risks since their deposits were guaranteed by the US government. They were certain to get their money back.

The government eventually cracked down and regulated S&Ls more closely but it was an expensive lesson.

The US paid over $100 billion to bail out depositors of the more than 1,000 S&Ls which failed.

The crisis contributed to a worldwide recession in 1982.

Crisis #2: The Asian currency crisis began on 1 Jul, 1997 when Thailand announced its US dollar reserves had fallen to zero. That shocking news led to a sell-off of the Thai baht.

It drew in currency speculators which triggered a sell-off of all Asian currencies. Hardest hit was the Indonesian rupiah. The crisis was largely confined to Asia. Singapore managed to sidestep the most devastating effects.

Still, the Straits Times Index dropped to a low of 805 on 4 Sep, 1998. The index now trades at around 3,400, a rise of 300 per cent in nine years.

Crisis #3: On 10 Mar, 2000 the US Nasdaq stock index hit a high of 5,048.

From there, high-tech counters began their long slide downhill. This became known as ‘the burst of the Internet bubble’.

It took 2 1/2 years for the Nasdaq to finally hit bottom at 1,114 on 9 Oct, 2002, a drop of 80 per cent.

Since then, the Nasdaq has risen to 2,600 for a gain of more than 100 per cent. It is now half-way back to its former high of 5,048.

The sell-off contributed to the worldwide recession in 2002.

Crisis #4?: Are we headed towards a fourth economic crisis?

If so, June 2000 will mark its beginning. That was when the US Central Bank cut its key short-term lending rate to 1 per cent and kept it there for one year.

Only Japan had such low rates and easy credit terms. It was unprecedented in the US, and it has led to an expansion that some say is another bubble ready to burst.

The low rates gave rise to hedge funds, private equity and a slew of creative financial products that seem to make risks disappear.

It all works as long as credit is easy and asset prices rise.

The first prick at the bubble came two months ago when US finance companies stopped making home loans requiring:

(i) no down payment and,

(ii) no proof of income.

Now, US borrowers must have a job before they can get a home loan. Gee, what will they think of next?

Are S’pore banks safe?

LAST week, we saw our three local banks explain their exposure to the risky sub-prime US housing market.

Banks own debt that is based on these loans. One local bank said it expects to lose about $50 million.

That is a lot of money and it shouldn’t have happened. But the amount is manageable.

DBS, UOB and OCBC have just reported earnings for the last three months.

Each earned over $500m. It means a $50m loss is only 10 per cent of one quarter’s earnings.

Singapore dollar deposits are guaranteed by the Singapore Deposit Insurance Corporation (SDIC) for up to $20,000 minus your outstanding loans from the bank.

The amount covers more than 80 per cent of depositors at full banks and finance companies.

Bigger deposits are not guaranteed. But in the remote chance of a bank crisis, I doubt that the Singapore Government would let a local bank fail.

The damage to the economy would be too great.

As for foreign banks, most are larger than our three local banks which would seem to make them even safer. Not true. While the SDIC guarantee applies, the parent bank does not guarantee local deposits.

We saw this in Argentina’s banking crisis in December 2000. At the height of the crisis, depositors tried withdrawing their US dollars all at once. The banks ran out of money and closed their doors.

The big foreign banks were not obligated to make good on deposits at their affiliates and, of course, they didn’t. Billions of dollars were lost in this country of 36 million people.

The conclusion is deposits at foreign banks may face a slightly higher risk than at the three local banks.

By Larry Haverkamp (Doc Money)

Source : New Paper - 14 Aug 2007