Many people still debate the causes of the global financial meltdown in 2008 and 2009. Most arguments have their merits and demerits, but the broad consensus is that many things came together create the set of conditions that led to the crisis. A crisis which still has repercussions until today.
Firstly, in no order of importance, was the policy objective of the US federal government to boost affordable housing and improving home ownership rates. In the mid-1990s the US federal government set on a strategy to move home ownership rates from 64 percent which they were in 1994 to 70 percent by 2000. The “public” corporations whose mandates were to expand mortgage markets set out do their bit towards the implementation of this objective. Part of their strategy involved lowering the standards over what was considered a risky mortgage asset.
Secondly, financial intermediaries like banks and other lenders flush with new technological tools created financial products which, while innovative, were difficult to understand. Mortgage debt from different home buyers and with different levels of risk were securitized and packaged together as assets whose quality was difficult to judge.
Imagine a tomato seller took three baskets of tomatoes, one with very fresh tomatoes, the second with just okay tomatoes, and the third with almost rotten tomatoes. Then mixed them all together, shared them equally into three baskets but made sure that the very fresh tomatoes were always on top. And then wrapped the baskets in plastic film and said you couldn’t open it until you bought it. The prices were very attractive though. The seller then got a respected market leader to announce that the baskets of tomatoes were okay. Financial institutions bought these securities of course.
Finally, regulators had become a bit lax in their supervision of financial markets. Deregulation and self-regulation were key phrases of the decades before the crisis and this worked on the assumption that financial markets could regulate themselves, and if any participant misbehaved then they could just die and leave the system. The idea of systematically important institutions was left to the realms of theoretical academics. The macroeconomic gurus constantly reminded everyone that risk premia in financial markets was very low and that all signs pointed to a continued growth in credit.
The funny thing is if you looked at US home ownership rates prior to the financial crisis the concoction of policies and innovations were a massive success. Home ownership rates stuck at 64 percent for the decade prior to 1994 started growing. It grew consistently reaching 69 percent in 2005. I can imagine politicians and CEOs clapping for themselves and giving each other awards over their strategic policy goal on its way to being achieved. Of course, we all know how that all ended up.
The global financial crisis was not new but represented a financial bubble which historically is a frequent occurrence, at least relatively. From the tulip mania in the Netherlands in 1636, to the Mississippi bubble in 1716, to the south sea bubble, to the Latin American debt crisis, and even to some extent the great depression. Here in Nigeria we cannot forget the stock exchange bubble which popped in 2008 and which continues to deter domestic retail investors from the stock market today. In all cases there is a common theme: liquidity flowing into assets whose fundamentals don’t support it.
Over the past month the Central Bank of Nigeria has put out various policies all with the objective of stimulating lending to small and medium enterprises. Banks have been given three months to get their loan to deposit ratios to a minimum of 60 percent or face severe consequences. The incentives to park money at the central bank have also been cut with banks now only allowed to earn interest on a maximum of N2bn from its standing deposit facility. Rumors of more circulars waiting to be released to push liquidity into the SME lending spaces are rife.
On the one hand the objective of incentivizing lending to SMEs to support growth is a noble one. SMEs are typically a key part of economic growth and job creation stories. But do the fundamentals support all the liquidity going to SMEs? Are there SMEs who can absorb all these loans, do some economic activity, and then generate enough profits to repay these loans? Because if there aren’t then we may simply just be creating the conditions for the next financial bubble. A bubble, like all the others, will show up in surprising places. As the famous saying goes: “the road to hell is paved with good intentions”.
Nonso Obikili
Dr. Nonso Obikili is chief economist at BusinessDay
