Nigeria's leading finance and market intelligence news report.

How are investors preparing for the next financial crisis?


In 2018, the world commemorated 10 years since the end of the financial crisis that shook the foundation of the global financial system. The collapse of the Lehman Brothers, a large United States-based investment bank, heightened a hitherto small crisis boxed up in the United States (US) and ushered in one of the world’s greatest financial crises of all time. One may want to ask what led to the financial turmoil in 2008. A brief retrospection will therefore suffice.

One of the catalysts for the crisis was the falling prices of the US housing units and a rising number of borrowers who were unable to repay their loans. Prices of the housing units in the United States peaked around mid-2006, coinciding with a rapidly rising supply of newly built houses in some areas.

As their prices began to fall, the share of borrowers that failed to make their loan repayments began to rise. Loan repayments were particularly sensitive to house prices in the United States because the proportion of US households with large debts had risen significantly during the boom. That led to the stress in the financial markets as lenders and investors in mortgage backed securities started incurring losses due to default on mortgages.

The crisis quickly spilled over to economies in other countries because foreign banks were active participants in the US housing market during the boom as the US banks also had substantial operations in other countries. The failure of the US financial firm, Lehman Brother, together with the failure or near failure of a range of other financial firms around that time triggered a panic in the financial markets globally. Investors began pulling their money out of banks and investment funds around the world as they did not know who might be next to fail and how exposed each institution was to the subprime and other distressed loans.

Consequently, financial markets became dysfunctional as everyone tried to sell at the same time and many institutions wanting new finances were denied. Businesses also became much less willing to invest and households less willing to spend as confidence the mortgage market waned.

Though, the 2007/2008 global financial crisis, considered by many analysts and economists as one of the worst crises in the world since the Great depression of 1930s, may have come and gone, its impact and the lessons learnt lives on.

The Business Insider, a US financial and business media outfit, puts the financial and economic costs of the crisis at a conservative amount of $10.2 trillion which was about one-fifth (20 per cent) of the global output in 2009. Emphatically, the crisis taught the world that it is quite difficult to return to the path of restoration in the event the financial system is shattered.

Should investors be wary of another financial crisis?

Analysts have predicted that another global financial crisis is underway though a timeline for its eventual occurrence remains blurred. However, JPMorgan estimated thatthe next crisis might occur in 2020, stating that the extent of damage would, however, be less severe when compared to that of 2008.

President Donald Trump who threatened to repeal the Dodd-Frank Wall Street Reform and the Consumer Protection Act, two key legislations enacted in 2010 to check against the regulatory gaps in the US financial system, finally got his way last year.

In May 2018, Trump signed a bill rolling back some of the regulations of Dodd-Frank into law. Though the largest banks were exempted from the relaxed rules, easing the mortgage loan data reporting requirements for the majority of banks is somehow a red flag considering the fact that it was the bubble in the mortgage sector that caused the 2008 financial crisis in the first place.

Source: Bloomberg

In October 2018, the anxiety came to a crescendo when the International Monetary Fund (IMF) raised an alarm of the possibility of the world economy experiencing another financial crisis underlined principally by growing global debt level and failure of governments to tighten regulatory frameworks for their financial systems.
Global nominal debt level

As at first quarter of 2018, the world’s debt stood at $247 trillion. By September, the global debt level had risen to $250 trillion compared to $173 trillion as at the time of the 2008 financial crisis with China accounting for about $40 trillion of that amount in 2018.
The percentage of debt to GDP has risen sharply from about 280 per cent in 2008 to 319 per cent according to Bloomberg estimate.
Debt as a percentage of GDP

Source: Bloomberg

The alarming growth of government debt is stirring widespread fear among the investment community albeit, a mild growth in financial institutions’ debts. Within a decade, government debt has increased by about $30 trillion to $67 trillion in 2018 while corporate debt has increased by 5.2 per cent to $61 trillion in 2018.

The extent to which Africa was insulated from the crisis in 2008 was informed largely by the continent’s low financial integration with the global financial system. However, a research by Overseas Development Institute (ODI) found that the short term effect of the crisis on Africa was essentially through the economic route – lower commodity prices, remittances, foreign direct investments and fall in trade volumes.

Nevertheless, the same cannot be said in the coming years should another crisis come knocking. The reason is not far-fetched. Within a space of 10 years and still counting, a lot have indeed happened especially in the financial sector. Financial institutions, the capital market and other critical sectors of Africa’s economy are not only becoming intertwined domestically but are increasingly interrelated and interdependent on the global space.
These interdependency and interrelatedness would largely determine the degree of impact the next financial crisis, should it happen, would have on the global economic dynamics, as well as on the economies in Africa.
As analysts speculate of a possible crisis in the near term, it has become imperative to stress on what investors should do to be on a safer side.

What should investors do?

Investors have to be mindful of their risk tolerance, time horizon and liquidity needs when making the decision to invest. Speaking at the 2018 Market Recap/2019 Outlook of the Nigerian Stock Exchange, the CEO of the bourse, Oscar Onyema, assuaged the fears on investors on the likely global financial crisis occurring in the near term noting that today’s investors are better informed than investors in 2008.

Onyema noted that in preparedness, it is advisable for investors to have a well-diversified and rebalanced portfolio across different asset classes. Rebalancing a portfolio simply entails a reallocation of assets to assume a predetermined proportion or makeup. It is the adjustment to an investment portfolio that realigns the investor’s holdings with their targeted allocation of assets.

Leave A Reply

Your email address will not be published.