Failure to implement risk regulation is at the heart of the credit crunch. The Middle East can lead a financial revival.
MENA in postion to lead global recovery
"Those who doubt there is much connection between the economy of the 1930s and the supercharged, information-age economy of the 21st century are invited to look at the current economic headlines - high unemployment, failing banks, volatile financial markets, currency crises and even deflation all feature in black and white. "The issues raised by the Depression and its lessons are still relevant today." So wrote the US Fed's chairman, Ben Bernanke, in his essays on the events of the 1930s. Even though these essays were written in 2000 their relevance today is paramount. The US Treasury today finds itself in unfamiliar territory. Large financial institutions in the US have been going under and pleading for a rescuing arm to pull them out of the gutter. Some were salvaged by government interventions or acquisitions by rival financial institutions. The US Treasury has notably saved AIG, Fannie Mae and Freddie Mac, while Lehman Brothers was left alone to go bust. The US Treasury then proposed a US$700 billion (Dh2.6 trillion) rescue fund to try to buy time for a swiftly unravelling financial system.
In Europe, several financial institutions have also gone under. We all understand that it began in the US mortgage market with the rest of the world feeling the ripple effect. There are two ways to look at this. There is the Wall Street-City of London way, which features theories, numbers, equations and ultimately rationalisation (as in: "How were we supposed to know that the people who lied about their income and assets would walk away from mortgages on houses they had no equity in? That wasn't in our model. It's not our fault."). Then there is the right way, which involves asking the questions that really matter: How did we get here? How do we get out of it? And what does this mean for the rest of the world and the average man and woman on the street?
In the past, problems in the economy caused problems in the financial markets, as in the Great Depression. This time, problems in the financial markets are causing the global economy to slow down. If the global economy continues to spiral downwards, this could cause a second dip in the financial system - which is having a hard time dealing with the first and principal problem. The consensus is that the root of the problem lies with the sheer greed, ignorance and poor risk management of financial institutions. Regulation was in disrepute and posed no concerns for them. They had no need to worry about risk, which had supposedly been magically whisked away by all sorts of spiffy nouveau product-derivatives like credit-default swaps. To a great extent it was more a problem of poor risk management than of greed and ignorance.
The securitisation business model worked perfectly: for a substantial fee, risk was redistributed to willing investors. Products were sliced even finer, and people lost sight of the inherent risk. The most sophisticated investors took the greatest risk and reaped the greatest rewards. This worked well. What failed financial institutions in the US and around the world were their credit and market risk management systems.
What failed the public was the impossibly outdated regulatory environment. The proper pricing of risk played second fiddle to underwriting fees. Risk controls were routinely overridden by business managers. Where do we [in the Middle East and North Africa (MENA) region] stand with regard to this ordeal? The question for the region is whether our strong economic prospects can shelter us from the global slowdown and the continuing inflationary pressures felt around the world. The answer, simply, is no. It is becoming evident that because we live in a more progressively globalised economy, we will continue to share the pain with the rest of the world. Financial markets around the MENA region have taken a hit since the beginning of the year. This period will be seen as a period of survival as opposed to growth.
On a more positive note, no major financial institutions in the MENA region have filed for bankruptcy. MENA will certainly be in the forefront of any recovery because of the strong economic prospects of the region, which are firmly linked to oil prices (which remain well above the break-even point for GCC budgets). On the other hand, MENA has some lessons to note. As a precautionary measure it should seriously consider the IMF recommendation that "a systemic crisis demands systemic solutions". The IMF has recently recommended that central banks make available liquidity provisions; purchase distressed assets and hold them until markets settle; and make capital injections into financial institutions when needed. Mohamed Ibrahim is an analyst with TNI Asset Management