How bad can this get and for how long?

DEMAND AND SUPPLY By Boo Chanco
Monday, October 13, 2008

The quick and honest answer is, no one knows. Just when you think things should brighten with governments acting in concert to inject not just money but try to put confidence in the system, something else crops up to spook the market. Only one thing seems sure… according to some 52 economists in the latest Wall Street Journal forecasting survey, they now expect US gross domestic product to contract in the third and fourth quarters of this year, as well as the first quarter of 2009. In other words, the “r” word is upon us!

But if you want to read something really scary, here are a few paragraphs from the latest outlook of Nouriel Roubini, Professor of Economics at the NYU Stern School of Business.

“The U.S. and advanced economies’ financial systems are now headed towards a near-term systemic financial meltdown as day after day stock markets are in free fall, money markets have shut down while their spreads are skyrocketing, and credit spreads are surging through the roof…

“At this point the risk of an imminent stock market crash – like the one-day collapse of 20 percent plus in US stock prices in 1987 – cannot be ruled out as the financial system is breaking down, panic and lack of confidence in any counterparty is sharply rising and the investors have totally lost faith in the ability of policy authorities to control this meltdown.

“At this point the recession train has left the station; the financial and banking crisis train has left the station. The delusion that the U.S. and advanced economies contraction would be short and shallow – a V-shaped six month recession – has been replaced by the certainty that this will be a long and protracted U-shaped recession that may last at least two years in the U.S. and close to two years in most of the rest of the world… the probability that the outcome could become a decade long L-shaped recession – like the one experienced by Japan after the bursting of its real estate and equity bubble – cannot be ruled out.”

Today’s flat world threatens to flat line most economies. Even the petro dollar rich countries of the Middle East are also feeling the bite. Thus the jobs of our OFWs are at risk. I just read at the Financial Times that the construction boom in Dubai has started to slow down. Apparently, they also need the flow of foreign capital to finance their building industry.

No wonder our Secretary of Labor looked troubled when he was interviewed on a television newscast last week. I would be, too, if I were in his shoes. I am afraid the mitigation measures he enumerated to cushion the impact of job losses in the Middle East and elsewhere, will be hardly adequate. We cannot expect our OFWs to morph instantaneously into small entrepreneurs as soon as they land in NAIA.

Unfortunately, nothing that I have heard from other cabinet members sounds adequate to meet the crisis already at our doorsteps. The most promising I have heard comes from Albay Governor Joey Salceda who proposed to Ate Glue a number of emergency measures to prevent panic and despair when the full impact of the financial crisis hits our shores.

Among the crisis countermeasures proposed by Joey are:

1. An economic stimulus package up to P75 billion a year is central. Banks are only as strong as the real economy. This shields the poor through direct income transfer, increases food production through DA intervention and expands productive capacity through infrastructure acceleration.

My only misgiving is my lack of trust that this administration will use this large sum of money properly. Ate Glue will more likely play politics… specially after the House Speaker has announced that cha cha is on the agenda by January next year.

2. Increase capitalization of BSP by P40 billion and PDIC by P10 billion through a National Government Multi Year Obligation Authority. It makes sense to now give government institutions the ammunition they can use in an emergency to stabilize a situation.

3. Integrate financial oversight in supervision to close regulatory gaps vs current Banks under BSP, stocks under SEC, insurance under IC. There is probably a need to put them all under one roof, an independent financial authority. What the present crisis teaches us is the need for effective regulation and this is one way we can approach the problem.

4. Coordinated regional stabilization fund under Asean for forex facility. This had been talked about a lot in the aftermath of the last Asian financial crisis. Time to bring this beyond talk.

5. Depositor confidence is key so deposit insurance coverage must be increased to P500,000 from P250,000. The rest of the world, including the US, is doing this as a confidence building measure that would keep people from instigating bank runs out of panic from rumors or other such things. Ireland has virtually covered entire deposits. While 95 percent of accounts are under P250,000 they account for only 13.7 percent of amount. Let us protect depositors and not bailout bankers or borrowers.

6. Give PDIC independent examiner power and bridge bank authority. There is a need to enable PDIC to become more proactive to prevent bank failures. And PDIC must also be made more viable through the bridge bank authority to sell assets at market rather than fire sale prices.

Over all, Joey’s proposals are directed towards increasing investor confidence in the country by enhancing investor protection. Our current low level of investor protection is a main reason why we scored very low in the last rating of countries for investor confidence.

Strengthening regulatory systems is probably the best lesson the world should learn from our current grief. Look at what’s happening in Iceland. The free for all regulatory environment enabled the country’s banks to lend heavily at home and abroad, their assets swelling to 10 times the economic output of the nation. With the credit crunch, Iceland’s financial system collapsed Thursday last week. The government took over the banks and was expected to turn to the International Monetary Fund for help.

Iceland in Chapter 11 made sovereign risk seem more risky than it is normally seen. Now, investors see the financial disease moving from banks and companies to countries. Thus, even if Iceland is geographically far from us in Asia, its bankruptcy could trigger, the WSJ warns, an exodus of investors from other small, debt-laden countries, pushing down their currencies and making it impossible for them to pay their foreign debt. That makes us vulnerable.

Confidence building is the most important strategy that any government can do at this point. The ordinary depositor and investor now want to have the assurance and guarantee of government. Otherwise, he will likely panic and destabilize the financial system further.

Gov Joey also observed that some chaos is necessary for the stability and resilience of systems. “Bottom line is… when dealing with complex systems we should act with a certain humble dubiousness not with unblinking rashness. Most clueless players (like some government economic managers?) are the most confident.”

In other words… continually expressing confidence in the resilience of our financial system is meaningless and even dangerous. We must act now because we aren’t going to be immune from the global disease much longer. It is better to be prepared. As Gov Joey so aptly puts it, even if you are healthy, it is not bad to get anti flu shots when there is an epidemic in your neighborhood.