- The Washington Times - Friday, December 28, 2007

Last of three parts

The implosion of the American Dream is causing sleepless nights far beyond our borders.

Spanish homeowners, German lenders, Asian investors and central bankers from Beijing to Bucharest to Bogota are all trying to cope with the fallout from the crisis that came to light this year in the U.S. mortgage market. Given the critical role of the U.S. economy in world finance, trade and investment, and the ever-closer links between the world’s major markets, the U.S. foreclosure crisis has quickly made its impact felt overseas.

“In earlier time, the fallout from housing bubbles was usually limited to the country in which borrowers and lenders were based,” according to a just-released analysis from the London-based Economic Intelligence Unit. “Not this time.”

Angel Gurria, executive secretary of the Organization for Economic Cooperation and Development (OECD), which includes the world’s biggest industrial economies, said it might take until mid-2008 — when rates adjust again on many of the most worrisome loans — before the extent to the damage worldwide can be judged.

“I don’t think we have seen the end of the manifestation of the problem,” Mr. Gurria told reporters last month. “We need more information about the impact in different markets, different countries and different institutions.”

And the pain will not be shared equally.

Countries whose housing markets soared and lending standards fell — Britain and Spain among them — already are feeling the same pinch that U.S. borrowers have suffered.

Britain has seen the steepest decline in average housing prices in a decade, while the number of new mortgages in October was off a third from a year ago. The London Independent newspaper asked in a recent headline: “Can we avoid America’s fate?”

The U.S. subprime debacle also sparked the first genuine bank run in Britain in more than a century when Northern Rock Bank in Newcastle in September appealed to the Bank of England for emergency credit to cover losses from assets tied to the U.S. mortgage market. The day after the request was made, customers flooded Northern Rock branches and withdrew an estimated $1 billion in holdings, 5 percent of the total deposits.

“Unfortunately, we do not believe the worst is behind us,” said David Miles, chief economist for UK Morgan Stanley in a recent analysis. “The [British] housing market is now showing similar indicators to those seen in the United States just a couple of years ago.”

The situation could be even more severe in Spain, which in recent years has been a star of economic growth and job creation among the 13 European Union countries who have adopted the common currency euro. But much of that growth was fueled by a consumer spending boom and a housing market where values have more than doubled in the past seven years.

An estimated 98 percent of Spanish home loans are adjustable-rate loans, and nervous Spanish banks have tightened credit and raised rates so quickly that Prime Minister Jose Luis Rodriguez Zapatero virtually begged national lenders not to retract too quickly and send the economy into a tailspin.

The International Monetary Fund recently cut its 2008 growth estimate for Spain from 3.4 percent to 2.7 percent, and many private economists think even that is too optimistic.

In fact, housing price gains in many Western European markets — including France, the Netherlands and Sweden — have outpaced U.S. appreciation in recent years, according to OECD data, and could be ripe for a correction.


Because of the nature of the U.S. foreclosure crisis, even countries who stayed far away from the American mortgage market find themselves rocked by the aftershocks.

The direct losses from bad home loans — for borrowers and lenders — might be manageable. The problem for private investors and central bankers is that the bad loans are packaged with good assets in securities whose value now is a massive question mark.

In Germany, for instance, homeownership rates are relatively low, consumers distrust heavy debt and there is no subprime mortgage market to speak of.

Yet one of the first signs the U.S. foreclosure crisis was spreading abroad came when Dusseldorf-based IKB Deutsche Industriebank, a heretofore-obscure bank lending to mid-sized German firms, revealed in August it was near collapse after speculating heavily in U.S. securities linked to the American subprime mortgage market.

A string of global financial giants, including Citibank, Merrill Lynch and the Swiss lender UBS AG, have taken massive hits from the crisis. UBS wrote off $10 billion in bad assets earlier this month and sold off a minority interest in its stock to foreign investors. But it is little IKB that has become the face of the crisis in Germany and for much of Europe.

While some see the chain reaction of losses as a classic financial bubble, others say the cascade of red ink concentrated in the world’s supposedly most sophisticated and regulated financial centers has been a critical failure for the brave new world of computer-generated, round-the-clock capitalism.

Influential Financial Times columnist Martin Wolf recently wrote that the global credit crunch “is a huge blow to the credibility of the Anglo-Saxon model of transaction-oriented financial capitalism.”

He added, “A mixture of crony capitalism and gross incompetence has been on display in the core financial markets of New York and London. … Not for a long time will people listen to U.S. officials lecture on the virtues of free financial markets with a straight face.”

Central banks to the rescue

Fearing a vicious cycle in which bad assets lead to tighter credit and faltering growth, the U.S. Federal Reserve and key central banks around the world announced Dec. 12 a coordinated plan to pump money back into the system in a bid to buck up investor confidence and convince banks to resume lending.

“We have a collective interest in the whole thing not going into a shambles,” Bank of Canada head David A. Dodge told the National Post newspaper.

The lightning strike involved the Federal Reserve, the European Central Bank, the Bank of England, the Swiss National Bank, the Bank of Canada and the Bank of Japan. One analyst called the move the financial equivalent of “shock and awe.”

“The coordinated effort with other central banks is probably the most important aspect of this as this crisis is certainly on a global scale,” Chris Rupkey, vice president at Bank of Tokyo Mitsubishi in New York, told Reuters news agency.

The move electrified global markets but its long-term impact remains an open question. Until the full extent of the bad mortgage loans is fully understood, lenders and stock markets face a difficult time.

Unequal impact

One striking difference between the U.S. foreclosure crisis and recent financial bubbles is that this time it is the less-wealthy developing world, not the OECD elite, that is best positioned to weather the current storm.

From the Latin American debt crisis of the 1980s to the Asian currency crisis of the 1990s, the developing world has been a net exporter of financial contagions in recent decades. But with healthier national balance sheets and few direct ties to the American mortgage security market, developing countries and emerging markets have not felt the shocks that have rocked U.S. and European markets.

China Central Bank Gov. Zhou Xiaochuan predicted the U.S. subprime crisis will have only a “limited impact” on his country’s booming economy.

The big danger for the developing world is that the financial crisis in the United States and Europe could tip the world’s biggest economies into recession, cutting into the biggest export markets for China and other emerging economies.

“The subprime crisis in the United States has dampened U.S. consumers’ spending and has likely affected some European consumers as well,” Mr. Zhou said. Still, China projects 11.5 percent growth this year and nearly that rate in 2008.

The Economist Intelligence Unit survey found that East Asian, Latin American and even sub-Saharan African countries are poised to ride out the crisis in relatively good shape. Mortgage markets in countries like Russia and China are relatively rudimentary and subprime lending is unknown.

“Emerging markets approach this bout of renewed financial volatility from a position of substantively greater strength than they had in previous rounds of instability, such as the Asian financial crisis of 1996-97,” according to Diane Vazza, head of Standard & Poor’s Global Fixed Income Research Group.

Mexico’s economy, closely tied to that of its northern neighbor, could suffer the most, and Latin economies that rely on money sent back from nationals working in the United States could suffer. But short of a full-blown U.S. recession, these economies are nowhere near as vulnerable as they would have been just 20 years ago.

And for those with valuable commodities like oil and natural gas, the foreclosure crisis could be a boon. While other economies stumble, big energy producers like Iran, Saudi Arabia and Russia “may be rubbing their hands,” according to the Economist survey.

Peter Sands, chief executive of Standard Chartered PLC, said Asia is not “immune” to the U.S. foreclosure meltdown, but he added the continent is in good shape to avoid the worst.

“I don’t think Asia is totally de-coupled from what is going on in the West,” Mr. Sands said at the World Economic Forum summit in New Delhi earlier this month. “I don’t think anybody should assume that any one country is totally immune to the turmoil in the global financial markets.”

“That said,” he added, “I think Asia is in very good shape.”

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