It seems that everywhere you go these days, everyone is talking about the ‘global financial crisis'. And while there is no shortage of experts discussing the technical aspects of the crisis as they unfold, many ordinary South Africans are asking themselves - what is this really all about and how does it affect me? Nedbank's Chief Economist, Dennis Dykes (pictured left) has some answers.
What is the global financial crisis all about?
In short, it's a case of some very risky lending practices by US banks coming back to haunt them. After the 2001 recession in the US interest rates fell to exceptionally low levels and US banks looked for new and creative ways of lending money. Given the solid history of rising house prices they started offering mortgages more aggressively to millions of households, even when it was less than certain that higher-risk borrowers would be able to repay their loans.
When interest rates peaked in the US in 2006, households with flexible-interest rate mortgages began struggling to pay off their mortgages. Many of them went bankrupt and lost their homes - an estimated 1.2 million nationwide.
As default rates on subprime loans shot up, investors lost confidence in firms involved or exposed to such loans and started selling their shares in these companies. Banks also started distrusting each other as related losses began mounting. By early September 2008 write-down's by banks had increased to around US$600 billion, bank failures were mounting and the banking system was in danger of seizing up altogether.
In early September, the US government had to bail out mortgage giants Fannie Mae and Freddie Mac. A week later, Lehman Brothers, the fourth-largest investment bank in the United States, filed for bankruptcy after it failed to find a backer willing to come to its rescue.
On September 17, the US government decided to offer an $85 billion loan to American International Group (AIG), a massive insurer on the brink of collapse, in exchange for an 80 percent stake in the company.
On 3 October, The House of Representatives approved a $700 billion bailout package for U.S. banks, in an attempt to halt the spreading financial crisis.
World stock markets, including South Africa's, have been hit hard by these events throughout the months of September and early October.
How is South Africa affected by all this?
Encouragingly, the impact on South Africa could potentially be far less than on many other countries around the world. Countries with extremely high household debt to income ratios, such as the UK and Australia, which are currently both at 160%, face far bigger risks than South Africa, at 76%. Banks in these countries are reluctant and unable to grant more credit to consumers, which will affect all aspects of these economies, particularly property prices.
Is my money safe in a South African bank?
None of the large South African banks have direct exposure to the sub-prime market in the US. Although there could be some counterparty losses resulting from bank failures elsewhere, it is likely that the direct impact will be very minimal. The consolidation that took place in the South African banking industry a few years ago has also left the remaining players in very strong financial positions. Finally, while not expressly stated by the South African government, it would in all likelihood back up the banking system in the unlikely event that this was required.
What should I be doing about my investments in the stock market?
As at the end of September, the FTSE-JSE All Share Index was down a total of 28.7% from its peak in May 2008. This is mostly as a result of negative sentiment from investors concerned about what is happening in the US and Europe, rather than poor performance by local companies.
Despite the recent decline in local markets, the basic principles of investing still apply. As long as your investments are correctly structured to meet your objectives, there should be no reason to make major changes to your portfolio. So for example, if you previously decided on a financial strategy for your retirement in 30 years time, you should stick to this and don't try to time the markets in the short-term.
These last few weeks have again reminded us of the importance of not having all your eggs in one basket. Make sure you are not exposed to unnecessary risk by having too much money in any one financial institution, sector, asset class or even country.
Finally, it is always important to seek expert advice from a qualified financial planner before making any major changes to your investment portfolio.
Will this affect the value of my property?
The current weakness in the local property market is probably more cyclical than structural. In other words, the global crisis is not really the cause of the slow-down in our property market. Higher interest rates, coupled with the huge gains in house prices over last few years were already having a cooling effect on our property market.
There is also a good possibility that interest rates in South Africa will decrease over the next few months, as global and local inflation slows. This will bring confidence back into the local housing market. However, a strong recovery is unlikely in the short term.
How will this affect my job?
It all depends on what industry you work in. Exporters, such as mining companies and vehicle manufacturers, which have done very well this year, may slow hiring or even shed jobs as global demand slows, depending on how deep and protracted the slowdown turns out to be. However, the weaker rand could balance this out as South Africa becomes more competitive on pricing. There is also likely to be job creation in the construction and tourism industries in the run up to 2010 and most companies will not want to lose skills that will be badly needed when the economy resumes a stronger growth path.