Way out lies on SMES
When the World Bank announced that the world economy was in crisis, we were all thrown into panic and, because of the effect it has had on our very livelihoods, we wanted to understand how, why and when this all happened.
However the feedback we get is too complex for an average Joe. The economic jargon straight from business pages is making the problem vague and more confusing. So let’s together put meaning into the facts that surround the crisis.
To understand the present implications we must understand the history. What happened and what caused the crisis?
In layman’s terms, here’s what happened: The housing market in the US was out of control as a result of real estate boom.
People, who should have never been given loans, got them. They used these loans to invest in housing .The banks were offering these people loans at rates far less than what it would take to pay off them (loan).
When a bank lends money it takes a risk because if the person who borrowed the money cannot repay it, then the bank has to write off the debt.
The bank is left with two options either to transfer that debt to another party or to reposes the property in this case repossessing was not an option because even if they did so they would not find another person to profitably sell the property to.
So the way out was selling the debt.
To reduce its risk, the banks started trading that debt to investment banks.
The investment banks bought these debts and in turn they we supposed to get their money back when the loan was repaid. The investment banks bought this debt off the bank’s books in exchange for a bond.
The banks then took insurance policies (called credit default swap or CDS) against that debt going bad. And all they had to do was to make monthly payments to the insurance company!
Good deal! Now the debt was off its books and it is no longer negatively affecting the stock price.
The investment banks that bought up these debts then took them and threw them all in a big pile and chopped it up into pieces and sold them to private investors as bonds.
Then the price of houses started to sink. People, who had taken mortgages, were really in trouble now. They had no money to repay their loan and they could not be able to sell their house in a value above their mortgage.
So they only option was to default or rather they then stopped servicing their loans
The banks realised that, if people weren’t repaying their loans and they couldn’t meet their credit obligations then they didn’t have enough cash in the bank to stay around.
Even though the banks had insurance on the debt, all this did was moving it off their books (out of sight, out of mind) instead of reducing their risk. They still had to make the “insurance” payments and now they couldn’t do that.
There was just too much of it. One thing you need to know is that banks rely on lending to meet their daily cash obligations. When financial institutions get uptight they stop lending money to each other.
In other words, no one wants to get stuck holding the bag. If there is no money coming back into the companies to repay the debt and no one can borrow the money to cover their cash needs, then the entire system starts to unravel. Boom!
Suddenly AIG fails — they insured a lot of that debt. And every time another institution fails, it becomes even harder and harder for anyone to borrow money to meet their daily obligations.
So the western governments had to be the lender of last resort either exchanging great amounts of money to companies for large equity positions or arranging buy out deals with others in order to stop more banks going down. This, they do by using the tax payers money.
And now the western governments are stuck with debts no one is willing to buy. The failure of mortgage bonds, or housing loans, due to rising interest rates in Western nations sparked the crisis
Today this crisis is of great concern because it may result in increased risk averseness on the part of banks and reduced [investment] flows to the region.
The flows that have been responsible for the high levels of growth may actually decline if the crisis continues. What this means is if there were any plans for private investors to invest in our country now they simply can’t.
One of the more likely indirect effects is the decline in remittances to African countries as unemployment rises in North America, Europe and other places.
This means that those Africans who live there and regularly send monies home are less likely to be in a position to send home these monies.
As Western governments try to pay for their billion-dollar rescue packages they might reduce foreign aid programmes. Private humanitarian groups, facing a drop in donations, might have to do the same.
This will adversely affect our economy as our yearly budgets rely on foreign aid. If the global credit crunch leads to a decline in capital flows and a reduced appetite for risk, this could severely affect African countries that have been relying on these flows for their infrastructure investment.
Economic and Policy Research Network (EPRN) recently held a panel discussion on the world financial crisis and its implications on Rwandan’s economy.
The main speaker warned that even though Rwanda currently has no cause for alarm, we must be concerned for issues like future price fluctuations which will eventually have an impact on the Financial, Public and Private Sector, especially on the Foreign Direct Investments.
“Given Rwandan Financial Sector and Private Sector, we are not yet built to deal with the external shocks” of the current Global Financial Crisis. Dr. Jean Francois Ruhashyankiko, Senior Economic Advisor in the Ministry of Finance and Economic Planning, said, advised that one possible durable solution would be the strengthening of SME’s, which would then support the Private Sector against such shocks.
This panel entitled “The Global Financial Crisis and its Impact on Rwanda”, was the first in a series of events EPRN has planned over the next 12 months, with further training sessions, research symposiums and panel discussions on topical economic issues all in the pipeline.