Whether it is in the international markets, or in the Saudi stock market, fear seems to stalk trading. The daily volatility seems to be symptomatic of a deep-seated anxiety and fear that the global credit squeeze, triggered by the US housing crash, is more pervasive then seems on the surface. Confidence is a precious commodity, and never more so than in the financial markets, but this time, despite some massive central bank interventions around the world, market behavior seems more fearful than the previous crashes seen in global stock markets.
In 1987, markets were less interconnected and IT technology was still in its infancy. Despite the largest one-day fall in the US stock market in 1987, the markets rebounded by December of the same year. The collapse was triggered by the fear then that the US economy was slowing down after a period of boom, fueled by borrowed money to fund mega takeovers. In 1997, the problems of Long-Term Capital Management, caused a fall in the global derivatives market triggered by the Asian financial crises of the same year. The difference between then and now is that stock markets, especially in the US, recovered quickly after these dramatic events.
Today, contagion is more powerful in world markets, and fear seems to be a more powerful driver than short-term bouts of euphoria. This even seems to have gripped the local Saudi market, which has seen a slide in the TASI index to the 7,900 levels after failing to effectively break and sustain a rally above the psychological 8,000 level. The international markets are now beginning to deal with the consequences of loose credit lending practices and excesses. On the other hand, the local market seems fearful to take the market index up, just in case they are left exposed to sudden panic selling.
Intra-day trading and quick profit-taking is the hallmark of Saudi trades, and it will be with us for quite a while. All indications, is that the fallout of the US subprime market will not have a direct effect on Saudi financial institutions, as they have minimal exposure to the US mortgage market, and did not have a high dependency on external financing that made them vulnerable in a credit squeeze. What domestic institutions will face is a tightening of lending margins and a more rigorous credit regime in line with world standards that could affect domestic borrowing.
However, until one can be more precise about the extent of possible credit loan defaults, the markets will continue to be driven by fear. Some brave souls in the financial community have urged fellow bankers to come clean on the extent of their subprime losses, but this call for transparency has not been heeded, as it flounders on one obvious issue: no one seems to have an idea about the extent of such losses, and this, in turn magnifies the current market fear.
Some institutions have attempted to allay such fear by stating that their Structured Investment Vehicles (SIV’s) assets remain strong, but again nobody seems to trust such statements.
This leads to a financial catch 22 situation — if such SIV assets cannot be refinanced in the commercial paper markets, the lenders to SIV’s have to take the underlying assets directly back on their books, and if they cannot be sold, then it is difficulty to assign a meaningful price to them. What will emerge from the current fiasco is tighter financial regulatory supervision of the risks posed by collateralized debt obligations, and other synthetically constructed debt instruments.
After some years of quiet warning about such instruments, the sudden collapse, and credit crunch has caught central bankers off-guard and there are many red faces all round. Some would argue that it is not the job of central banks to control and stifle banks from creating wealth through new risk instruments, otherwise financial engineering would stand still. That is a good argument, and if no lasting damage is done to the financial system, then central bankers will collectively sigh in relief. The simple truth is that greed had overtaken events in the management of risk, and such risks is now putting whole economies at risk and have embarrassed regulators. Only time will tell which argument will prevail, but for the moment, fear dominates the markets’ actions due to this precise unknown factor.
(Dr. Mohamed Ramady is visiting associate professor, Finance and Economics at King Fahd University of Petroleum and Minerals)