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“Boom and Bust – Preparing our Industry and Customers for the Next Financial Crisis”

April 22, 2019

– Speech Presented on December 18, 2018 at the Chartered Institute of Bankers of Nigeria Rivers State Branch 2018 Annual Bankers’ Dinner

“And there were seven cows, fat and sleek coming out of the Nile … And then seven other cows came up, behind them, starved, very wretched and lean … The lean and wretched cows ate up the first seven fat cows” – Genesis, 41.18-19.

This is the Christian bible, describing a boom and bust cycle. How many of us know that the next economic bust is inevitable? That after every boom, expanding asset classes that come with a boom always lead to a bust. These busts lead to economic damage as they destroy a lot of wealth very fast. Better known busts are Tulips in 17th century Holland, stocks in the 1929 Great Depression, land in Tokyo in 1989, the 1992 UK Exchange Rate mechanism crisis, the 1997 Asian financial crisis, the 1998 Ruble crisis, the 2001 Dot com crisis, and the 2008/9 Global Financial Crisis (GFC).

According to the National Bureau of Economic Research (NBER), globally, there have been 29 credit busts in the last 145 years, roughly one every five years, and the last one was 11 years ago in 2007. Of these 29, just 9 included a banking crisis. 21 led to monetary shortages, 16 had extended credit availability contractions, 18 had stock market crashes, but just two were quinfectas that included; banking crisis, stock market crash, credit availability contraction, and real estate market collapse. These two are the Great Depression of 1929 and the 2008 Global Financial Crisis.

We can argue that this is history, so how many of us here know that globally 2018 has been the worst rout for traders and investors on the world’s stock markets since 1920? 90% of the 70 asset classes tracked by Deutsche Bank are posting negative total returns in dollar terms for the year through mid-November. The previous high was in 1920, when 84% of 37 asset classes were negative. Last year, just 1% of asset classes delivered negative returns. The global stock markets peaked at US$87.289 Trillion on January 28 2018 but have since lost US$14.889 Trillion.

This year also saw an anomaly, three bubbles detonated in the US financial markets; the Bitcoin bubble with a descent from its high of US$20,087 per bitcoin on December 17, 2017, down to about US$3,200 as at last week (crashing from a Market Capitalisation of about US$830 Billion at its peak to about US$100 Billion as at December 15, 2018). The FAANG (Facebook, Amazon, Apple, Netflix and Google) bubble also led to a US$1 Trillion value wipe-out and of course we are still tracking the unfolding medical marijuana bubble.

Some have ascribed the sharp sell-off partly to the Feds quantitative tightening program. Until recent market signals, many economists and analysts projected 4 more Fed rate hikes (one per quarter), including one on December 19, 2018, but the gathering storm may change this prognosis.

According to property website Zillow, US housing prices are now 8% higher than the 2006 property bubble peak. Price to Earnings ratio (a measure of the reasonability of stock prices) is now higher than it was before the 1929 Great Depression and the 2008 GFC.

Corporates and sovereigns with dollar denominated debt have seen the cost of their debt service increase with each Fed rate hike. The Fed has been reducing economic stimulus by not replacing bonds used for quantitative easing (estimated at US$50 Billion every month) at maturity. Brexit is hammering the UK, while Italy’s political crisis and Germany’s diesel vehicle emissions scandal have bruised both economies.

Italy’s case is interesting, the country is likely to request for a rollover of more than EUR600 Billion of its debt over the next three years and more than half of its debt over the next five years. More than three quarters of this debt is owed German financial institutions, thus a debt crisis in Italy could lead to an unravelling of the German banking industry.

Clearly, the Feds monetary tightening is revealing the soft underbelly of the global financial markets as the continued crash of price of the various asset bubbles can trigger another economic crisis. Add this to diplomatic tension, Trump’s trade / tariff wars, rising nationalism, technological disruptions, political polarization, then you have a very toxic mix.

How many of us know that global debt over the last 15 years has more than doubled, increasing by over US$150 Trillion?

When I say global debt, I refer to the totality of Household, Non-Financial Corporates, Government and Financial Corporates debt.

This debt has reached unprecedented and mind boggling proportions.

How many of us know that earlier in the year (in July 2018 to be precise), the Institute of International Finance warned that global debt increased the highest in two years, by US$8 Trillion in the first quarter of the year alone, reaching US$247 Trillion (the IMF has a figure of US$184 Trillion in nominal terms but I believe that this does not include household debt), 318% of Global GDP.

The trio of Japan, China and the USA account for more than half of this debt, significantly greater than their global output and leading to the aforementioned distortion that is 318% of Global GDP.

I know that as bankers, we are taught that public sector debt is not ever actually fully repaid as rollovers lead to an evergreen facility. However, with our public sector debt breeching acceptable debt service to government revenue ratios, it is just a matter of time before we hit a sovereign debt wall that will drag private sector debt down with it.

The US Federal Government closed its fiscal 2018 books with a US$779 Billion deficit, projected to further increase in coming years given Trump’s tax cuts and increased debt service driven by increased interest rates from the Feds.

China on the other hand has binged on debt since the 2008 Global Financial Crisis (GFC) and has printed more money than the USA. China’s debt binging is of note as its share of global debt only increased at the start of 2000, from about 3% to over 15% today, particularly surging after its 2008 stimulus programme.

Unlike the USA that essentially borrows its own money (US$ denominated debt) thus technically cannot default (though debt service is projected to surpass Defence budget spending), a lot of China’s debt is in US$ denominated bonds. As China prints more money and weakens the Yuan (ostensibly to make exports more attractive), it becomes even more difficult for the country to repay its US$ denominated debt.

A point that should be of interest to us as bankers, is that a lot of this global debt increase is from financial corporates and non-financial corporates’ debt (in essence, our customers and us) and public debt from the developed countries.

The other day I had a private chat with one of Nigeria’s leading economists and a former member of the Central Bank of Nigeria’s Monetary Policy Committee (MPC) about Abenomics “three arrows” of monetary easing, fiscal stimulus and structural reforms. I wanted to know whether Abenomics policies where the Bank of Japan (BOJ), in trying to stimulate the economy, has on its balance sheet assets valued at more than 140% of the Japanese economy, could help stimulate the Nigerian economy. The reasons that he proffered on why it cannot work in Nigeria will not be shared here mostly because I do not have his permission to do so, however the BOJ now joins both the Swiss National Bank and the European Central Bank in buying massive amounts of private sector debt and equity to inflate the economy.

Despite the Abenomics reservations expressed, I still expect innovative monetary policy interventions from central banks across Africa soon. With Zambia, Mozambique, Nigeria, Kenya, Tanzania, Uganda, Ghana, Cape Verde, the Gambia, Mauritania, Republic of Congo, Sudan all aggressively binging on external debt, we are reminded that the debt crisis of the 1980s, 1990s and early 2000s was triggered by a fall in the price of commodities and rise in US interest rates. US interest rates are rising and if they continue to rise, the current illusion of liquidity will soon disappear…all that is left is a crash in price of commodities, and guess what? As I was leaving my house this evening (December 18, 2018), U.S. West Texas Intermediate crude price fell about 4 percent to a 15-month low at US$47.84 overnight, after slumping 2.6% in the previous session. WTI was last down 68 cents, or 1.4 percent, at $49.20 a barrel. Brent crude, the international benchmark for oil prices, tumbled to a nearly 14-month low at US$57.20 on Tuesday. It was trading 67 cents, or 1.1 percent, lower at US$58.94 a barrel.

What has Changed Since 2008?

A number of economists and analysts have noted that globally, the response to the 2008 economic crisis relied a lot on quantitative easing, monetary stimulus and near-zero (or even negative) interest rates, with little structural reforms. Thus the underlying fault lines still remain, but now on a larger debt base and with central banks and federal governments already stretched from the earlier interventions. Not much was done for the much required financial and labour markets reforms to tax systems, fertility patterns, and education policy reforms. The result is that the massive liquidity that central banks injected into their systems were not efficiently allocated.

In the event of another global financial crisis, it is this level of unprecedented debt binging and quantitative easing from regulators that will make intervention by local central banks and federal governments extremely difficult. Back home, Fitch noted recently that “sovereign support to Nigerian banks cannot be relied on, given Nigeria’s weak ability to provide support, particularly in foreign currency. In addition, there are no clear messages of support from the authorities regarding their willingness to support the banking system”.

Moody’s, one of the leading global rating agencies, noted within the week that Nigerian Tier 2 banks, are operating with weaker capital buffers, making them more vulnerable. Nigerian Tier 1 banks are said to be better capitalized, however we cannot pretend that Nigerian banks are not struggling with acquisition loans granted power investors during the privatization of power assets which earned the federal government US$3.2 Billion / N1.15 Trillion (generation and distribution companies were sold for US$1.7 Billion and US$1.5 Billion respectively). These assets were supposedly bought with 70% debt and 30% equity provided mostly by local banks and it is quite probable that a lot of the equity portion are also sitting as loans on the balance sheets of local banks.

We cannot also ignore that before the crash and at the peak of the oil price boom of US$115 per barrel in 2014, Nigerian banks gave loans to indigenous oil prospecting companies to purchase assets of the International Oil Companies like Shell, Chevron and Total. By end of December 2016, loans to the oil and gas sector constituted 30.02% of the gross loan portfolio of the nation’s banking system and grew from N4.51 Trillion to N4.89 Trillion.

It is these vulnerabilities, exacerbated by a looming global sovereign debt crisis, and the disappearance of the illusion of liquidity that can possibly trigger a financial crisis in Nigeria sooner than later.

So What Should We do?

The Regulator and Money Deposit Banks

There are three stages required for a regulator to catalyse recovering from a financial crisis; admit the losses, decide who should bear them, and fight the ensuing downturn—as quickly as possible. “Delay allows problems to fester on bank balance sheets, increasing the ultimate cost of bailing out the financial system. This was the mistake Europe made and the United States avoided”.

It is extremely important to acknowledge the extent of the problem and determine how much wealth was destroyed. This may be difficult where banks may not be open to revealing the true state of their delinquent assets to avoid aggressive write-downs but should be evident when increasingly large balance sheets are yielding compressed Net Interest Margins. The regulator may also conveniently look the other way, especially for Systemically Important Banks (SIB) as properly flagging the true state of these delinquent assets would mean that the attendant loan loss provisions must be taken, capital written down and losses must be allocated to tax payers, a step a lot of regulators may be reluctant to take.

Unfortunately, the fact that 10 years after the 2008 global financial crisis, some of these assets are still on banks’ balance sheets makes the Nigerian banking sector extremely vulnerable to another crisis. Look at the five countries in Europe worse hit by the 2008 global financial crisis, while Iceland, Spain and Ireland acknowledged the level of their wealth destruction and wrote down the assets, Italy and Greece refused to bite the bullet as long as possible leading to a heavy drag on both economic systems till date.

The last stage is for government and central banks to deploy monetary and fiscal policies to reduce the impact on the economy. From 2008 to 2011, across the 11 countries hit hardest by the crisis, governments spent an average of 25% of GDP on stimulating their economies. It is a big concern that given the volatile crude oil market, the Federal Government of Nigeria does not have the capacity for such spending if we were to be faced with another financial crisis as soon as next year.

For the money deposit banks, this will also be a good time to pre-liquidate that Eurobond, if you have the liquidity, especially when it no longer qualifies as capital.

We have also not been behaving as if another financial crisis is likely. Government bureaucracy is still expansive and expensive. Operating Expenses is more than Government revenue and Cost of Debt Service is more than our entire non-oil revenue.

Unfortunately, what we have learnt 10 years after the last crisis is that we all; regulators, policymakers, politicians and bankers have all reverted to our old complacent ways.

Individuals and Customers

Exchange Rate Risk – For our corporate borrowers, as always, avoid exchange rate exposures unless the organization has dollar receivables. Even with dollar receivables, a sovereign FX crisis would mean that dollar liquidity would dry up thus dollar receivables may not be honoured.

Projects Funding – Other than straight equity, this may not be the time to take on debt for ambitious big projects.

Emergency Fund – For individuals and corporates; if possible, build an emergency fund that can cover six months of your living expenses. Keep these funds in cash or easy to liquidate near cash assets.

Reduce your Running Costs – Cut down on your fixed living costs, and social / lifestyle costs that are not absolutely necessary.

Investment Diversification – Spread the risk of your investment by diversifying your portfolio across a wide range of assets across different sectors.

Increase your income streams or get a side gig – With a financial crisis comes job losses, company shutdowns, thus primary sources of income can be supported by a side gig, provided it does not go against the ethics of your profession, employment contract and does not affect your primary job.

We may not know the time, however, what we know for sure is that the next financial crisis is coming.

Government

Our external debt increases vulnerability to shocks, particularly the commercial part of our external debt which has increased from US$1.5 Billion in June 2015 to US$11.6 Billion as at December 2018, a 673% increment.

This commercial debt is also less flexible than multilateral debt in terms of terms renegotiation.

Cost of Government bureaucracy is still too high and expensive for our income size. We have the spending habits of an oil rich country and in fact, but we are “oil poor” per capita. It is this false “oil rich” narrative that our politicians deploy to justify profligate government expenditure, the irrational cost of our bureaucracy, irrational salaries for political office holders and the various subsidies on consumption.

A favourite analogy of mine is that Nigeria is like a level 17 federal civil servant who has 5 wives and 20 children, spending money like his bachelor colleague on the same level. They may earn the same income but while one takes care of only himself, the other has a household of 26 to cater for. The utility and elasticity of the income of these two level 17 federal civil servants is relative to the number of mouths each of them has to feed.

So, in summary, another financial crisis is inevitable. It may arrive here as soon as next year.

Are we prepared?

Thank you.

– Dr. Jekwu Ozoemene

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