Special Features
Impact of the US Sub-prime Market Crisis on the GCC
Globalization brings about highly integrated financial markets. Therefore, an upswing or downswing in one market or industry can have either a direct or an indirect impact on the other. A recent example of this is the US housing bubble burst.US Sub-prime Market Crisis The US sub-prime mortgage crisis is a result of careless extensions of loans to people unqualified for traditional loans and exaggeratedly high Standard and Poor (S&P) ratings given to highly risky sub-prime loans. Under incorrect risk assumptions based on S&P rankings and high rate of returns, investors and institutions around the world bought collateral debt obligations (CDOs). A CDO is an investment vehicle which acquires asset and mortgage backed securities and then sells the rights to the cash flows from these associated risks. These CDOs were incorporated into major hedge funds managed by some prime financial institutions. However, when the interest rates increased, the sub-prime lenders were hit hard due to defaults on home loans.
Impact on World Economy According to American economists, as per the UAE embassy in the United States and many other financial experts from various international banks, the global economic growth will take a hit as a result of the US sub-prime mortgage crisis. Negligence in the management of investments risks associated with the US sub-prime market has led to a loss of trust in the world financial markets. American economists suggest the main reason for the creation of this crisis was the moral hazard practices of US financial institutions. Moral hazards arise when lending institutions believe that they can make risky loans and reap the benefit if the investments turn out well. But if investments turns out badly then they can exploit the government’s monetary policy by transferring a substantial burden of their losses to institutions such as central and reserve banks which assist in financial bails outs. Additionally taxpayers, depositors and other creditors also shoulder at least part of the burden of risky financial decisions made by lending institutions.
A clear assessment of risk spread and the size of the questionable assets of the US sub-prime crisis still remains to be unknown. Fear from these unknown and uncertain losses has led to compounding problems for financial institutions and their counterparts. As a result, they have stopped underwriting new debt issues as a contingency to cover their own unanticipated and anticipated funding needs. Financial experts believe that although the impact of the crisis has been a major damper on the global stock and debt market, the debt market has been affected more intensely.
Difference of opinions exists in the remedial practices to end the crisis suggested by many experts. On one hand, some experts suggest that lowering interest rates will encourage more market liquidity. Whereas, other experts disagree and point out that lowering interest rates will again lead to moral hazard practices. Instead, they suggest market bailouts with central and reserve banks injecting more money into the economy in addition to a simultaneous reduction in interest rate.
Hence, in the wake of bailing out major market players from risky loans and stabilizing the volatile effects of the crisis, the U.S. Federal Reserve Bank, the European central banks, the Japanese central bank, and central canks from Australia and Canada have injected more than USD 240 billion dollars. However, the aftershocks from the crisis are assumed to continue thereby affecting the world economy.
Impact on GCC Although the worsening mortgage crisis is taking its toll on the world economy, a special survey conducted by the S&P indicated that the banks in the GCC have no or insignificant exposure (less than 1%) to the US sub-prime crisis. However, according to local sources it is still early to detect the magnitude of the impact. There are signs of alertness for a possible spill-over effect into othe
