– Thoughts on Strategy and Management

Specific aspects of financial crisis

The last two days can be described as a dramatic change in terms of the global financial crisis. Not so long ago – or to be more specific: last weekend – a liberal approach seem to rule governmental measures how to tackle the financial crisis. Lehman Brothers did not receive a public backup. But at the end of this week we could observe an enormous change: US authorities moved towards an agreement on a program of government intervention in financial markets. The German regulator BaFin (as well as other regulators) bans short selling transactions of 11 financial institutions in Germany (Aareal Bank, Allianz, AMB Generali Holding, Commerzbank, Deutsche Bank, Deutsche Börse, Deutsche Postbank , Hannover Rückversicherung, Hypo Real Estate (HRE), MLP and Münchener Rückversicherungs-Gesellschaft). The BaFin’s move was part of a massive measure by global regulators on short selling aimed at calming the turmoil in global markets. So, let’s have a look at an interesting issue: Is this the end of the financial crisis?

Unfortunately this is likely not to be the case. A key role is given to real estate market in the United States. As long as we see a decline in real estate prices, we cannot expect a total stabilization in US financial markets, US economy or US financial system. Declining prices for real estate does not only reduce the wealth of US consumers. It also reduces the value of mortgages and therefore the values of structured financial products and bonds that are linked with the value of these mortgages. How long may it take before we see the bottom line in terms of house prices? The ratio between real estate prices and rents can be used as an indicator (some sort of price-earnings ratio for real estate). Until the year 2000 this ratio was quite stable. The strong price increase for real estate did change this ratio after 2000. Taking into account the development of the Case/Shiller Index –which shows a 16 % decline per year for 10 selected cities – as well as rent increase, it would take several months (until 2010!) before the ratio has reached it long term median. Of course, everything (different to this) is possible. But considering this ratio it can be assumed that real estate prices will be under pressure in 2009, too.

Since the beginning of the financial crisis US banks had to write down 260 billion USD. But they were just able to raise 184 billion USD in terms of new equity to stabilize their capital base. Due to an ongoing decline in real estate prices it can be expected that this disproportion will continue. Even if the US government’s plan to buy bad securities from banks can be described as a right step, the pressure for the US banking system will keep high. Do we face the risk to end in a situation like Japan in the early 90’s? Probably this won’t be the case. The US economy can be characterized by extremely flexible labor- and commodity markets. First and foremost US banks have started to write downs their mortgages and securities more quickly compared to Japanese banks at the early 90’s. Furthermore the US government seems to accept a more active role to stabilize the markets. In sum it cannot be recommended to put US situation on a level with the situation in Japan.

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