Posted by: Godfrey Smith - Wednesday, September 24, 2008If the old adage that when the US sneezes the Caribbean catches a cold were true, the financial trauma affecting the US economy would have already plunged the Caribbean into an economic coma. It is unlikely that this will happen. But the outward ripples of the financial crisis in the US will cause an economic downturn in the Caribbean.
How the US Financial Crisis Impacts the Caribbean
If the US sneezes�If the old adage that when the US sneezes the Caribbean catches a cold were true, the financial trauma affecting the US economy would have already plunged the Caribbean into an economic coma. It is unlikely that this will happen. But the outward ripples of the financial crisis in the US will cause an economic downturn in the Caribbean.
The US financial meltdown has its origins in what has been called the US subprime mortgage crisis. Mortgage lenders made loans available to borrowers who would not normally qualify for mortgages at market rates. These mortgages would typically have attractive, easy initial payments but included adjustable rates of interest if the market changed. At a time when housing prices were climbing, many borrowers took on difficult mortgages, thinking that as the value of their homes increased, they could quickly refinance.
But once housing prices started to fall due to oversupply of housing stock, refinancing became more difficult and the adjustable rates on mortgages kicked in, unleashing a wave of defaults and foreclosures. The effects of this were felt beyond the borders of the United States because the credit risk did not remain solely with US lenders but had been transferred to investors all over the world.
Financial engineeringThrough innovative financial vehicles called mortgage-backed securities (MBS) and collateralized debt obligations (CDOs) the rights to mortgage payments are repackaged and transferred to third party investment banks, individuals or other entities all over the world.
Theoretically, the third parties picking up these securitized instruments would do so only after reputable credit rating agencies had given an investment grade rating to the transaction. But often, the credit rating agencies are paid by the company that is selling the debt to investors, giving rise to questions of conflict of interest.
Several former managers of a now fallen-from-grace credit rating agency, Bear Stearns, have been sued by investors claiming they had been misled. They were told, they claim, that the portfolio's asset values were up when in reality it was plummeting.
Between 1998 and 2003, the Government of Belize successfully used securitization to bundle and repackage housing mortgages from various state-related institutions and transfer them to international investors. Bear Stearns had served as Belize's credit rating agency.
The proceeds from securitization were like a shot in the arm to the languid Belizean economy. It shook the country from its economic torpor. It enabled new credit to be available for more housing loans. The new mortgages were then repacked into more securitized instruments and spun off again to third party investors.
The thinking was that this could be duplicated indefinitely. It ignored the old chestnut that the appetite grows on that which it feeds. It ignored the fact that credit availability tends to lead to consumerism and public spending. Without proper reserves in place, public debt soon ballooned out of control leading to a downgrade in Belize's investment profile with the concomitant inability to float more securitized paper. Eventually investors holding Belize debt had to agree to a "haircut" on repayment.
International investors were on the receiving end of downgraded Belize investments just like the international investors who picked up the US subprime mortgages have suffered losses in the hundreds of billions of dollars.
Because Belize and much of the Caribbean do not have a stock market, there probably were not many investment banks or investors to speak off that would have picked up US mortgage backed securities. Stock exchanges exist only in Jamaica, Barbados and Trinidad and Tobago. Direct financial losses from the US housing crisis may therefore not be that substantial in the Caribbean.
Caribbean consequencesCaribbean economies will nonetheless feel the impact from the meltdown in the US financial market. The effect of the financial crisis will most immediately be felt in the tourism sector which is the primary foreign exchange earner for most of the Caribbean. In Belize, above 70% of all overnight tourists comes from the United States. This figure probably approximates to that of the wider Caribbean. The tightening of credit availability will affect those intending vacationers who borrow to finance a vacation. The general financial climate in the US may also cause people to be more conservative and postpone vacations in order to save.
The effect of the subprime housing crisis was felt from as early as two years ago with the moderate decline in cruise tourists to Belize. The cruise ship passengers coming to the Caribbean do not, for the most part, represent the upper crust of American society. They would therefore have been affected by the housing crisis leading them to postpone vacations. The cruise lines, attuned to the slightest variations in the market, immediately sent their ships to parts of the world that had not yet begun feeling the pinch from the housing crisis.
Remittances from relatives in the United States play an important role in the economies of Latin America and the Caribbean, accounting for about 2.6 % of its GDP, and growing. The Caribbean and Latin American region is the region of the world that benefits the most from remittances. While the US financial crisis has resulted in the loss of tens of thousands of jobs, these are primarily in the financial sector where it is not expected that a significant number of Caribbean people are employed.
Undoubtedly after the housing bubble burst, the US construction industry that employs a large number of Central Americans, notably Salvadorans, would experience a decline. The percentage of Caribbean immigrants employed in the construction industry in the United States, compared to Central Americans, is perhaps not that great.
The black holeBut that is not an end of the matter. As sources of credit continue to dry up, it will affect many businesses that borrow to meet payrolls or to help bridge cash flow problems. Many of these businesses operating at the margins of profitability might be sucked into the black hole of the crisis. Many Caribbean people might be employed by many such businesses across the US. It should be expected that the remittance system between the US and the Caribbean will also be affected by the crisis.
The bulk of whatever foreign direct investment comes into the Caribbean is tourism-related. In Barbados, for example, a Four Seasons hotel and residences complex is being constructed representing the single biggest visible investment in Barbados right now. It is unlikely that investments of this scale will be affected by the crisis. But if there is a general dampening of credit availability, as there is, then it is to be expected that this will also impact the flow, however meager, of investment into the Caribbean.
At a time when rising food prices and oil prices are creating downward pressure on its economy, the Caribbean is now vulnerable to the shocks emanating from Wall Street and may have to adopt a number of short-term social measures to minimize the impact on the marginalized people of the region.
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