Philippines ~ The Economy ~

Taxwise Or Otherwixe

By Jose Jaffy Y. Azarraga

The global credit meltdown

While not exactly a prophet of doom, the world’s wealthiest man (or second wealthiest, depending on the year), Warren Buffet, astutely predicted the present financial crisis back in 2002: "Large amounts of risk, particularly credit risk, have become concentrated in the hands of relatively few derivatives dealers...The troubles of one could quickly infect the others...In our view, however, derivatives are financial weapons of mass destruction" (Warren Buffett, 2002 Berkshire Hathaway shareholder letter).

The US financial crisis is the result of various risky financial transactions which spawned from the aggressive financial engineering done by the US Federal Reserve (US Fed) in spurring the US economy largely through consumer spending.

The gradual cutting down of interest rates to record 40-year lows for a prolonged period after the 2000 stock market crash fueled a massive housing bubble through speculative buying and mortgaging of real estate properties by debtors financially unable to pay for them except through refinancing at steadily higher prices. This eventually resulted to what we call "toxic mortgages."

In addition, esoteric derivative instruments by aggressive investment bankers like Bear Stearns and Lehman Brothers got traded over the counter unregulated. The unregulated credit default swaps market alone reached an astounding $50 trillion.

When the US fed raised interest rates steeply in 2005, the housing bubble collapsed, and falling real estate prices resulted in widespread defaults of these toxic mortgages. It spread like cancer throughout the entire financial sector, from the government-sponsored enterprises holding the mortgages to the investment bankers who could no longer finance their highly-leveraged purchases, and eventually to the sound insurance giants, e.g., AIG, which guaranteed the instruments but somehow failed to meet their obligations.

Moreover, the widely criticized bail outs by the US Government of Freddie Mac and Fannie Mae and even AIG, effectively nationalized the US financial sector and arguably ending laissez-faire capitalism, while leaving others to their fate.

The bill for US taxpayers alone could amount to at least $700 billion, excluding interest, against which Warren Buffet’s $10-billion offer for support seem ridiculously trifling.

For scale, this amounts to over 20 times the entire national budget of the Philippines.

And while the central banks of the other highly developed, sophisticated and capitalized countries followed suit in scrambling to provide funds and liquidity to their banks and financial institutions reeling from this unprecedented financial implosion, the Philippines and the average Juan stand on an arguably enviable position of being virtually oblivious to the global credit melt-down, principally because our financial and capital markets are neither highly developed, nor heavily capitalized, and consequently much less financially sophisticated to suffer the full effects thereof.

But even so, news of the global financial meltdown still reached the eyes and ears of the average Juan, thanks to modern media. A probable immediate effect of said melt-down has likewise been felt locally with the recent fall in stock market prices, which caused heavy losses to investors.

What may be largely overlooked, however, is that the stock market crash may already herald a global depression or deep recession, much like the stock market crash of 1929 which preceded the Great Depression of the 1930s in the US.

The public, wearied of the spate of high prices a few months back and now expectantly looking forward to lower prices due to falling crude oil prices in the world market, may not realize that the reduction of oil prices is a mere side effect in anticipation of lower world demand for oil, and that the depression itself would have more serious consequences and deeper and longer lasting effects on the life of the average Juan than the preceding rise in prices.

The financial meltdown is expected to result in a freeze in hiring, or worse, bankruptcy and loss of jobs, particularly in the US, Japan and other developed markets.

Most affected therefore, will be our overseas Filipino workers (OFWs). A reduction in their foreign currency remittances will affect our balance of payments, and when their dependents have much less to spend, our own domestic markets.

While pundits in the business process outsourcing (BPO) industry are optimistic about the prospect of foreign firms further availing of the outsourcing option during hard times, the overall loss in demand for our other export goods, leading to cutbacks, closures and loss of jobs might far outweigh any such benefits gained by the BPO sector alone.

This is not far fetched if we look at the effects of the Great Depression in the 1920s, when more than a third of the working force in the US alone lost their jobs and were left with no source of income and countless households all over the world also suffered from lack of employment and famine, not to mention the resulting strife in these countries.

Worse, the prospect of stagflation is also staring us in the eye. This invariably happens when recession occurs with inflation, wherein production and employment falls but prices of commodities increase, as what had happened during post-war Germany and the oil shock years, among others, and most recently, in Kenya.

Needless to say, this can even have more serious consequences than depression and is to be avoided at all cost.

What is now the challenge for the Philippines in the face of this crisis?

Our government has assured our citizenry that our country is ready for any challenge, citing strong OFW base as shield against recession.

However, as pointed out, such reliance is like building a house on shifting sands. Given this uncertainty, government must be able to present more concerted and well-thought strategies and measures to meet the prospect of a worldwide depression and/or stagflation.

As citizens of this country, we must do our share to keep our financial institutions afloat and stable. Panic buying and massive withdrawal of our investments or savings or deposits would not do us any good and would even worsen our situation. Thus, the less we panic and be overwhelmed with the possible adverse effects to our economy, the better for all us.

Lastly, in our land where hope springs eternal, prayers that we will be able to weather the impact of this financial crisis would be a safe haven during this tumultuous and volatile period.