Impact of Globalization on Finance

1. Impact of Globalization on Finance “Understanding the Impact on Investments in Africa especially in Agriculture and Rural Finance" By Carol Musyoka Dar es Salaam - November 26th 2008

2. What is a Mortgage Backed Security? A mortgage-backed security (MBS)is a debt instrument whose cash flows are backed by the principal and interest payments of a set of mortgage loans. Payments are typically made monthly over the lifetime of the underlying loans Dar es Salaam - November 26th 2008

3. Bank X pools together the mortgages and sells them to a player on the secondary mortgage market such as Fannie Mae Bank X sells the future P+I cash flows from these mortgages to the Secondary Mortgage Trader Secondary Mortgage Trader POOL Bank X receives funds from the buyer which it uses to provide more mortgages SCT puts together many mortgage pools from banks and sells them further to institutional investors as Mortgage Backed Securities POOL Mortgage Borrowers at Bank X Purchasers include Investment Banks, Hedge Funds, Institutional Investors Dar es Salaam - November 26th 2008

4. Classes of Risk in Mortgage Borrowers 1. Prime These are conforming mortgages: prime borrowers, full documentation (such as verification of income and assets) and strong credit scores • Alt – A This is an ill-defined category, generally prime borrowers but non-conforming in some way, often lower documentation (or in some other way: vacation home, etc.) • Sub – Prime These are typically characterized by weaker credit scores, no verification of income or assets, etc. Dar es Salaam - November 26th 2008

5. Benefits of Mortgage Backed Securities • They help to transform relatively illiquid, individual financial assets into liquid and tradable capital market instruments. • They allow mortgage originators to replenish their funds, which can then be used for additional origination activities. • They are frequently a more efficient and lower cost source of financing in comparison with other bank and capital markets financing alternatives. • They allow issuers to remove assets from their balance sheet, which can help to improve various financial ratios, utilize capital more efficiently and achieve compliance with risk-based capital standards. Dar es Salaam - November 26th 2008

6. A combination of low interest rates and large capital inflows from outside the U.S. created a surplus of loan-able funds and easy credit for many years leading up to the crisis • Between 1997 and 2006, American home prices increased by 124%. Some homeowners used the increased property value experienced in the housing bubble to refinance their homes with lower interest rates and take out second mortgages against the added value to use the funds for consumer spending. U.S. household debt as a percentage of income rose to 130% during 2007, versus 100% earlier in the decade. • Overbuilding during the boom period eventually led to a surplus inventory of homes, causing home prices to decline beginning in the summer of 2006. History of the Crisis Dar es Salaam - November 26th 2008

7. How MBS led to the Global Financial Crisis • A variety of factors have caused lenders to offer an increasing array of higher-risk loans to higher-risk borrowers. The share of subprime mortgages to total originations rose from 5% ($35 billion) in 1994 to 20% ($600 billion) in 2006. In 1999, under pressure from the Clinton administration to offer more loans to minorities (who are traditionally underrepresented in the mortgage market), Fannie Mae began a program to extensively expand loans made to people with low to moderate credit. • In addition to considering higher-risk borrowers, lenders have offered increasingly high-risk loan options and incentives. These high risk loans included the "No Income, No Job and no Assets" loans, sometimes referred to as Ninja loans. • Another example is the interest-only adjustable-rate mortgage (ARM), which allows the homeowner to pay just the interest (not principal) during an initial period. • Still another is a "payment option" loan, in which the homeowner can pay a variable amount, but any interest not paid is added to the principal. Further, an estimated one-third of ARM originated between 2004 and 2006 had "teaser" rates below 4%, which then increased significantly after some initial period, as much as doubling the monthly payment. Dar es Salaam - November 26th 2008

8. Critical Numbers $12 Trillion Mortgage Market in 2008 1.3 Million foreclosures in 2007 $6.1 Trillion of MBS by Q1 2006 $501 billion of losses by Banks in US and around the world by August 2008 9.2% of mortgage loans were delinquent by August 2008 8.8 Million homeowners with zero or negative equity Dar es Salaam - November 26th 2008

9. The $700 Billion Rescue Plan The aim of the Troubled Asset Relief Program is broadly to: • Improve liquidity in the Secondary Mortgage Market by buying up to $700 billion of illiquid securities • Stabilize the economy by minimizing the number of Financial Institution failures • Return Investor Confidence to the market for the buyers of securities issued by historically solid institutions • Gives US Secretary of Treasury sweeping powers to spend without judicial or congressional review Passed October 1st 2008 by the Senate with $150 billion in tax breaks and increase in FDIC insurance. Dar es Salaam - November 26th 2008

10. The $700 Billion Rescue Plan doomed to fail even before it began… • By November 12th 2008, the US Treasury admitted that it had abandoned the bail out plan as originally envisaged as banks were more than ever unwilling to lend to consumers • Instead the plan is to use the bailout funds specifically to help consumers instead of banks and Wall Street firms. • Treasury officials said they hoped to invest about $50 billion from the bailout fund into the new loan facility, with the aim of helping companies that issue credit cards, make student loans and finance car purchases. • US automakers are also looking for a share of this kitty – at least $25 billion, as low car sales and a looming recession cause earnings to drop and factory closures imminent Dar es Salaam - November 26th 2008

11. How does the Crisis affect Africa ? Dar es Salaam - November 26th 2008

12. Foreign Direct Investment in the form of debt and equity withdrawals leading to FCY devaluation • Cost of FCY borrowing increases • Diaspora remittances reduce • Reduced development aid • Significant impact on African Exports due to slow down of global economy Dar es Salaam - November 26th 2008

13. Critical Numbers For Africa 93.4% of the AGOA exports were oil related items 40 African countries are eligible for AGOA benefits US imports to Africa $14.4B with African exports to the US of $64.4B in 2007 $700B amount of financial bail out package for US Financial Institutions $21B – Amount of Overseas Development Aid from the US in 2007 Only 6.6% of the AGOA exports were NON-OIL items Dar es Salaam - November 26th 2008

14. THE END Carol Musyoka Consultant Bungani Tel: +254733391144 Email: carol.musyoka@bungani.com