Financial globalization and the capital market

The impact of the financial crisis on the Tunisian financial market

The patterns of cross-border capital raised the effect on the developments of domestic markets and highlighted the differences between advanced and developing economies. One of the effects of this globalization is the introduction of the euro and the effect it had on the European and global capital markets by bringing into existence a currency area comparable in size to that of the United States. However, the globalization had also a downside resulted by the effects of the financial crises on foreign capital raisings during the 2007-09 global financial crisis.

Financial globalization expanded the international capital markets to investors and firms all over the world. Foreign capital raisings by firms have increased substantially since the early 1990s in terms of equity as well as debt. The integration of financial markets has emphasized the rapid flow of capital across borders as well as magnifying the contagious effects of the financial crisis with wide implications for transmission of financial policies on the domestic economy and internationally.

The case of the 2007-09 global financial crisis:

Overview:

·         The collapse of the sub-prime mortgage market in the US, beginning in mid-2007.

·         Subprime Lending:

Ø  Subprime refers to borrowers whose credits fall below a certain rating (620 points).

Ø  Very high-risk debtors in the mortgage market.

Ø  Mostly unemployed, part-time or low paid temp workers.

·         Aggressive securitization of high-risk assets:

·         Sub-prime debts repackaged and sold to banks, other financial institutions in the US, Europe, and Asia.

Effects of the crisis:

·         Financial Crisis (i.e. shortage of Liquidity (or Credit crunch)).

·         Cross-border spillovers because Financial Institutions and markets across borders are closely linked.

·         World economy experiencing downturn (i.e. global economic growth equal to 0.5% in 2009 vs 3.5% in 2008)

·         Economic crisis (i.e. bankruptcies, rising unemployment, foreclosures)

·         Confidence crisis: (investor/consumer) confidence

The impact of a financial crisis on the capital market of Africa:

·         -First Round Impact

Ø  Africa escaped mainly because financial market generally decoupled from the global market.

Tunisian Stock Exchange is slightly affected by the direct effects of the financial crisis, given its weak international financial market integration. Domestic banks have not suffered any liquidity risk because they have not invested in the subprime market and do not hold backed securities.

The Moroccan financial market strongly linked with the European markets, especially French markets is directly affected by the subprime crisis of 2008.

·         -Second Round Impact

Ø  Direct hit on major sources of resource inflow

Ø   demand for Africa’s exports

Ø   drop of the remittance by Africans abroad

Ø  drop in foreign aid

Ø  drop in private capital flows

the Tunindex returns evolved during this period to a slower pace compared to the first period, meaning that stock returns series are affected by the bursting of the housing bubble in the United States indicating that Tunindex suffered from consequences in the fourth quarter of 2008 recorded an annual return of 10.65% in 2008 versus 12.14% in 2007 and 44.3% in 2006.

The index MASI posted in the third quarter of 2008, a variation of -12.00%, during the third quarter of 2008, the Casablanca Stock Exchange has experienced a sharp drop of 13%.

è In comparison with different indices, the Tunis Stock Exchange has performed well during the spread of the subprime crisis in the world in 2008, where Tunindex ended the year 2008 with a performance of 10 65, in the same year the index Moroccan flagship MSI ended the year with a variation of -21.07%.

The impact of the financial crisis on the capital market of the developed countries:

·         The recent examinations of the financial crisis revealed that the dividend yield of the S&P500 index is significantly and negatively affected by the bankruptcy of U.S. investment bank Lehman Brothers. During 2008, the American stock exchange is characterized by negative stock returns and a volatility of stock prices. During 2008, the American stock exchange is characterized by negative stock returns and a volatility of stock prices.

·         Between 2005 and 2006, the CAC40 has been a sharp decline with the bursting of the housing bubble in the United States. From the beginning of August 2007, the performance of the index fell from one day to another. In 2008, the CAC 40 drops sharply; it recorded its biggest drop since Sept. 11, 2001. Indeed, the CAC 40 lost 6.83% in a session back in January 2006 its value is less than 5000 points. It follows a low of 416.71 on March 4, 2008, a recovery allows to reach 5 142.10 in May 2008, only to fall again and back in the 4200 and in July 3200 under the points on October 10.The CAC 40 has been the worst year in its history.

·         The FTSE100 index another European index was negatively affected by the recent financial crisis.

Short-term response:

The U.S. Federal Reserve and central banks around the world have taken steps to expand money supplies to avoid the risk of a deflationary twist, in which lower wages and higher unemployment lead to a self-reinforcing decline in global consumption. In addition, governments have enacted large fiscal stimulus packages, by borrowing and spending to offset the reduction in private sector demand caused by the crisis. The U.S. executed two stimulus packages, totaling nearly $1 trillion during 2008 and 2009. The U.S. Federal Reserve's new and expanded liquidity facilities were intended to enable the central bank to fulfill its traditional lender-of-last-resort role during the crisis while mitigating stigma, broadening the set of institutions with access to liquidity, and increasing the flexibility with which institutions could tap such liquidity.

This credit freeze brought the global financial system to the brink of collapse. The response of the Federal Reserve, the European Central Bank, and other central banks was immediate and dramatic. During the last quarter of 2008, these central banks purchased US$2.5 trillion of government debt and troubled private assets from banks. This was the largest liquidity injection into the credit market, and the largest monetary policy action, in world history. The governments of European nations and the USA also raised the capital of their national banking systems by $1.5 trillion, by purchasing newly issued preferred stock in their major banks

Governments have also bailed out a variety of firms as discussed above, incurring large financial obligations. To date, various U.S. government agencies have committed or spent trillions of dollars in loans, asset purchases, guarantees, and direct spending.

Long-term response:

United States President Barack Obama and key advisers introduced a series of regulatory proposals in June 2009. The proposals address consumer protection, executive pay, bank financial cushions or capital requirements, expanded regulation of the shadow banking system and derivatives, and enhanced authority for the Federal Reserve to safely wind-down systemically important institutions, among others. January 2010, Obama proposed additional regulations limiting the ability of banks to engage in proprietary trading. The proposals were dubbed "The Volcker Rule", in recognition of Paul Volcker, who has publicly argued for the proposed changes

European regulators introduced Basel III regulations for banks. It increased capital ratios, limits on leverage, narrow definition of capital (to exclude subordinated debt), limit counter-party risk, and new liquidity requirements. Critics argue that Basel III doesn’t address the problem of faulty risk-weightings. Major Banks suffered losses from AAA-rated created by financial engineering (which creates apparently risk-free assets out of high-risk collateral) that required less capital according to Basel II. Lending to AA-rated sovereigns has a risk-weight of zero, thus increasing lending to governments and leading to the next crisis. Johan Norberg argues that regulations (Basel III among others) have indeed led to excessive lending to risky governments (see European sovereign-debt crisis) and the ECB pursues, even more, lending as the solution.

To lessen the effects of the crisis on the Tunisian stock market and reduce their exposure to external shocks measures should be implemented. During the crisis Tunisia must refer the appeal to international capital markets for resource mobilization and funding necessary to return to the local market and must take measures to control capital movements and ensure the security of investments in foreign currency assets abroad with the aim to reduce interdependence with other international markets and minimize the effects of financial crises. Also, avoid the use of derivatives as the most sophisticated technique of securitization, which was at the origin of the recent financial crisis.