US debt, mortgage default and failing industry.
By: Tarique Khan Javed
President, Overseas Pakistani Investors Forum.
                           Dated 14th Nov 2008

US Debt and trade deficit:
US international debt of USD 10,000 billion is scary, not only for world’s financial system, but also for world’s stability and peace.

The debt is the result of short sighted and almost stupid policy of maintaining a strong dollar, as if on it depended nation’s status as “Super power” after the Second World War. During and after the war, USA become the sole industrial power in the world, as rest of the world lay in ruins.

The cumulative effect of high parity rate; policed and managed by IMF and World Bank under the Breton-wood system; eat away US competitiveness as a traditional industrial power. By 1954 it started having trade deficits which has continued till date. The current deficit is USD 2 billion a day. The first wake up call came in 1985 when suddenly US insisted to changing the parity rates drastically. It depreciated its currency by almost half. Thus the new rate for Yen was fixed at 1 USD= 140 compared to previous 240, DM was fixed at 2 instead of 4. This gave US industry advantage over Japanese and German manufactured goods while Japan suffered heavy and its Share market dropped from 40,000 to 10,000 in the next five years.

Inspite of improvement in competitive edge; US continued to face trade deficit unabated and its external debt to finance it has been growing and has now reached the level of USD 10 trillion. The debt is the form of Direct Foreign Investment, Treasury Bills, Investment in Equity market and a large chuck in Mortgage refinanced by International Banks. These investment in general and mortgage market in particular was considered a safe heaven of worldwide investment. Now they become the riskiest investment. In the process Investors all over the world have lost huge sums. Most affected are Banks who instead of lending to the local business choose to invest in massive syndicated lending to US mortgage agencies like the Federal Mortgage Agency.

It was common for a Bank to investment upto 40% of its assets US mortgage refinance market. Objection against such large concentration was brushed aside on the ground that they were no alternative large investment avenues and that there could be no better investment. The argument was that such lending was backed by assets, which yielded good return, and was safe, as the Mortgage Agencies, had special eviction power which allowed them to repossess the financed houses after 3 months of default. It was assumed that the price of these houses would never fall and therefore reselling them after repossession would never mean a loss for the lenders while the borrower may see his equity vanish in the process.

 Mortgage defaults:
Most American are over leveraged and live beyond their means. The huge financial obligation they took in the form of Housing, Student, Car, Furniture, Vacation and Credit Card Loans is beyond their capacity to repay. The sudden and substantial  increase in Oil and Food price disturbed the fine balance they maintained in their budget. Unable to manage it by borrowing on Credit cards they defaulted on the biggest bill- the mortgage payment. This has resulted in increasing defaults/repossessions and collapse of many Banks. . Americans suddenly find that they can not sustain the high standard of living they got used to.

It is feared that two to three trillion investment in the mortgage market has gone bad. The extent of Banking Crisis is still not clear and all Banks are holding on to their cash leading to a slow down in world economy and collapse of equity markets.

The proposed USD 700 billion bailout plan, which was originally meant for giving support to families facing eviction form houses due to default, is now being used for saving Banks and Insurance Cos. Direct help to defaulters is not in sight and people are fearful. 

Failing industries:
Three major car producers of USA –GM, Ford and Chrysler are on the verge of closure unless rescued by the Government. These factories are located in the North, which is vote Bank of President elect, so he is keen to save them and has advice Bush accordingly.

However the fundamental problem is the Labour Unions of these car makers. Over the period they have forced the management to increase the wages to USD 40 per hour level or 320 (Rs. 25,600) per day based on 8 hours workday. At that rate what they earn in a day is equal the two workers salary, with same skills, for a month in Pakistan. This the reason why saliently jobs from these factories are shifting to places like China. Most Economists believe that instead of giving funds to these unviable units, Government should let them go under bankruptcy procedure and reorganize themselves. Bailouts of any amount will go waste and only increase burden on tax payers. However this has become a political issue and some rescue effort will be made.

The car industry is one example how in-competitive USA has become and it does not bode well for its future. After the Car industry, Air Lines and other ailing industries will seek help. There is no end to this.

As the sole Military power in the world, USA’s sudden decline as an economic power has grave implication all over the world. Currently USA is holding a military balance in the world with its huge net work of Military bases. If these are closed who will full fill these gaps? Will it lead to anarchy like the one we are witnessing off the coast of Somalia, where ships are being attacked by pirates regularly?