The market fundamentals of the Nigerian capital market are strong with many quoted companies still posting mouthwatering profits.

However, Lucky Fiakpa, Adekunle Adekoya, Hector Igbikiowubo, Babajide Komolafe report that the external shocks of the global financial meltdown on the prices of listed stocks have been very telling putting many investors in distress

What actually caused the on-going global financial crisis? The crisis has its root in a banking practice called sub-prime lending or sub-prime mortgage lending in the United States. A mortgage is a long-term loan that is designed to make home ownership more affordable.

In the U.S there are three types of mortgages namely Conventional, Interest Only and Sub-prime. In conventional mortgages, part of each month's payment goes towards paying off the principal and part goes toward interest. Conventional mortgages include fixed rate mortgages, where the interest rate is the same throughout the life of the loan, or adjustable rate mortgages, where the interest rate can vary.

In an interest-only loan or mortgage the borrower only pays interest each month. This makes it cheaper than a conventional mortgage, where part of each month's payment go towards the principal and part goes towards interest.

Sub-prime mortgage is granted to borrowers whose credit history is not sufficient to get a conventional mortgage or who do not qualify for market interest rates owing to various risk factors, such as income level, size of the down payment made, credit history, and employment status.

When banks book these mortgages or loans, they package them into Mortgage Backed Securities (MBS), sell them to two institutions known as Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac). The two institutions were created by the U.S government in 1968 for the purpose of to buying off MBS from banks.

The intent was to allow banks to sell off mortgages, thus freeing up funds to lend to more prospective homeowners. But this removes one constraint on banks which is to make sure the loans are to qualified borrowers. These two institutions in turn repackage the loans and sell them to investors and financial institutions around the world.

Banks usually hire sophisticated "quant jocks" who wrote computer programmes that could repackage these MBS into high risk and low risk product bundles. The computer programmes were so complicated that no one really understood what exactly was in each product bundle or how much of the bundle had sub-prime mortgages. When times were good, it didn't matter, and everyone bought the high risk bundles because they gave a higher return. As the housing market declined, however, everyone knew that these products were losing value but, since no one other than the computer programmes understood them, the resale value of the products was unclear.

Also many of those who purchased these MBS were not just other banks, but individual investors, pension funds and hedge funds. This meant that the risk was spread throughout the economy.

Between 1994 and 2004 the U.S Housing market experienced persistent boom fueled by a host of factors, chiefly sub-prime borrowing. During this period sub-prime borrowing was a major contributor to an increase in home ownership rates and the demand for housing. The overall U.S. home-ownership rate increased from 64 per cent in 1994 (about where it was since 1980) to a peak in 2004 with an all time high of 69.2 per cent.

One factor for this trend was that during boom years, mortgage brokers enticed by the lure of big commissions, talked buyers with poor credit into accepting housing mortgages with little or no down payment and without credit checks.

This demand helped fuel housing price increases and consumer spending. Between 1997 and 2006, American home prices increased by 124 per cent .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 per cent during 2007, versus 100 per cent earlier in the decade.

However, by 2006, a number of factors like, the rising gasoline prices, the Huricane Katrina, the War in Iraq and Afganistan, outsourcing and the rising food price due to the global food crisis, led to rising unemployment and decline in business activities. This macroeconomic turbulence translated to increasing default by home owners hence increasing foreclosure rates. Rising foreclosure rates coupled with over building during the boom years led to an over rising housing inventories i.e.

excess supply of housing, and these in turn led to decline in housing prices. Once housing prices started depreciating moderately in many parts of the U.S., refinancing became more difficult. Some homeowners were unable to re-finance and began to default on loans as their loans reset to higher interest rates and payment amounts. Other homeowners, facing declines in home market value or with limited accumulated equity, chose to stop paying their mortgage. They were essentially "walking away" from the property and allowing foreclosure.

Pertinent to these is that most of the default or foreclosures were sub-prime mortgages. While as at March 2006 the value of U.S. sub-prime mortgages was estimated at $1.3 trillion as at March 2007, 16 per cent of these loans were 90-days delinquent or in foreclosure proceedings as of October 2007. By January 2008, the delinquency rate had risen to 21 per cent and by May 2008 it was 25 per cent. Though sub-prime only represent 6.8 percent of the loans outstanding in the U.S, yet they represent 43.0 per cent of the foreclosures during the third quarter of 2007.

As indicated above mortgages are repackaged as MBS and sold to financial institutions (banks, hedge funds) and investors around the world. The import is that many investors and institutions around the world became exposed to the U.S housing market especially the sub-prime mortgages. The mass default of sub-prime mortgage debtors meant that the MBS became bad loans in the books of banks, financial institutions and investors who bought these securities. The bad loans led to huge lose by banks and financial institutions and eventual collapse of some of them.

With MBS becoming bad loans, banks became unwilling to lend to each other, afraid that they would receive bad MBS in return. No one knew how much bad debt they had on their books, and no one wanted to admit it. If they did, then their credit rating would be lowered, their stock price would fall, and they would be unable to raise more funds to stay in business.

Many banks, mortgage lenders, real estate investment trusts (REIT), and hedge funds suffered significant losses as a result of mortgage payment defaults or mortgage asset devaluation. As of May 21, 2008 financial institutions had recognized sub-prime related losses and write-downs exceeding $379 billion.

In fact, profits at the 8,533 U.S. banks insured by the Federal Deposit Insurance Corporation (FDIC) declined from $35.2 billion to $646 million i.e. 89 per cent during the fourth quarter of 2007 versus the prior year, due to soaring loan defaults and provisions for loan losses. It was the worst bank and thrift quarterly performance since 1990. For all of 2007, these banks earned approximately $100 billion, down 31 per cent from a record profit of $145 billion in 2006. Profits declined from $35.6 billion to $19.3 billion during the first quarter of 2008 versus the prior year, a decline of 46 per cent.

Other companies from around the world, such as IKB Deutsche Industriebank, have also suffered significant losses and scores of mortgage lenders have filed for bankruptcy. Top management has not escaped unscathed, as the CEOs of Merrill Lynch and Citigroup were forced to resign within a week of each other. Various institutions followed with merger deals.

In addition, Northern Rock and Bear Stearns have required emergency assistance from central banks. IndyMac was shut down by the FDIC on July 11, 2008. The crisis also affected banks from other countries which have ventured into USA. For example ICICI, India's second largest bank, has reported mark-to-market loss of $263 million in its loans and investment exposures. Other state owned banks such as State Bank of India, Bank of India and Bank of Baroda have refused to release their figures. At least 100 mortgage companies have either shut down, suspended operations or been sold since 2007.

Those who had the eyes to see it warned then, but those who had the ears to hear probably did not listen, or if they did, they could not do anything about it, while the efforts of those who tried to do something amounted to very little.

The current financial meltdown, at first localized in the United States where it began last year as a result of bad mortgages seem to have been derived from two human needs that largely drive economic activity in structured societies - homes and energy. For nearly four years, oil prices have remained skyward bound, which in itself had been preceded by three price crises - in 1973/74, 1979/80 and 1990/91. In the first case, oil prices surpassed US$10, while in case of the latter two, oil prices rose to $40. We should not lose sight of the fact that the first had to do with the Arab oil embargo, the second - the Iran/Iraq conflict, while the third was propelled by the Gulf War.

Finally, Saddam Hussein was ousted, later executed, with Iraq occupied by Western powers searching for weapons of mass destruction, in reaction to which unspeakable carnage rages in that troubled country. As the prices rose and the West paid more for fuel, the oil producers smiled to the banks and their economies boomed. OPEC tried futilely to moderate prices with a regime of production quota ceilings, but we all know the result.

As a result of the political instability in the Middle East, which has been worsened by a mushrooming of terrorist activities, full oil production could not be maintained, talk less of exploring reserves. To compound the oil market scenario, countries like Nigeria and Venezuela started experiencing domestic problems which seemed slight, at first, like strikes. But soon the problems snowballed, like in the Niger Delta, resulting in crude shut-ins in the neighbourhood of nearly one million barrels per day of production.

To cap it all, US policy shifted towards accumulation of oil reserves, instead of releasing strategic reserves as had been done in the past to battle high crude prices. In a market where human beings operate, it was only a matter of time that all the in-built shock absorbers would deflate, hence the bubble burst.

Now it has come round since it went round; oil prices are falling, bankers that lend money to finance trading activities now have no money to lend, and indeed are looking for money to remain in business. As the world's leading brand names in banking and finance continue to tumble, governments are stepping in to see what can be done to halt the spread of a deadly disease: poverty.

They are hardly succeeding; the $700 billion lifeline offered by the US government has not calmed the markets as investor confidence continues to fall. Last Wednesday the US Federal Reserve announced interest rate cuts so that banks can lend more easily, a move copied almost instantly by the central banks of Japan, England, and other European nations.

But the damage had been done, and the global economy has taken a beating, the extent of which is yet to be determined. This is because many emerging markets hold huge reserves denominated in US dollars; like China, and thus financing imports for industries back home may be threatened in the short or medium term. Same holds true for Nigeria, whose oil economy is threatened directly as the national budget may collapse if oil prices go into a free fall. Already the IMF has predicted in its World Economic Outlook released Wednesday that global economic growth would drop from this year's five per cent to 3.9 next year.

As we all watch events unfold, one thing is clear: the world's most vulnerable people have been rendered more vulnerable; there is fear of great deprivation ahead as investment losses may trigger factory shut-downs and generate more unemployment.

The initial reaction of government to the global financial meltdown was to play dumb or so it seemed. While the rest of the world was making frantic efforts to tidy things in their economy Nigeria pretended that the country was immune from whatever shocks that were coming from the US. This was not for nothing.

There is the general believe that the Nigerian informal sector is so resolute and will always provide some shocks absorbers to any thing that may want to disturb the economic equilibrium. But if the country had survived past external shocks through the instrumentality of its informal sector, the current one appears to be too tough for the sector to absorb.

First it came by a meltdown of the capital market. The stock market, which witnessed recorded growth in the first two months of the 2008, began its decline early March and has so far lost some 23 per cent or N2.9 trillion in market capitalisation. The market capitalisation, which stood at N12.6 trillion in the early period of March, closed last Friday at N9.7 trillion.

Initially, the decline in activities was attributed to some malfunctioning of the trading system.

But as price depreciation continued unabated, the authorities decided to have a second look at the market.

The market fundamentals were strong, what could therefore be wrong with the market, questions were asked? It did not take long for answers to be found.

At the peak of the market, several investors from abroad took advantage of the high returns to invest heavily in the economy. Well over $200 billion was invested by foreign investors in the economy. It was this push from abroad that largely explained the sharp increase in stock price during the boom period.

So many Nigerians who knew little or nothing about the operations of the capital soon became experts in the market over night. Tales of how people were making millions of naira overnight from the market were commonplace. This activated more people to enter the market.

Not willing to play small, some investors even went the extra mile to borrow from the banks to invest. Given the profit some banks made from early borrowers in the market, bankers were not shy to lend big to anyone that wanted to play the market. It was good while it lasted.

Then suddenly the center, so to say, started failing in the US. First it was the sub-prime crises and this dove-tail into credit crunch and before President Bush could spell Lehman Brothers, the over 150 year old financial institution had become history. Merry Lynch and AIG were already on the brinks. It dawned on the God's own country that what they had to grapple with was more than a child's play.

US investors started calling home their foreign investments including those in Nigeria. This gave rise to a glut of shares in the market, which prompted the sharp depreciation of share prices. The impact of this on the Nigerian Stock Exchange has been quite severe as the market capitalization tumbled more than 30 per cent within the period.

Nigeria's Oil & Gas Projects at Risk As the world tethers on the brink of an economic tsunami of cataclysmic proportion, indications are that inflow of foreign direct investment to drive expansion in the Nigerian oil and gas industry albeit economic growth in the country may be stunted. Investigations show that growth and development of projects witnessed in the sector in the last eight years have been largely driven by foreign direct investment.

Contrary to earlier claims that the Nigerian economy is insulated, Financial Vanguard checks revealed that the sharp drop in share value in the Nigerian capital market was a direct result of foreign investors pulling out their funds from the market leaving it saturated with stocks. Indications are that a sustained investment in stocks is needed to rally investor confidence. Unfortunately, almost one month after the Nigerian stock market prices took a dive, and three weeks after the US economy posted clear signs that a recession was imminent; there hasn't been a coherent effort on the part of the organized private sector or even the government, save for discordant rhetoric, to salvage what is left of the economy.

The government of the United States of America (USA) has risen to the challenge, proposing a $700 billion stimulus package to cushion the impact. Following the collapse of the Lehman Brothers, the US government had moved in to safeguard AIG, its pre-eminent insurer. In Europe, the Far East and South East Asia, efforts are on to mitigate the impact of the economic downturn. It would be recalled that in Nigeria however, the apex bank and the Ministry of Finance have been quick to allay worries, noting that the economy is insulated from unfolding events.

Checks revealed that owing to the global economic downturn, ongoing projects in Nigeria's oil and gas industry dependent on foreign financing may suffer setback. These projects initially had to contend with security concerns arising from the activities of militants operating in the Niger Delta. With a global financial meltdown well underway, chances are that outstanding projects may take a longer time leaving the drawing board.

A major problem facing Nigeria's upstream oil and gas sector is insufficient government funding of its Joint Venture commitments. There are two major funding arrangements for oil producing in the country: JV and PSC arrangements. Under the JV arrangements, the Nigerian government and its partners contribute to fund projects based on their equity holding.

Under the PSC arrangement, the oil companies' fund the operations and the profits are shared according to agreed terms after the company might have recouped its expenditure.

Since 2003 when federal government objectives of achieving 40 billion barrels of proven reserves and 4.0 mm barrels per day of production capacity by 2010, the Nigeria National Petroleum Corporation has tried to ensure that its funding request is consistent with the government objective.

Mr. Odein Ajumogobia (SAN), Minister of State for Energy (Petroleum) had late last year disclosed that $15 billion was the projected total investments in the sector for 2008 and that while the government is supposed to shoulder $8.8 billion, it had allocated only around $5 billion. The government had asked the oil companies to seek alternative funding for the balance of $3.8 billion on its behalf.

Shell, Chevron, Exxon Mobil, Total and ENI/Agip had explained that the 2008 budget was based on an oil price of 53 dollars per barrel.

A Shell executive who spoke on condition of anonymity explained that the company was going through very difficult times, adding that in 2007 Shell Petroleum development Company (SPDC) spent one billion dollars on pipeline maintenance alone. The company had initially been looking at a total budget of 6.6 billion dollars but pruned it drastically, first to 4.5 billion, then to 2.7 billion.

The multinational operators had gone ahead to secure alternative funding on behalf of government to cover the $3.8 billion shortfall, however, given the current realities in the international financial market, indications are that some other projects including: the Olokola Liquefied Natural Gas (LNG) project, the Brass LNG, the Nigeria LNG trains 7 & 8 expansion and the Chevron Escravos Gas to Liquids project among others may take a longer time coming off the drawing board.

In a recent release of explanatory notes on its operations in Nigeria, Shell served notice that it had so far spent $3 billion (about N351 billion) on gas flares down projects, adding that another $3 billion was requires to achieve government's objectives in the sector. Similar scenario applies to the other operating companies in the country. However, given the current global financial situation, chances are that funding may not be readily available.

In budgeting for the 2009 fiscal year, government had benchmarked the price of crude at $63 per barrel. Unfortunately, in the last two months prices have dropped from an all time high of $147.20 close at a little over $77.26 per barrel last Friday. Although analysts say the chances of oil price dropping below $50 per barrel is far fetched, it is pertinent to note that oil prices are largely driven by the fundamentals of supply and demand.

Financial Vanguard gathered that because of high energy costs, consumers have reduced their gasoline use at the fastest pace since the oil shock of the late 1970s. As prices peaked, oil consumption in the United States fell by six percent in July to its lowest level in five years. Meanwhile, gasoline demand had its steepest monthly decline since 1983, according to the latest figures from the U.S. Energy Department.

Consumption of oil in other developed economies is also dropping. Last month studies revealed that demand for fuels in France had declined by six percent this year.

In a piece published in the International Herald Tribune last week, Jad Mouwad disclosed that in the industrialised world, which accounts for about 60 per cent of global oil demand, consumption fell by 1.3 million barrels a day this year, the steepest decline since 1982, according to analysts at Bernstein Research. That would more than offset growth in consumption from developing countries like China, the analysts said. "A study of the 1980s reaffirms our pessimism about oil demand in 2008 and 2009," the analysts said in a recent research note. "Recent data suggests we may finally be reaching the point of negative demand."

As the global financial crisis takes its toll, indications are that the purchasing power of US and European consumers would continue to shrink with implications for current levels of fuel consumption in these countries. While it is anticipated that demand in China and India as well as South East Asian countries may replace dwindling oil supply demand from Europe and America, it is pertinent to note that the industrial boom in these two emerging economic giants have been largely fueled by consumer demand in Europe and America. Essentially, oil at $50 per barrel or below suddenly doesn't appear a remote possibility given unfolding realities.

Some experts opine that in view of the current realities, the Nigerian government and the organized private sector needs to periodically reappraise the country's level of exposure to the global financial melt down and take steps to safeguard the domestic economy, while seizing the opportunity provided by the development to invest in equities that may yield bumper dividend when the situation turns around.

Government's Efforts to Address the Problem

The pain was more felt, so it seems, the investors down the street. Many who borrowed to invest witnessed their investment collapse in their faces. First they were told it was just a temporary thing that would soon bounce back. But as month roll in months and share prices continue their downwards slide, it became apparent that certain measures must be taken to sustain investors' confidence.

In a bid to stem the meltdown in the capital market, the Central Bank of Nigeria (CBN) only last week granted reprieve to banks with large portfolio of margin facilities by approving their request to restructure such facilities for a longer period.

Margin loans are facilities extended to investors by banks for the purpose of share purchase to buoy up individual and institutional investment portfolio. Some of these facilities have, however, fallen due for repayment but are still outstanding because of the current low share price regime in the stock market, which makes repayment difficult, if not impossible.

The Prudential Guidelines for banks stipulate that facilities that are three months old but not performing should be classified as "doubtful". If after six months, and they are still not performing, they should classified as "non-performing" and said to be "bad" after six months when the banks are expected to start making provision for them.

It is estimated that the banks may have granted as much as N336 billion margin facilities to investors, prompting insinuations that the banks may have lost substantial money to the stock market crash.

The Federal Government had a meeting with the management of the NSE and other stakeholders in Abuja a couple of weeks ago. A number of measures were adopted by stakeholders to stop the tide of sliding fortunes of stocks in the country. The meeting resolved that the office of the Attorney-General of the Federation should issue an exemption to the provisions of the relevant sections of CAMA, to permit quoted companies to buy back up to 20 per cent of their shares to curb the spate of bearish trading in the market.

The CBN was also directed to take appropriate measures to ensure adequate liquidity within the system to oil operations in the capital market. The meeting also resolved that a Capital Market Stabilisation Fund be established, as an intervention instrument to stem the meltdown in the market.

Also, the commercial banks were advised to restructure existing facilities to aid operations of licensed stockbrokers, institutional and individual investors on longer repayment terms. Both the Securities and Exchange Commission (SEC) and the NSE, and all capital market operators also agreed jointly to reduce the burden on investors by cutting fees significantly. It was also directed to review its trading rules and regulations.

The NSE has since cut its fees by 50 per cent and taken the following steps: One per cent maximum downward limit on daily price movement would be allowed, while the current five per cent limit on upward movement is retained.

The CBN on its part, has injected liquidity into the economy through intervention by rolling out a number of measures, which has increased the liquidity by over N1 trillion. The measures include, a reduction in the bank's benchmark interest rate by 50 basis point from 10.25 per cent to 9.75 per cent; a reduction in the Minimum Liquidity Ratio (MLR) from 40 per cent to 30 per cent; and the Cash Reserve Ratio (CRR) from 4 per cent to 2 per cent, and they are aimed at reflating the economy by N1.05 trillion.

Additionally, the CBN has also allowed banks to buy back their securities and extended the lending window to 365 days (one year), as opposed to overnight lending. About six banks have also agreed to provide about N600 billion bailout facilities to the market. Although there are conflicting signals as to the authenticity of the claim, more banks filed out last week in readiness for the bailout.