A Financial Storm

| 10/10/2008

Ronald Reagan said the worst words you can hear are “I’m from the Government and I’m here to help you”. In stark contrast, they were music to the ears of the US banking industry when the US Government said it would spend US$700 billion or more on dubiously valued mortgage backed securities.

This may be sufficient to stabilize financial markets but may not stop the deteriorating economic climate. The US, the UK and parts of Europe are in recession with a real contagion risk to the global economy. Cayman will not be immune.

Cayman’s domestic lending market is different from the US and the UK. There is no originate to distribute market, i.e. banks keep and manage the loans they make. And financial institutions have not engaged in unwise lending to those who cannot repay. But local deposits/savings are insufficient to fund local lending. So tightening international credit standards will make local loans less available and more expensive, adversely impacting local economic activity.

The broader financial services industry seems fairly resilient. Fund registrations through August 2008 (1269) are slightly ahead of 2007. The termination rate remains stable. But many hedge funds have seriously disappointed investors who may be reluctant to back new ones from the same promoters with the same enthusiasm as previously. Banking and trusts are stable. Captive insurance is a little soft. General financial services activity is pretty robust. And there will be good work for restructuring, insolvency and litigation experts. But the structured finance (debt) side of the business has hit a brick wall. 

The tourism industry is under stress. The decline in the US will continue to adversely impact both cruise ship and air visitors. Confidence and discretionary spending are declining in the face of falling house prices, foreclosures, rising unemployment and inflation or stagflation. Less spending power, attractive hotel rates, real estate prices and lower costs in Florida and other US vacation States are bad news for Cayman. And the UK economy and sterling are now suffering. Canadaand continental Europe are in less bad (but not great) shape and price-wise the Caribbean (like Florida) is attractive due to the weak US dollar (although not the bargain of a few months ago). 

The post Ivan reconstruction, the Ritz Carlton and Camana Bay projects and Government’s huge (and much needed) investment in infrastructure resulted in a construction boom not seen before in Cayman. Related construction continues as the financial industry and support services expand. But a key statistic is that building permits (future projects) to April 2008 were down by 30%. There has been serious residential overbuilding inland and tourist related water/beach front development has likely peaked. Some local residential projects are in trouble. And we will shortly see an oversupply of office accommodation, particularly in grade B buildings. 

The confidence of potential high end buyers is eroding. Manhattan and London prices are off their highs and starting to drop. Less noticed is the financial meltdown in Russia.  But lack of confidence in financial securities and onshore centres may encourage continued investment in Cayman real estate as a safe alternative, if the price is right. And perhaps South American, Middle East and Asian investors will fill the gaps left by our traditional buyers. All big “maybe’s”. 

At best, a continuing slow down in economic activity is very likely. Expansion and new projects will be put on hold. Overseas workers will go home. The value of pensions will decline. People will retrench. Government revenue will decline. Readers (and Government) would be wise to have their economic bad weather gear to hand. 

Timothy Ridley is an attorney-at-law and the former chairman of the Cayman Islands Monetary Authority. This article first appeared in this months edition of The Journal and is reproduced with permission.

 

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  1. Jedi Dread says:

    Local Exchange Trading Systems (LETS)

    To counter the coming pitfalls of the financial crisis, Cayman being a relatively small community could implement a LETS system..

    The principle has now spread to small pocket bartering systems around the world. Argentina is one of the first countries where a LETS type program has started to move up into the mainstream levels of the economy replacing the old monetary system which is based on usury.

    As a result, Argentina was recently able to retire its debt to the International Monetary Fund, one of the first nations in the world to be able to do so.

    Local Exchange Trading Systems (LETS) also known as LETSystems are local, non-profit exchange networks in which goods and services can be traded without the need for printed currency. In some places, e.g. Toronto, the scheme has been called the Local Employment and Trading System.
    LETS networks use interest-free local credit so direct swaps do not need to be made. For instance, a member may earn credit by doing childcare for one person and spend it later on carpentry with another person in the same network. In LETS, unlike other local currencies, no scrip is issued, but rather transactions are recorded in a central location open to all members. As credit is issued by the network members, for the benefit of the members themselves, LETS are considered mutual credit systems.
    Michael Linton originated the term "Local Exchange Trading System" in 1982 and, with his wife Shirley, for a time ran the Comox Valley LETSystems in Courtenay, British Columbia. The system he designed was intended as an adjunct to the national currency, rather than a replacement for it, although there are examples of individuals who have managed to replace their use of national currency through inventive usage of LETS.
     
    more here http://en.wikipedia.org/wiki/Local_Exchange_Trading_System
     

  2. Knal N. Domp says:

    The projected cost of the new Government Administration Building = (Our Worst Fears) x 1.3.

    It would also be interesting to see how the financing of this project has been structured. Unlike normal rental streams which are invariably market-related and can move positively or negatively in favour of both tenant (Government) and landlord (property owners) where Government is a tenant spread over many private-sector premises, this sort of leaseback deal may lock in interest rates and (like sub-prime mortgages) may even have stepped rate thresholds. Nasty…

    • Anonymous says:

      Government needs to re-activate the cross sectoral PSIC (Public Sector Investment Committee) which was set up years ago to look at major capital projects being considered by Governemnt, consider their overall impact as well as expected recurrent costs and to prioritize.  It seems that each Ministry pushes their own projects and fights to get a piece of the pie (budget). Bearing in mind official public statements to the press it is quite clear that decisions on massive spending projects are declared even before the capital costs are even estimated, much less the ongoing operating costs. The likely effects on the local economy (private sector included) thru a study of some kind is usually nowwhere in the picture unless it si done in away to support the decision already taken.  Politicians want to make their mark (usually in concrete) and this is understandable. What we need is to beef up our institutional backbone.  

  3. Knal N. Domp says:

    Tim’s analysis is most likely right on the money, so to speak, but I have reservations about his premise that Government spending on infrastructure was "much-needed". Regardless of the state of the local and international economy, the PPM’s over-spending on the East-West arterial road and the West Bay and Frank Sound new schools projects is inappropriate and inopportune. Local opinion against these projects, particularly the schools project, predated the economic stasis now infecting world markets and correctly reflected Joe Cayman’s concerns on profligate public spending in times of uncertainty. Government was not listening at the time, though…

    • Tim Ridley says:

      You make a good point. Tight space in the Journal did not permit me to make the point that our Government (like so many Governments sadly) has a poor record of getting value for money and keeping a tight oversight rein on the projects to which it commits. In a more recent comment, I said that it is imperative that Government control waste in its spending. It will be interesting to see the final cost number for the new administration building!