How the turmoil started

Q&A with Datuk Seri Dr Fong Chan Onn

Please explain in simple terms the financial crisis now strangling America.
The cause of the turmoil had its beginning in the aftermath of Sept 11, 2001. After the incident, consumers were in a state of gloom and there was loss of confidence. The Federal Reserve (Fed), in order to stimulate the econo­my, went on a policy of a low-interest rate regime.
Before Sept 11, the Federal Reserve discount rate (interest rate that banks pay to borrow directly from the Fed) was 3.7%, with cost of fund for prime rate (a reference interest rate used by banks) at 6.5%. By the end of 2002, the federal discount rate was 1%, with the prime rate for loans at 4%. This low interest rate regime went on until mid-2005 and, because of these low-cost funds, banks were aggressively lending, especially for housing.
Mortgages were given to those without good record — no employment, no credit rating and no stable income. The banks were doing that because by 2005, there was a steady appreciation in house prices. Banks were treating houses as very good collateral; in case of foreclosure, the price of houses were more than the mortgages. Unfortunately, inflation went up. By 2006, the Federal Reserve had to increase the rates. In June of that year, the federal discount rate was 4.95%, and the cost of funds for prime rate was 8%. This resulted in heavier mortgage payments for many house owners and they could not pay. Many had to forego their properties. The banks took over the houses and this created a slump in the market. By 2007, banks were facing difficulties, including Citibank and UBS, which sought injection of funds. That was the initial stage. The property market kept on slumping and even good paymasters couldn’t pay. This escalated and Lehman Brothers as well as Fannie Mae and Freddie Mac, the primary organisation for housing loans, were in deep trouble. It must be noted that Fannie Mae and Freddie Mac had packaged their loans and resold them to buyers, including sovereign countries like China and Japan.
For the foreign countries, buying these financial products were akin to buying US treasury bills because they were implicitly guaranteed by the US government. As for AIG, it became problematic because it provided insurance for many mortgaged properties. In a nutshell, even the final protector also collapsed.
Some say the current American crisis is akin to the Great Depression. The Great Depression was also due to loss of confidence. Investors lost faith in the stock market back then. But there is a major difference: in 1929, the US government did not have the power to spend because laws restricted them from overspending, so it had no capacity and no hindsight to act. Although the effect this round is considered not as severe as the Great Depression, there is only a small consolation - the Depression took 10 years and the Second World War to stimulate the economy.Is the Government doing enough to minimise the impact of the crisis?Competition vis-a-vis the regional countries is tough. Singapore, Vietnam and Thailand are trying their upmost best to attract the slowing foreign investments. And for the past seven months since the general election, the perception is the Govern­ment is not making concerted efforts to resolve issues because they are too caught up with politics.

But the Cabinet has been proactive in reacting to the high oil prices, preventing a runaway inflation, and making sure the poor and the public get some relief. The hike in oil price was also external in nature, but the Government got blamed too.The small- and medium-scale industries, for instance, are still facing difficulties when seeking co-operation from local municipalities. MCA recently had a dialogue with fishermen as well, and they complained about a host of problems. As for other issues - simple things like the recent road tax rebate for cars: it excluded certain cars, such as those with 2000cc engines because they were deemed for commercial use, or owned by a wealthier class of folks. But many are not.These are things that bog the public down and make them feel as if the Government is not looking at their problems in totality. As for the onslaught of this economic crisis, we do not see the Government coming out to clearly explain to people the source of the problem and how we can withstand the negative impact. On foreign investment, what is not being done is to further liberalise the economy - fast. For example, are there improvements in processing of work permits for foreigners and their spouses? Has the Government made it more attractive for them to work here? In a ministerial statement made during the 9th Malaysia Plan mid-term review, Deputy Prime Minister Datuk Seri Najib Tun Razak said the Foreign Investment Committee guidelines would be announced. This is the crucial information that investors want to know.Until now, though, there is no word yet. We have not made any clear policy statement to announce to investors that we want their investment. This is a glaring aspect that we have not done.