Fannie, Freddie, Lehman: The Week Global Finance Changed Jamaica’s Housing Outlook — October 2008

Publication Date: October 3, 2008 | Coverage Period: September 3–October 2, 2008 | Category: Monthly Review

Month in Brief

• Fannie Mae and Freddie Mac were placed into US government conservatorship on September 7, 2008 — the largest government bailout in US history to that point, representing a de facto nationalisation of institutions with combined mortgage exposure exceeding US$5 trillion and marking the definitive end of any remaining market confidence that the US housing and mortgage system could self-correct.
• Lehman Brothers, one of Wall Street’s oldest and most storied investment banks, filed for Chapter 11 bankruptcy on September 15 — the largest corporate bankruptcy in US history — triggering a global market panic of an intensity not seen since 1929 and effectively freezing interbank lending markets worldwide; no buyer could be found and no government rescue was forthcoming.
• Merrill Lynch, facing the same structural vulnerability as Lehman, was acquired by Bank of America on September 14 in an emergency weekend transaction brokered under extreme duress — the effective end of Merrill Lynch as an independent institution and a further signal that the era of the standalone Wall Street investment bank was over.
• AIG — the world’s largest insurance company by assets — was rescued by the US Federal Reserve on September 16 with an US$85 billion emergency credit facility, averting a collapse that would have triggered catastrophic losses across global financial markets through AIG’s vast credit default swap exposures.
• Global equity markets fell sharply across the coverage period, with the Dow Jones Industrial Average losing more than 10% in the week following the Lehman bankruptcy alone; credit markets seized, and the London Interbank Offered Rate (LIBOR) reached its highest level in years as banks became unwilling to lend to each other.
• Jamaica’s financial markets reflected the global turbulence, with the JSE main index falling and the Jamaican dollar coming under intensified depreciation pressure; the Bank of Jamaica intervened to defend the exchange rate as capital outflows accelerated and risk appetite evaporated.

Housing Market Overview

September 2008 will occupy a singular place in the history of global finance — and, by extension, in the history of every housing market in the world that was connected to the international financial system. The events of that month — the conservatorship of Fannie and Freddie, the bankruptcy of Lehman, the forced sale of Merrill Lynch, the rescue of AIG — constituted, in aggregate, the most severe shock to the global financial architecture since the Great Depression. No market was unaffected; no economy was insulated; and Jamaica, as a small open economy deeply integrated into the global financial and trade system, was no exception.

The immediate effect on Jamaica’s residential property market was not a sudden collapse of prices or a wave of forced sales. The Jamaican market does not have the leverage or the institutional complexity of the US market, and the transmission from Wall Street to Kingston real estate is indirect rather than instantaneous. But the channels through which the crisis would eventually affect Jamaica’s property market were clearly visible by the end of September, and they all pointed in the same adverse direction.

For the Jamaican buyer already attempting to navigate a market characterised by elevated financing costs, rising construction costs, and compressed real incomes, the events of September added a new and deeper layer of uncertainty. The question was no longer merely whether to buy now or wait for conditions to improve; it was whether the external environment would deteriorate to the point where conditions in Jamaica itself — interest rates, exchange rates, employment — worsened materially. For many potential buyers, the rational response to that degree of uncertainty was to defer.

At the same time, the collapse of global financial confidence paradoxically reinforced, for some local investors, the appeal of tangible assets. If financial institutions could fail overnight, if paper wealth could evaporate in a week, if the entire edifice of leveraged finance could prove built on sand — then land and buildings, which one could see and touch and which could not be made insolvent by a credit default swap gone wrong, retained a fundamental appeal as a store of wealth.

This dynamic — macroeconomic uncertainty depressing transaction volumes while inflation and financial system anxiety supported real asset prices — would define the Jamaican market’s behaviour in the months and quarters ahead.

Government Policy and the NHT

The Golding government faced, in September 2008, a policy environment that had become materially more challenging than at any prior point in its tenure. The global financial crisis was not a problem that Jamaican policy could prevent or cure; it was an external shock of the first order that had to be managed as best as the available tools permitted.

The Bank of Jamaica’s monetary policy framework was placed under pressure from multiple directions simultaneously: inflation running above target argued for rate increases, but a deteriorating growth outlook and elevated external risk argued for caution; capital outflow pressure argued for higher rates to defend the exchange rate, but the cost of domestic credit was already a significant constraint on economic activity. The BOJ navigated this dilemma through a combination of intervention in the foreign exchange market, carefully managed communications, and a hold on the policy rate that balanced competing objectives.

The NHT, functioning largely outside the commercial credit cycle, continued to provide the most important institutional support to the housing market. Its mortgage disbursement programme and scheme delivery pipeline were not directly affected by the events on Wall Street, and the Trust’s continued operation provided a critical anchor of housing market activity at a moment when commercial mortgage lending was contracting sharply.

The government announced a series of economic monitoring measures in late September, committing to track the impact of the global financial crisis on Jamaica’s key external accounts — remittances, tourism, FDI — and to respond with policy adjustments as the picture became clearer. The honest acknowledgement from senior officials that the situation was unprecedented and the range of outcomes wide was notable for its candour.

Construction Sector

One unambiguously positive development for Jamaica’s construction sector in September was the continued retreat of oil prices from the July record. By month-end, crude oil was trading in the US$90–95 range — still well above pre-2008 levels, but representing a decline of approximately 35% from the July 11 peak. This price retreat was beginning to feed through, with a lag, into diesel and cement costs, and the industry was cautiously anticipating a period of input cost stabilisation or modest decline.

However, the global financial crisis introduced new concerns that partially offset the commodity price relief. The availability of project financing — both for developers seeking construction loans and for buyers seeking mortgages — tightened sharply in September as banks globally retrenched and as Jamaican financial institutions assessed their own exposure to a deteriorating economic environment. Several planned residential developments were reported to have had their financing commitments reviewed or withdrawn as lenders adopted more conservative postures.

Infrastructure construction — road rehabilitation, government building programmes — continued under existing contracts, but the pipeline of new government construction commitments was being reviewed in the context of a fiscal environment that was likely to tighten as tax revenues reflected the economic slowdown and as debt service costs rose with the exchange rate depreciation.

Investment Climate

The investment climate for Jamaican real estate in September 2008 was, in a word, turbulent. The global flight to safety — toward US Treasuries, away from all forms of risk asset — that followed the Lehman bankruptcy was not good for Jamaica. The island’s government bonds, denominated in both Jamaican dollars and US dollars, saw yield spreads widen as investors demanded higher compensation for the risk of holding Jamaican sovereign paper in an environment of acute global uncertainty.

Foreign direct investment into Jamaican real estate — which had been decelerating through the first half of the year as the global outlook darkened — effectively stalled in September. Investment decisions of the size and duration typical of resort property development in Jamaica require a degree of global financial confidence that was entirely absent through the last two weeks of September. No rational investor was committing to a multi-million dollar development project in the Caribbean while the global financial architecture was visibly fracturing.

Domestic investors, paradoxically, found themselves with a somewhat more interesting set of options. The collapse of confidence in financial institutions, the volatility of equity markets, and the erosion of real returns on fixed-income instruments all pointed, for the locally based investor with a medium-to-long horizon, toward real property as a store of value. Commercial property in Kingston, land in premium locations, and quality residential assets in established neighbourhoods all attracted inquiry from investors seeking to reduce their exposure to the financial system’s volatility.

Diaspora and Remittances

The events of September 2008 in the United States had immediate and severe consequences for the Jamaican diaspora communities that are the source of a substantial proportion of Jamaica’s foreign exchange inflows. Jamaican workers in New York’s financial district — in administrative, support, and professional roles at institutions that were collapsing or contracting — faced direct employment risk. Jamaican workers in construction, hospitality, retail, and healthcare services — sectors directly affected by the economic slowdown that the financial crisis was accelerating — faced the prospect of reduced hours, layoffs, and declining earnings.

The Bank of Jamaica and the government were acutely aware that a significant decline in remittance inflows — from the approximately US$1.9 billion received in 2007 — would have severe macroeconomic consequences. Remittances fund household consumption for hundreds of thousands of Jamaican families; they support the current account; they provide the foreign exchange that underpins the currency. Any meaningful reduction would be felt across the economy, and in the housing market in particular through its effect on diaspora buying capacity and on the household savings that fund self-build construction.

September remittance data would not be available for several weeks, but the anecdotal evidence from diaspora communities — relayed through churches, community organisations, and individual family networks — was that the crisis was already affecting Jamaicans in the US. Job losses, reduced hours, and a climate of severe financial anxiety were the reality for many overseas Jamaicans in the weeks following the Lehman bankruptcy.

Affordability Watch

The affordability equation for Jamaican housing in September 2008 was, by any honest assessment, the worst it had been for a generation. Construction costs remained elevated. Commercial financing rates were at 15–18%. Real household incomes had fallen in the face of double-digit inflation. And now, over and above these structural challenges, a global financial crisis of historic proportions was bearing down on the external environment that Jamaica depended upon for remittances, tourism, and investment.

The NHT continued to serve as the essential buffer for qualifying contributors. Its role in maintaining some level of housing market access for working Jamaicans was more important in September 2008 than at any prior point in the cycle. But even the NHT operates within limits: it cannot serve non-contributors, it cannot produce units faster than construction timelines permit, and it cannot entirely insulate its beneficiaries from an economy-wide deterioration in real incomes and employment security.

The risk, as the fourth quarter of 2008 approached, was that the affordability crisis deepened from its already acute level. If the Jamaican dollar depreciated significantly — under pressure from capital outflows and a widening current account deficit — import costs would rise further, adding another layer of inflationary pressure. If commercial banks tightened their lending standards, as seemed likely in the global context, even those buyers who could theoretically afford commercial mortgage terms would find access to credit restricted.

Looking Ahead

Writing at the beginning of October 2008, with the dust of September’s financial earthquake still settling, the outlook for Jamaica’s housing market must be characterised with an honesty that acknowledges the severity of the moment. The global financial system has experienced, in the space of a single month, a series of shocks whose full consequences are not yet known and whose interactions with each other and with the broader real economy will unfold over months and years, not days and weeks.

What can be said with confidence is that the external environment facing Jamaica’s economy — and by extension its housing market — has deteriorated dramatically over the coverage period of this edition. The channels through which this deterioration will transmit into Jamaica are multiple: tighter global credit conditions, reduced capital flows, slowing tourism as consumer confidence in source markets contracts, and — most importantly in terms of scale and immediacy — the risk of a significant reduction in remittance inflows as Jamaican diaspora communities in the US face a sharply more difficult labour market.

Against these headwinds, Jamaica’s housing market has genuine structural buffers: low mortgage penetration, the NHT’s continued operation, the underlying demographic demand for housing, and the island’s enduring appeal as a place to live, invest, and retire. These buffers will not prevent the market from feeling the effects of the global crisis, but they will limit the severity of the impact relative to more leveraged, more credit-dependent markets.

The prudent participant in Jamaica’s housing market — buyer, developer, investor, or policymaker — will enter the fourth quarter of 2008 with a clear-eyed assessment of the risks, a realistic view of the timeline over which conditions might improve, and the financial resilience to navigate a period of sustained uncertainty. The events of September 2008 will be studied for decades; their consequences for Jamaica’s housing market will be felt for years. Navigating them well requires precisely the discipline, patience, and structural understanding that have always distinguished the successful long-term participant from the short-term speculator.

Jamaica Homes Monthly Housing & Development Review is published on the first business day of each month. This edition covers the period September 3–October 2, 2008.