Lehman Brothers Collapses and the World Financial System Seizes Up, Russia Invades Georgia and Hurricanes Gustav and Ike Batter the Caribbean and Gulf Coast

Jamaica Homes Global Conflict & Caribbean Impact Review | Published 3 October 2008 | Reporting Period: 3 July – 2 October 2008

Quarterly Briefing

• Lehman Brothers files for the largest bankruptcy in US history on September 15, triggering a global financial panic; the US government rescues AIG the following day with an $85 billion emergency loan; the US Treasury places mortgage giants Fannie Mae and Freddie Mac into conservatorship on September 7; credit markets freeze worldwide; the era of unregulated financial innovation ends in catastrophic failure.
• Russia launches a large-scale military intervention into Georgia on August 8, following Georgia’s assault on the breakaway territory of South Ossetia; Russian forces advance to within 40 kilometres of the Georgian capital Tbilisi before halting; Russia recognises South Ossetia and Abkhazia as independent states; NATO’s response is sharp condemnation but no military action; the post-Cold War European security order is fundamentally disrupted.
• Hurricane Gustav makes landfall near Cocodrie, Louisiana on September 1 as a Category 2 storm after devastating Hispaniola and Cuba; Gustav killed 138 people in Haiti, whose hurricane preparedness remained severely compromised; over 1.9 million people were evacuated from the US Gulf Coast; Hurricane Ike strikes Galveston and Houston on September 13 as a Category 2, after passing over Cuba and the Turks and Caicos.
• China’s Beijing Olympics, August 8-24, proceed in an atmosphere of geopolitical tension following Tibet protests in March; China uses the Games to project an image of national power, modernity and competence; 87 world records are broken; the Games are widely regarded as marking China’s formal arrival as a major global power.
• The US presidential election enters its most intense phase; John McCain selects Alaska Governor Sarah Palin as his running mate on August 29; Barack Obama has secured the Democratic nomination after defeating Hillary Clinton; polls show a tightening race following the Republican convention but fundamentals favour the Democrats amid the economic crisis.
• Global oil prices, which reached a record $147 per barrel in early July, collapse to below $90 by October as the financial crisis destroys economic growth projections; the price spike’s Caribbean consequences were severe; Petrocaribe’s deferred payment terms were essential for island economies unable to pay spot prices.

Prologue: The End of the Financial Age

September 2008 will stand as the month the financial architecture of the post-Cold War era collapsed. The institutions that had channelled global capital, financed US housing and generated the securitised debt instruments that distributed risk — and, it turned out, concealed it — across the international financial system broke apart within a fortnight. Lehman’s bankruptcy on September 15 was not the crisis’s cause; it was its revelation. The crisis had been building since August 2007, when interbank lending first froze following the discovery that mortgage-backed securities rated AAA were actually worthless. What September brought was the recognition that the exposure was universal, the losses incalculable and the systemic consequences potentially comparable to the Great Depression. For the Caribbean, the question was not whether the recession now beginning would hurt but how badly and for how long.

The Financial Crisis and Caribbean Impact

The direct exposure of Caribbean financial institutions to US mortgage-backed securities was limited; most Caribbean banks had neither the sophistication to hold these instruments nor the regulatory permissions to do so. The indirect exposure was enormous. Caribbean tourism depended on American and European consumer confidence; the recession now visibly beginning would cut discretionary spending on travel. Remittances from the diaspora — the largest single source of foreign exchange for several Caribbean countries, including Jamaica — depended on diaspora employment in the United States, United Kingdom and Canada, all of which were now entering recession. Financial services sectors in the Cayman Islands and other offshore centres had more direct exposure; their structured finance business had been partly dependent on the instruments that had just collapsed.

Trinidad and Tobago’s energy economy was affected through the oil price collapse: revenues that had been projected at $140 per barrel were now being estimated at $80 or less. The Petrocaribe scheme — under which Venezuela supplied oil to Caribbean member states at preferential prices with long repayment terms — had become a critical stabiliser for island economies facing high energy costs; President Chávez’s ability to continue the scheme depended on Venezuelan oil revenues that were themselves declining with the oil price.

Russia, Georgia and the New Cold War

Russia’s military intervention in Georgia in August was the most direct challenge to the post-Cold War European security order since the break-up of Yugoslavia. Georgia’s Mikheil Saakashvili had made a catastrophic tactical error in attacking South Ossetia on the night of August 7; Russia’s response was deliberately disproportionate and extended well beyond South Ossetia into undisputed Georgian territory. The political message was unambiguous: Russia would not accept former Soviet republics joining Western military and political alliances, and it had the capacity to enforce that position. NATO’s inability to respond militarily — Georgia was not a member — exposed the limits of Western security guarantees to the post-Soviet borderland states. For the Caribbean’s energy economics, the Russia-Georgia conflict’s most direct consequence was its effect on European energy dependency: Russia supplied a third of Europe’s natural gas, and its willingness to use energy as a geopolitical instrument was now beyond doubt.

Hurricane Season and Caribbean Resilience

The 2008 hurricane season was above average and its Caribbean impact concentrated in Hispaniola, Cuba and the Texas Gulf Coast. Gustav’s passage over Haiti before reaching Louisiana reminded the international community that Haiti’s hurricane vulnerability — conditioned by deforestation, poverty and inadequate disaster management infrastructure — remained one of the Caribbean’s most persistent humanitarian challenges. Ike’s passage over Cuba caused significant damage to agricultural infrastructure; the Cuban government’s extensive civil defence preparations limited the human toll but the material destruction was severe. Jamaica, which lies in the belt most frequently struck by Atlantic hurricanes, had passed through this season without a direct hit; the near-misses of recent years had, however, accelerated investment in emergency management capacity.

Looking Ahead

The financial crisis is not over; it has barely begun. The $700 billion TARP programme being debated in the US Congress as this edition is published will provide a firebreak, but the recession it cannot prevent will reshape Caribbean economies for years. The US election in November will bring either Obama or McCain to the presidency of a country whose global credibility has been significantly damaged by the financial crisis. Russia’s aggression in Georgia will force a fundamental reconsideration of European security arrangements. And the Caribbean’s dependence on US tourism and remittances, Venezuelan oil subsidies and offshore financial services — each of which is now under pressure — will test the resilience of economies that have no buffer against external shocks.

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Jamaica Homes Global Conflict & Caribbean Impact Review is published quarterly, examining how wars, geopolitical tensions and major international crises have shaped Jamaica, the Caribbean and their economies.

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