A summary of the paper: How has South African construction been insulated from the global financial crisis? Authored by Reamogetje Ngoepe, Mbongeni Simelane and Ian Kennedy – School of Construction, Economics and Management (University of the Witwatersrand) The paper argues that five factors acted towards insulating South Africa from the cold chill of the Global Financial Crisis.

Together,they were:

• The National Credit Act (NCA), which provides an extremely useful financial tool for controlling residential mortgages.
• The Reserve Bank and its Liquid Asset Requirement (LAR), which had already applied strict financial controls in the banking sector.
• The provision of free Reconstruction and Development (RDP) housing, which effectively removed a large portion of potential defaulters from the market, creating a very low-risk loan environment.
• Foreign Exchange Controls (FEC), which reduced the offshore exposure of South Africa to toxic assets.
• The FIFA World CupTM events and other major infrastructure projects, which were financed and contracted to proceed through 2010, thereby supporting the construction industry.

THE CRISIS ITSELF

One needs to begin with an understanding of what actually happened, and what kind of people triggered it all. The subprime mortgage crisis is an ongoing financial crisis, one brought on by a dramatic rise in mortgage delinquencies and foreclosures in the United States (US), with major consequences for banks and financial markets around the globe. The crisis, which had its roots in the closing years of the 20th century, became apparent in 2007, and exposed widespread weaknesses in financial industry regulation and the global financial system.

Too many incentives in the subprime market existed to make loans, which put borrowers at great risk of failure. For example:

• Over half of the sub-prime mortgages are stated-income loans, which the industry refers to as 'liar's loans'. Shockingly, 43% of brokers who made the loans did so knowing their clients did not have the income to qualify for the loan.
• Brokers 'up sell' borrowers. That is, they put borrowers in loans with higher interest rates than they otherwise qualify for, because the brokers make bigger commissions.
• Minority borrowers were targeted for higher cost subprime mortgages, regardless of their financial health.
• About 70% of subprime loans have costly prepayment penalties that trap borrowers in high cost mortgages. These mortgages strip wealth rather than build it, and the penalties keep borrowers from shopping for better deals. Unfortunately, living in a minority neighbourhood puts homeowners at significantly higher risk of having a prepayment penalty.
• Approximately 8 in 10 subprime loans are adjustable rate mortgages, mortgages whose monthly payments can spike by as much as 50% or more.

Many borrowers who took these loans were unaware of the payment shocks awaiting them and had no prospects of being able to make the payments. Thus, they were forced to refinance the loan, if they had sufficient equity to do so. Each re-finance generated new fees for the lenders and brokers, stripping more equity from the homeowner. One lender called sub-prime loans "foreclosure loans".

When U.S. house prices began to decline in 2006-07, mortgage delinquencies soared, and securities backed with subprime mortgages, widely held by financial firms, lost most of their value. The result was a large decline in the capital of many banks and US government-sponsored enterprises, which tightened credit around the world. The effects of the recession affected all aspects of the United Kingdom (UK) national economy as well. According to The Times, in December 2008, the UK construction sector shrank at its fastest pace since records began.

How did, and does, the South African construction sector differ?

SOUTH AFRICA & THE CRISIS

Trevor Manuel, the previous Minister of Finance, said that South Africa, the economic powerhouse of Africa, was 'reasonably well insulated' from the financial crisis, despite the lower export revenues of 2009. What did Manuel mean by "reasonably well insulated"?

He continued to say that, in relative terms, South Africa had not been badly affected by the current global economic turmoil. To illustrate this, Group Five's order book was back at R13bn after its Middle Eastern cancellations.

The South African construction industry is divided into many different parts;

• small and large companies;
• construction projects overseas and across Africa;
• local residential, commercial and industrial markets;
• Government and civil works.

The paper does not differentiate between these parts, which have been affected individually in different ways. For example, factors such as high interest rates affected the demand for residential far more than the financial crisis would. In fact, the residential plans passed nationally were down 25.5%, without recourse to the crisis itself.

There is a simple explanation for residential plans being down: The interest rate is the major driver as Figure 1 illustrates.

Figure 1 reveals that mortgage advances in the residential sector are highly sensitive to (and in fact, now negatively controlled by) the mortgage rate applied by the South African Reserve Bank (SARB). It is not necessary to invoke the introduction of the NCA in 2006 as an explanatory variable causing any jump, except that it does force residential advances to mirror the interest rate more closely after 2006. PPC, which derives more than 90% of revenue from cement operations, said that regional cement volumes declined marginally by 1.6% after seven consecutive years of strong growth.