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Manuel Kaar
A critical analysis of the 2007-2009 global financial and economic crisis and its
implications for the travel industry and associated businesses
ISBN: 978-3-8366-3545-5
Herstellung: Diplomica® Verlag GmbH, Hamburg, 2009
Zugl. IMC - International Management Center GmbH, Krems, Österreich, Bachelorarbeit,
2009
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© Diplomica Verlag GmbH
http://www.diplomica.de, Hamburg 2009
ACKNOWLEDGEMENTS
I would like to express my sincere gratitude to all those contributors whose efforts
made it possible for me to construct this paper. I would like to thank the team of
the IMC University of Applied Sciences Krems for their excellent support during
the time of my studies at this fantastic institution. In particular, I would like to thank
Mag. Bakk. Thomas Schmalzer and Mag. Kerstin Freudenthaler, M.A. for their
exemplary assistance during the research process for this paper. Above all, I am
deeply indebted to my parents, who are giving me the most wonderful and
invaluable support you can only wish for in all of my academic, professional and
private endeavors.
Second Bachelor's Paper
Manuel Kaar
4
TABLE OF CONTENTS
1
INTRODUCTION ... 8
2
HOW THE 2007-2009 GLOBAL ECONOMIC CRISIS EVOLVED ... 10
2.1 Recent historical background ... 10
2.2 The problem of sub-prime lending ... 13
2.3 The end of an era ... 18
2.4 Effects of the financial crisis on the real economy ... 21
3
RESEARCH METHODOLOGY ... 25
4
IMPACTS OF THE CRISIS ON THE TOURISM INDUSTRY ... 27
4.1 General aspects ... 27
4.2 Key negative impacts ... 29
4.2.1 Decreased public funding for tourism projects and infrastructure ... 29
4.2.2 Restricted access to capital... 31
4.2.3 Excursus: Unemployment in the tourism industry ... 33
4.2.4 Changing patterns in leisure travel ... 33
4.2.5 Changing patterns in corporate travel ... 37
4.3 Selected possible opportunities ... 41
4.3.1 Shift in source markets ... 41
4.3.2 Intensification of the trend towards `Smart tourism' ... 42
4.3.3 New spirit of companionship ... 44
4.3.4 Other opportunities ... 45
5
DISCUSSION AND CONCLUSIONS ... 46
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Second Bachelor's Paper
Manuel Kaar
5
TABLE OF FIGURES
Figure 1: Effective Federal Funds Rate 07/1954-02/2009 ... 11
Figure 2: S&P/Case-Shiller Home Price Indices as of October 2008 ... 12
Figure 3: The New Model of Mortgage Lending ... 14
Figure 4: The New Model of Mortgage Lending - How it went wrong ... 16
Figure 5: Dow Jones and S&P 500 Indices 1996-2008 ... 18
Figure 6: U.S. mortgage delinquency rates 1998-2008 ... 19
Figure 7: The Vicious Circle of Financial Crisis ... 22
Figure 8: Phases of Crisis Management ... 28
Figure 9: World Travel and Tourism Economy GPD and World Travel and Tourism
Economy Employment Forecasts ... 29
Figure 10: Consumer Price Index for selected countries 01/2007-07/2008,
including forecast until July 2009 ... 39
Figure 11: Growth in outbound travel from selected markets in the Americas ... 41
Figure 12: Advito 2009 hotel rate forecast by world regions ... 45
Figure 13: Consumer Segment's Changing Behavior ... 47
Second Bachelor's Paper
Manuel Kaar
6
LIST OF ABBREVIATIONS
Abbreviation
Explanation
ABS
Asset Backed Securities
BRIC
Brazil, Russia, India, China
CDO
Collateralized Debt Obligation
DMO
Destination Marketing Organization
ETC
European Travel Commission
F&B
Food and Beverage
Fed
United States Federal Reserve System
GDP
Gross Domestic Product
IATA
International Air Transport Association
ICT
Information and Communication Technologies
SME
Small and Medium-Sized Enterprises
S&P
Standard and Poor's
UNWTO
United Nations World Tourism Organization
USP
Unique Selling Proposition
WTTC
World Travel and Tourism Council
Second Bachelor's Paper
Manuel Kaar
7
ABSTRACT
There have been numerous incidents in one or more countries in the past that led
to sudden and unexpected reductions in demand for tourism services and
confronted travel businesses with an economic environment of high uncertainty.
However, the current financial and economic crisis appears to be of a larger
dimension than most other crises before, and numerous experts around the globe
agree that the present economic slowdown has the potential to become one of the
most challenging and transformational disturbances on a supranational level since
the Great Depression. Predictions of future developments are vague and can only
be educated speculation at best, yet for the tourism industry the initial effects of
this first major crisis of the globalization era are already clearly perceptible.
Drawing on an extensive review of already existing literature, this paper explains
the various milestones during the period that led to the 2007-2009 global financial
and economic disorder, and subsequently considers a choice of selected key
implications for the tourism industry and associated businesses. The aim of this
paper is therefore to provide an academically substantiated reference guide for
market participants and policy-makers alike, with the ultimate purpose of making a
contribution to reduce the number of cases where wrong decisions lead to major
difficulties or even the failure of a destination or an individual business.
Results of the research indicate that the identified impacts are likely to intensify
throughout 2009 and 2010, and that the crisis will most likely also entail
fundamental changes for the industry on a long-term basis. In particular, it was
found that in the medium term decreased public funding for tourism projects and
restricted access to capital are likely to force many travel businesses into serious
liquidity problems. This may cause a series of reactions, including widespread
workforce reductions and severe cuts in the quality of the provided services.
Besides, the crisis is likely to have considerable effects on the way leisure and
corporate travel is conducted, as for instance shorter and less frequent trips or a
stronger tendency towards cost containment. However, the paper also points out
that every crisis embodies a great number of opportunities and provides an
analysis of a range of selected chances for destinations and tourism businesses.
Second Bachelor's Paper
Manuel Kaar
8
1
INTRODUCTION
At present (spring 2009), the world experiences one of the most severe economic
crises in post-WWII history, precipitated mainly by the U.S. sub-prime mortgage
crisis which became apparent to the broad public in 2007. In 2008, the U.S. sub-
prime crisis turned into a global financial crisis, and subsequently into a global
economic downturn that forced numerous countries into recession. Stock markets
have fallen, large financial institutions have collapsed, and governments had to
come up with rescue packages to bail out their financial systems.
Although it can be argued that overall the tourism industry may not be as
vulnerable as other commercial sectors when it comes to fluctuations in clients'
purchasing power, in the medium term tourism businesses are still likely to be at
least as seriously affected by the upcoming new distribution of economic power as
any other industry. A long-term trade and industry downturn may bring about a
broad range of changes to the world, like altered roles of the United States, the
European Union and the Asian block, insecurity and crime, a different
understanding of handling energy resources, further polarization between rich and
poor, or changing values and therefore consumer preferences in general to
name just a few. All these factors may potentially have adverse impacts on tourism
businesses, and thus require adequate attention and timely academic research.
However, change can also mean positive development and can open up new
chances and opportunities for the world economy. These opportunities need to be
identified, assessed and exploited. With an estimated direct and indirect
contribution of the travel and tourism sector of 9.4 percent to global GDP, 10.9
percent to world exports and 9.4 percent to world investment, the significance of
the industry's role in the struggle for economic recovery clearly must not be
underestimated (cf. WTTC, 2009, p. 4). As the tourism industry is all about
pleasant experiences and the positive things in life, it is sometimes hard to think
about crisis management. When having to operate in an economically insecure
environment of the current dimension, numerous managers therefore face the
challenging situation of having to make decisions in fields they do have little or no
knowledge about. However, in a fast-changing and highly volatile economic
Second Bachelor's Paper
Manuel Kaar
9
climate like the present, inaccurate decisions by executives of tourism businesses
can have devastating consequences and can seriously jeopardize the existence of
a company. The timely information and education of decision-makers on the
implications of the crisis can therefore become a decisive factor for a company's
overall survival or failure in the months to come as well as the years after the
crisis. As many policy-makers and executive managers encounter ambiguities
when it comes to comprehending the origins, backgrounds and possible threats of
the current economic turmoil, this paper provides a concise overview of the
emergence of the crisis and a critical examination of selected issues that are
fundamental for the effective operation of tourism businesses during these
economically troubled times. The aim of this paper is, therefore, to consider the
overall global context of the crisis from various angles in order to identify and
assess specific threats for the tourism industry, as well as to advance the
perspicuity of the question which of the erupting risks are the most relevant.
To arrive at this objective, the paper draws upon three main pillars. First, in the
introductory section a profound description of the causes and the development of
the crisis is provided, together with a short explanation on how the crisis touched
upon the world's real economies. Then the paper presents a detailed examination
of a range of selected positive and negative short- and long-term effects that the
crisis may potentially have on the tourism industry and associated destinations
and businesses. Finally, in the discussion section of the paper conclusions and
recommendations on how to mitigate the concomitant risks will be provided.
As indicated above, the main focus of this paper is not on providing information
about a specific branch of the tourism industry or geographical region. The main
spotlight is rather on the enhancement of the general knowledge of tourism
managers and policy-makers on the current crisis and its implications, with the
ultimate goal to make a contribution to increase the number of cases where
adequate decisions have been made and destinations and businesses have
successfully weathered the storm. Due to the inherent complexity of the financial
crisis, a certain level of previous knowledge about finance and economics is
expected from the reader in order to be able to follow the content of this paper.
Second Bachelor's Paper
Manuel Kaar
10
2
HOW THE 2007-2009 GLOBAL ECONOMIC CRISIS
EVOLVED
2.1
Recent historical background
Since the current global economic turmoil undoubtedly has its roots in the U.S.
financial system, an analysis of the recent developments in the latter must be
regarded as an integral part of every attempt to comprehend the present state of
affairs. The appointment of Alan Greenspan as Chairman of the U.S. Federal
Reserve System in 1987 serves as a reasonable starting point for this analysis. It
is crucial to recall that when Greenspan took over office from his predecessor Paul
Volcker, during the first years of his administration guaranteeing price stability was
considered as one of the main goals of the U.S. central banking system, and was
also more or less successfully implemented (Greenspan, 1989, cited following
Orphanides, 2006, pp. 2-3).
However, with the fall of the Berlin Wall in 1989 and the dissolution of the Soviet
Union in 1991 countries like Russia, China or India significantly liberalized their
economies, and thus contributed to a fundamental reorganization of the world-
economic order during the years that followed. The development clearly brought
along great opportunities for capitalist economies like the United States, which
profited from the sudden emergence of several hundred million potential new
consumers on the global market. Nevertheless, the onset of modern globalization
in the early 1990s also put strong pressure on the U.S. job market, mainly as a
result of cheap mass production in Asian countries. With rising international
competition and the 1990/1991 recession, the U.S. financial policies had to
undergo major changes during this period in order to avoid the disastrous
consequences a substantial decrease in consumer demand would have entailed.
As a result, the Fed's attention gradually shifted from price stability towards
economic growth in the course of the 1990s, and in response to the need for
economic stimulus, Greenspan's team started to focus on an exceptionally
inflation-responsive interest rate policy (cf. Mankiw, 2001, pp. 36-40). This in turn
led to the frequent occurrence of periods with comparably low federal funds rates,
a situation that clearly created a favorable business environment for investment
Second Bachelor's Paper
Manuel Kaar
11
banks. At the time, traditional commercial banks were to a large extent dependent
on savings deposits to fund their credit business, and were thus also limited in the
amount of lending they could do. They were safe partners to place money with, but
"[...] failed to direct capital to its most productive uses" (Krugman, 2009, p. 65).
Investment banks on the contrary offered a broader spectrum of financial products
and could almost entirely be financed by the capital market.
Figure 1: Effective Federal Funds Rate 07/1954-02/2009; Source: Federal Reserve Bank of St.
Louis
This facilitated access to capital, along with sustained periods of low federal funds
rates, made it easier to fund financial institutions like investment banks or hedge
funds and, among other things, led to a strong overall increase in the lending
business. This trend towards easier access to credit for almost anyone can
therefore be regarded as the beginning of the alleged `golden era' of American
investment banks on Wall Street, and thus also of the U.S. financial system as a
whole.
Figure 1 shows the history of the effective federal funds rate, which is widely
considered to be the Fed's most important tool to implement short-run monetary
Second Bachelor's Paper
Manuel Kaar
12
policy changes (cf. Mankiw, 2003, pp. 290-91). As the chart depicts, the Fed
sharply cut the federal funds rate in answer to the bear market that followed the
dot-com bubble burst in 2000 and the destruction of the World Trade Center in
2001, mainly with the aim to halt the then harsh economic downturn and to boost
investment. The Fed's policy of low interest soon started to take effect, and
cheaper loans and growing credit expansion in general made it easier to finance
private homes, resulting in skyrocketing demand for real estate, both for
speculative purposes and for private use.
Figure 2: S&P/Case-Shiller Home Price Indices as of October 2008; Source: Case-Shiller
Housing Whitepaper 2008, p. 3
While most experts agree that the low federal funds rate was one of the main
preconditions for a U.S. housing bubble to develop (cf. Krugman, 2009, p. 148;
Soros, 2008, p. 82; Stiglitz, 2008b), others claim that the heavy increase in U.S.
housing prices cannot even be regarded as a classic bubble, but rather as the
Second Bachelor's Paper
Manuel Kaar
13
result of newly invented financial tools like Asset-backed securities (ABS), in
conjunction with sustained U.S. productivity growth and the strong influx of funds
from Asian countries and oil exporting nations (cf. Reinhart & Rogoff, 2008, pp. 3-
4). In any case the artificially created demand constantly drove U.S. house prices
up over the years, with its peak in 2007, as illustrated by the S&P/Case-Shiller
Home Price Indices shown in figure 2.
The soaring U.S. house prices led to improved loss experience with previously
problematic borrowers, and subsequently to increasingly relaxed assessment
practices for collateralized mortgage obligations by the rating agencies (cf. Soros,
2008, p. 83). Together with other related factors like declining saving rates and
seemingly endless investor enthusiasm, the loosened valuation standards brought
lending institutions to gradually ease conditions when awarding loans in order to
sustain the affordability of real estate acquisitions and to generate more business
in general. Starting in 2005, a strong rise in the issuing of loans to borrowers with
little or insufficient securities, poor credit histories or inadequate down payments
could be observed (cf. Krinsman 2007, p. 3; Krugman, 2009, pp. 148-49; Soros
2008, p. 83; Zandi, 2009, p. 163), and soon an inescapable, self-feeding vicious
circle started to evolve.
2.2
The problem of sub-prime lending
In the course of the 1990s the financial community `invented' a number of new
credit derivatives with the goal not only to enable commercial banks to access
financing options apart from traditional methods, but also to mitigate the inherent
risks of weakly rated loans by simply spreading them over the entire banking
system. Soon a broad range of structured finance products like Credit Default
Swaps (loan default insurances) appeared, and a certain lack of regulation allowed
the emergence of a number of highly complex and nontransparent monetary tools
that were difficult to control. Collateralized Debt Obligations (CDOs), which can be
described as packages of loans of unequal security levels that bundle high-quality
with low-quality (`sub-prime') assets in order to spread the risk of defaults, became
one of the most prevalent instruments in this segment. It goes without saying that
investment banks like Lehman Brothers played a key role in this business.
Second Bachelor's Paper
Manuel Kaar
14
Figure 3: The New Model of Mortgage Lending. Source: BBC 2007
Figure 3 compares the traditional model of mortgage lending with the sub-prime
model. Since the traditional model puts natural restrictions on the degree to which
banks can engage in mortgage lending by limiting the sources of capital that can
be used for this purpose to the clients' deposits, the sub-prime model soon
became popular among conventional commercial banks. Sub-prime lending
offered a highly attractive alternative for banks as the hypothecary credits were
passed on to investors in the bond markets, thus enabling the banks to finance
more lending business (cf. BBC News, 2007, para. 2). The model seemed safe,
and besides banks earned a fee for each contract, consequently making sub-
prime lending very profitable for both banks and investors, as supported by Hull,
who in a paper on the Credit Crunch of 2007 describes the participants' course of
action as follows:
"A key issue is the extent to which the behavior of mortgage originators was
influenced by their knowledge that the majority of the loans would be securitized.
Casual empiricism suggests that the interests of mortgage originators were not
Second Bachelor's Paper
Manuel Kaar
15
aligned with the interests of investors. Mortgage originators did not ask the natural
question: `Is this a good lending opportunity. Will the borrower make payments as
promised?' Instead the question was `Can I make a profit by selling this mortgage
to someone else?'" (Hull, 2008, p. 6)
Due to the lucrative nature of the business and the strong focus on short-term
gains, over the years more and more of these low-grade mortgages were sold,
despite the obviously very poor credit standing scores of the sub-prime borrowers.
Finally, again to further spread the involved risks, to maximize profits and to boost
foreign investment, the highly sophisticated credit security bundles containing
substandard loans were also heavily sold overseas to financial institutions across
the world, who frequently did not even fully comprehend what products they were
buying (cf. Krugman, 2009, p. 149; Soros, 2008, pp. 82-83; Zandi, 2009, p. 79). By
2007, U.S. mortgage bonds had already amounted to the largest single part of the
U.S. bond market, even outperforming Treasury bonds (cf. BBC News, 2007, para.
8).
Yet, literature suggests that several skeptics also raised their voices fairly early. As
one of the most notable speakers on the subject, the American billionaire investor
Warren Buffett was one of the first to point out that credit derivatives entail
potential dangers that could easily get out of control, notoriously dubbing them
"financial weapons of mass destruction" in the 2002 annual report of his holding
company Berkshire Hathaway Inc. (cf. Berkshire Hathaway Inc., 2003, p. 15).
However, despite numerous early warnings, the American people continued their
spending spree and kept on financing their homes and stock purchases through
ever higher mortgage loans during the huge run-up phase in the post-9/11 years.
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