<TABLE cellSpacing=0 cellPadding=0 width="100%" border=0><TBODY><TR>Global credit crisis: 'Surprisingly, China has provided good leadership.'
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<!-- START OF : div id="storytext"--><!-- more than 4 paragraphs -->I REFER to last Saturday's letter by Mr Syu Ying Kwok, 'Top dollar for star talent', in which he used the recent efforts by United States Treasury Secretary Henry Paulson as the model justification. This is a misplaced example. Mr Paulson is just doing his job as Treasury Secretary in a time of need. US investment banks, including Goldman Sachs when Mr Paulson was chairman, are partly responsible for the current mess by creating dubious leveraged structured products, over-leverage in using derivatives and the global distribution of these toxics. Mr Paulson saved tens of millions of dollars in exempt taxes on realising his Goldman Sachs shares - estimated at US$485 million (S$695 million) - as a privilege provided to new public servants, when he took on the Treasury Secretary post.
The most incredible point is that, throughout this crisis, not one of the extremely well-paid bankers who have ruined their banks, hurt the economy, their employees and the investing public has said sorry or made restitution. The real lesson is that unrestrained greed and loss of moral compass hurt others.
Recent bold efforts to stem and reverse the banking and financial crisis, though unfortunate, are necessary. Quick and effective implementation, supported by complementary measures from other global central banks, will certainly help. For example, besides the aggressive liquidity provision by European Central Bank, Bank of Japan and Bank of England, other financial centre monetary authorities in Asia, like the Hong Kong Monetary Authority, should cut its interest rates and buy cheap shares to stop the rout and concern in their own markets. Surprisingly, China has provided good leadership in its measures and should follow up with more to restore confidence in Asia.
To prevent future financial crises of this nature, US policymakers must study its root causes and not jump in with too many piecemeal reactive regulations but implement comprehensive preventive measures while the political will is still present.
Root causes of the current financial and banking crisis may include:
- The US Federal Reserve printed too much money for too long at too low a cost during the last seven years of chairman Alan Greenspan's term. Perhaps the Fed should have only one objective - to keep inflation low and currency stable - and not maximise growth during phases of sharp asset price inflation (which can be measured objectively, despite Mr Greenspan's denial).
- US consumers and government are too addicted to an ever more financial debt and leverage model for economic growth, as promoted and lobbied by Wall Street, which is not sustainable.
- US bankers, especially investment bankers and traders, are provided with a free option of immediate extreme financial rewards without bearing the costs of future losses. There is a time mismatch between rewards and costs, tempting some bankers and traders to be short term, dishonest and greedy without the need to eat their own cooking years later. To prevent blowouts, perhaps all bank directors (past and present) should have to pay back 50 per cent of financial rewards of the past five years, as mistakes can be assumed to be attributed to them in a blowout. This will ensure private sector executives are incentivised to watch the downside.
- Banks and financial institutions can create gigantic off balance sheet derivative positions without proper disclosure and limit to leverage. There is no clear transparency and control in important but complex instruments. A solution may be for all financial items to be in the balance sheet and total leverage limit of, say, no more than 20 times, excluding overnight foreign exchange swaps. Now investment banking is incorporated into commercial banking, the reckless human nature 'cowboy' days will surface again unless transparency, leverage and 'too big to fail' free options are addressed adequately.
- Weak and improper regulatory oversight, especially on bank loans to 'no income, no asset applicants', abandoning the uptick sell-short rule in securities, absence of approval and supervision of over-the-counter (OTC) derivatives and global sales of these toxic structured products disguised as high-yield low-risk interest-rate products to the na�ve man in the street that extracts a long-term put option from them.
OTC credit default swaps are opaque and have increased systemic counterparty and option price risks exponentially, thereby requiring risk supervision and capital provision, and by moving current outstanding $60 trillion positions into a government-controlled clearing exchange to clear counterparty risk. Once $60 trillion of counterparty risk is eliminated, banks' inter-bank and lending activities will be activated vigorously. The Securities and Exchange Commission and the Fed have been passive on this most urgent matter that needs immediate action.
Policymakers should address these fundamental and technical issues systematically to minimise another recurrence, while giving full support to Mr Paulson with proper modifications to resolve the immediate need and danger. Chua Soon Hock
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<!-- START OF : div id="storytext"--><!-- more than 4 paragraphs -->I REFER to last Saturday's letter by Mr Syu Ying Kwok, 'Top dollar for star talent', in which he used the recent efforts by United States Treasury Secretary Henry Paulson as the model justification. This is a misplaced example. Mr Paulson is just doing his job as Treasury Secretary in a time of need. US investment banks, including Goldman Sachs when Mr Paulson was chairman, are partly responsible for the current mess by creating dubious leveraged structured products, over-leverage in using derivatives and the global distribution of these toxics. Mr Paulson saved tens of millions of dollars in exempt taxes on realising his Goldman Sachs shares - estimated at US$485 million (S$695 million) - as a privilege provided to new public servants, when he took on the Treasury Secretary post.
The most incredible point is that, throughout this crisis, not one of the extremely well-paid bankers who have ruined their banks, hurt the economy, their employees and the investing public has said sorry or made restitution. The real lesson is that unrestrained greed and loss of moral compass hurt others.
Recent bold efforts to stem and reverse the banking and financial crisis, though unfortunate, are necessary. Quick and effective implementation, supported by complementary measures from other global central banks, will certainly help. For example, besides the aggressive liquidity provision by European Central Bank, Bank of Japan and Bank of England, other financial centre monetary authorities in Asia, like the Hong Kong Monetary Authority, should cut its interest rates and buy cheap shares to stop the rout and concern in their own markets. Surprisingly, China has provided good leadership in its measures and should follow up with more to restore confidence in Asia.
To prevent future financial crises of this nature, US policymakers must study its root causes and not jump in with too many piecemeal reactive regulations but implement comprehensive preventive measures while the political will is still present.
Root causes of the current financial and banking crisis may include:
- The US Federal Reserve printed too much money for too long at too low a cost during the last seven years of chairman Alan Greenspan's term. Perhaps the Fed should have only one objective - to keep inflation low and currency stable - and not maximise growth during phases of sharp asset price inflation (which can be measured objectively, despite Mr Greenspan's denial).
- US consumers and government are too addicted to an ever more financial debt and leverage model for economic growth, as promoted and lobbied by Wall Street, which is not sustainable.
- US bankers, especially investment bankers and traders, are provided with a free option of immediate extreme financial rewards without bearing the costs of future losses. There is a time mismatch between rewards and costs, tempting some bankers and traders to be short term, dishonest and greedy without the need to eat their own cooking years later. To prevent blowouts, perhaps all bank directors (past and present) should have to pay back 50 per cent of financial rewards of the past five years, as mistakes can be assumed to be attributed to them in a blowout. This will ensure private sector executives are incentivised to watch the downside.
- Banks and financial institutions can create gigantic off balance sheet derivative positions without proper disclosure and limit to leverage. There is no clear transparency and control in important but complex instruments. A solution may be for all financial items to be in the balance sheet and total leverage limit of, say, no more than 20 times, excluding overnight foreign exchange swaps. Now investment banking is incorporated into commercial banking, the reckless human nature 'cowboy' days will surface again unless transparency, leverage and 'too big to fail' free options are addressed adequately.
- Weak and improper regulatory oversight, especially on bank loans to 'no income, no asset applicants', abandoning the uptick sell-short rule in securities, absence of approval and supervision of over-the-counter (OTC) derivatives and global sales of these toxic structured products disguised as high-yield low-risk interest-rate products to the na�ve man in the street that extracts a long-term put option from them.
OTC credit default swaps are opaque and have increased systemic counterparty and option price risks exponentially, thereby requiring risk supervision and capital provision, and by moving current outstanding $60 trillion positions into a government-controlled clearing exchange to clear counterparty risk. Once $60 trillion of counterparty risk is eliminated, banks' inter-bank and lending activities will be activated vigorously. The Securities and Exchange Commission and the Fed have been passive on this most urgent matter that needs immediate action.
Policymakers should address these fundamental and technical issues systematically to minimise another recurrence, while giving full support to Mr Paulson with proper modifications to resolve the immediate need and danger. Chua Soon Hock
