By Al Edwards, Business Co-ordinatorAs a follow-up to our just-concluded 5-part retrospective series on the 1990s financial sector crisis, the Financial Gleaner now
presents the second portion of a
2-part follow-up, examining some present implications of the crisis, and addressing some issues that arose in the series.
THE PERFORMANCE
OF THE GOVERNMENT
Should Omar Davies have
intervened sooner?
THE MINISTER of Finance and Planning, Dr. Omar Davies, has often said that his intervention in the financial crisis that befell the sector during the mid to late nineties was imperative because a lack of faith in local institutions would certainly sound its death knell, but the question is: should he have acted sooner? It would be fair to say that the sector had for some time said that greater liberalisation was needed and that it should not be over-regulated
and shackled by heavy-handed
regulation.
Like any concerned parent you allow your children to assert their independence, give vent to "their free spirit" until they come a cropper and then inevitably you have to intervene, pick up the pieces and sort out the situation. It would be fair to say this is what the Minister of Finance did. Last week the Financial Gleaner considered whether the sector needs two
regulators, given its size. But considering its collapse, regulation is of paramount importance if lessons are to be learnt. Playing devil's advocate here, what if Dr. Davies had allowed the sector to fail and refused to intercede? What would have been the likely consequence of such non-action? Almost certainly it would wreak a kind of havoc that would be even more devastating than the crippling debt burden that FINSAC has spawned.
In isolation, this would be true, but hardly anything happens in
isolation, and the financial crisis didn't. The truth is that if the Government took the decision to correct the sector sooner, not allowing certain personalities to bluster and sound the clarion call for a financial sector free of draconian Government intervention, then much of the crisis would simply not have happened in the first place, and the cost of intervening which is somewhere near J$350 billion would have been much less.
ECONOMIC GROWTH:
HAS IT BEEN SO LONG WE
HAVE FORGOTTEN HOW?
The old deterrents such as high crime rates and a frustratingly investor-hostile bureaucracy are still there, and the continued absence of growth, plus the growing strain of a bloated and mismanaged fiscal deficit, means that monetary-induced stability is starting to crack under the strain. While the monetary side of the economic equation has in the past seven years laid some basis for growth stable prices via single digit inflation, a stable exchange rate, lower cash reserve ratios for banks, and interest rates that were trending down that growth has not been forthcoming in a major way, and what growth there has been is being overshadowed by a fiscal problem that has grown faster than the economy. Monetary policy, however, though critical, is merely half of the equation of macroeconomic management, and on the fiscal side, government has not only failed to build on the platform provided by monetary policy, but now seems intent on sabotaging that platform and putting to waste the decade of effort from the central bank and the financial sector that went into achieving it.
The March 2003 Country Risk Assessment by the Economic Intelligence Unit (EIU) hints at the fact that the government's fiscal indiscipline is pushing the central bank into a corner:
"--renewed pressure on the local currency since mid-December, in response to the government's failure to contain the fiscal deficit in the first six months of 2002/03, has prompted further action by the monetary authorities."
THE NATIONAL DEBT:
THAT SINKING FEELING
According to Standard and Poors' December 2002 ratings report, "-the-debt burden-is one of the highest for sovereign nations, exceeded only by the Republic of Lebanon and Japan." Bear Sterns' most recent pronouncement points to "-a country under extreme fiscal pressure," where "current trends do not look sustainable."
Over a hundred per cent of GDP is an ocean of debt, and the Jamaican government does indeed appear to be quite lost at sea. As long as the proliferation of government paper continues, it will be difficult to generate the economic growth Jamaica needs. A cruel cycle has already set in: higher levels of debt = higher debt servicing ratios in the national budget = pressure to generate more debt to service old debt as well as meet present housekeeping needs = greater risk attached to increasing stock of debt = higher interest rates = disincentive to productive investment = no growth. The government, in relation to its debt burden, has become a dog chasing its tail. Because of its fiscal debt problems, and its inept management of those problems, the government has in recent years been approaching the local market for financing via offering long term, moderate interest-rate instruments, which the public can only access through investment houses.
A GOVERNMENT
PYRAMID SCHEME
In addition to the fact that the vast market of government paper is the single biggest reason behind the country's high interest rate structure, which worsens government debt as well as stifles production, in the caustic terms of one financial sector analyst, the government paper environment is a house of cards, and the government of Jamaica is running a variation of a pyramid or Ponzi scheme. Ponzi Schemes are named after one Carlo Ponzi, an Italian/American who ran such a scheme in New England, USA, in 1919-1920. A Ponzi is an investment scheme in which returns are paid to earlier investors, entirely out of money paid into the scheme by newer investors. Unlike valid, legitimate business activities, which in some way create wealth, or contribute to the creation of wealth, Ponzi schemes produce no goods of any significance, and create no wealth. Every dollar that one person gains through such a scheme, is a dollar that someone else has lost. The structure seems to work at first,
but is unsustainable.
Cash flows from assets in the near-term will eventually fall short of cash payment commitments and only with some future "bonanza" will cash flows ever be sufficient to service debts and provide any realistic hope of generating profits. A 'Ponzi' operation must increase its outstanding debt in order to meet its financial obligations, so new money and more credit is necessary for perpetuating the unsustainable game.
The government of Jamaica does not produce sufficient revenue to meet its short-term obligations. In an effort to meet these obligations, the government, in an apparently limitless expansion of credit, borrows money from the private sector by way of a non-value based repo market. Investment firms run the market and absorb virtually all the risk in the scheme, thereby acting as the Ponzi machine. The investment firms then turn around and borrow high yield short-term funds from clients to lend to the government. The essence of the Ponzi mechanism lies in the new funds taken in and old funds rolled into new investments. It's the age-old story borrowing from Peter to pay Paul.
Ordinary people can't pay a credit card bill with the very credit card the bill belongs to, so exactly what is continuously creating the wealth for government to repay the investment firms, and for the investment firms in turn to then repay the clients? There has been no significant growth in the economy in recent history, there seems to be a bankruptcy of ideas on how to generate growth, and the government obviously is far too incompetent to efficiently collect fiscal revenues. How then can an investment firm justify continuously offering yields above all government securities when these securities are for the most part not liquid? The only way this can work is by using new funds to pay off near-term obligations, and then hoping that more funds keep coming in to cover the new obligations created. This is Ponzi Finance, because it is all based on nothing but government debt, and unless measures are taken to correct and halt the
cycle, the scheme will eventually "implode" when the Ponzi scheme runs out of steam.
"It has happened,
And it goes on happening,
And it will happen again
If nothing happens to stop it
The innocent know nothing
Because they are too innocent
And the guilty know nothing
Because they are too guilty--
The poor do not notice
Because they are too poor
And the rich do not notice
Because they are too rich
The stupid shrug their shoulders
Because they are too stupid
And the clever shrug their
shoulders
Because they are too clever
The young do not care
Because they are too young
And the old do not care
because they are too old
That is why nothing happens
to stop it,
And that is why it has happened,
And goes on happening, and
will happen again."
Erich Fried (1921-1988)
Captured Voices
