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Finsac and the 'mismanagement' of the financial sector crisis - A response to columnist Wilberne Persaud
published: Friday | August 31, 2007
Paul Chen-Young, Economist and Investment Banker
Dr. Paul Chen Young on the cover of his book: 'The Entrepreneurial Journey in Jamaica', which details the fall of his finacial group, which he blamed largely on misplaced government policies. - File
In a Letter to the Editor
Having read the recent articles by your business columnist, Mr. Wilberne Persuad, about the demise of the domestic financial sector and Finsac where he has sought to rebut analyses and views that I have expressed, I am responding to a few matters of substance that he has addressed.
It is relevant for readers to knowthat Mr. Persuad served as a director of Finsac and is also a close ally of Finance Minister Dr. Omar Davies. Both were lecturers at the University of the West Indies.
Mr. Persaud was very involved as a policymaker at Finsac and readers can draw their own conclusions as to whether he is biased from the material presented and the tone that is reflected in his writing.
It is instructive to quote the promo to his book, Jamaica Meltdown: "Unwarranted optimism guided Jamaica's indigenous financial sector institutions. They converted cash to speculative investments. Driven more by egos than economics they built grand head offices - dubbed the 'edifice complex' by one of Jamaica's most successful businessmen. Some of their activities skirted legal lines. The Courts adjudged others outright fraud. This general attitude and euphoric behaviours always precede a crash."
Such writing is emotive and in parts factually wrong. I am not aware of any of the principal players being charged with fraud. The mindset of Mr. Persuad is clear. It is not surprising that his writings are strong on opinions but short on objective analyses. This makes them merely polemic.
In one of his columns he made the extraordinary claim that there was no financial crisis in the financial sector in Jamaica. One has to ask whether Mr. Persuad lives in the real world. Any commentary that follows must be clouded by this outrageous assertion.
Firewall
In another column, he quotes extensively from his book and states the following: "The previously existing firewall constructed between and among banking, insurance, money management, and other financial services was jettisoned like so much useless ballast."
In actuality, there has never been any legal restriction against the creation of financial conglomerates and Eagle was foremost in this strategy. Former Bank of Jamaica Governor Bussieres and Minister Davies echoed sentiments against financial conglomerates, much to their disadvantage.
The financial legislation, which Minister Davies enacted, imposes no restriction against financial conglomerates. Today we see such staid financial institutions like the Bank of Nova Scotia expanding into insurance and brokerage services.
In the views that I have expressed about the demise of the domestic financial sector, I have always maintained that management of these entities must share in the blame. Strategic investment strategy mistakes were made, and these did not happen in a vacuum. The financial policies of Minister Davies contributed significantly to the problem.
One of the mistakes made by the nationally owned financial entities was the mismatch of assets and liabilities, that is, using short term funds to lend and invest long.
This is generally to be avoided from a risk management viewpoint. But that is theoretical.
The "Economic Focus" column of the August 18, 2007 issue of the Economist magazine states: "However much marble they lay in their foyers, banks have been brittle institutions. They borrow short [collecting deposits or short term loans that might have to be repaid quickly] and lend long [making loans that cannot easily be converted into cash at anything close to their value at the bank]."
The quotation above correctly reflects how funds are raised and used by the banking system in the real world. In times of stability that mismatch of funds works fine.
But when there is instability in the financial markets, as Jamaica experienced in the 1990s, as a result of unstable financial policies, it is inevitable that financial institutions which do not have a heavy concentration of Government paper in their portfolios will get into trouble. And that was what happened in Jamaica.
In any serious analysis of widespread dislocation of enterprises, a distinction has to be made as to whether it is a problem associated with an enterprise or whether it is a sector problem.
Where it is an enterprise problem, then specific action can be taken against those specific enterprises.
But where the problems are throughout the sector there is a systemic problem, which suggests that the problems that face enterprises are widespread and intervention of the Authorities is warranted.
I have argued that the problems that faced the financial sector were not caused just by managerial investment strategy mistakes, which did occur, but by unstable Government financial policies that resulted in sustained periods of high inflation, high interest rates and devaluations.
The reality is that the problems extended throughout most of the financial sector and was not limited to an enterprise.
The heavy handed manner in which Century Bank was handled created the impression that it was only that bank that had problems. I recall Minister Davies making a public statement that there was no systemic problem. He was to be proven wrong.
And so Finsac was formed.
True that the Government took a very deliberate and costly decision to bail out depositors and insurance policy holders — and not the shareholders of the troubled entities, except to certain entities like National Commercial Bank, where preferential treatment was meted out to shareholders who benefited from the massive Government support to the bank.
The main beneficiary was Jamaica National Building Society while Victoria Mutual Building Society suffered losses from the collapse of Island Victoria Bank.
Mr. Persuad writes that: "The IMF publicly mandated that NCB was to be sold by a certain date."
It is astonishing that he could have used that rationale to draw his conclusions about the sale of financial entities since Jamaica has no formal loan agreement with the IMF. This is a fact about which the Minister of Finance has boasted on numerous occasions.
The issue surrounding Finsac is not about bailing out depositors and policyholders. It is about the mismanagement of a crisis and the failure of Government to provide any leadership to restructure the sector. Simply taking liability for bad loans and cleaning up the balance sheets of the entities before selling them off is not leadership. It was a very costly course to have pursued-both financially and from a balance of payments perspective.
The sector should have been restructured by mergers and consolidation with change in boards of directors and management, where justified, that would allow for strong bargaining for joint ventures with overseas financial institutions.
Joint ventures have been the path undertaken by most countries that have experienced a crisis in the financial sector, as well as those which have liberalised the sector to foreign participation.
It makes sense since the domestic financial sector - and the country - benefits from foreign capital, closer links to the international capital markets, management and technical expertise.
It also has the significant advantage of reducing investment capital outflows, instead of where banks and insurance companies are just sold off.
The Authorities did not encourage joint ventures and took an antagonistic attitude towards those who were at the helm of the domestic financial sector. It was clear that there was no intention by FINSAC to collaborate with those decision makers who were involved. And where any understanding about restructuring was reached they were simply arbitrarily discarded by Finsac as in the case of Eagle. This, I am told, was also the case with other financial entities.
The model of joint ventures was given no serious consideration by the Authorities and I believe that this was a big mistake. I can say for sure that there was definite interest by the Royal Bank of Trinidad and Tobago in undertaking a joint venture with Island Victoria Bank since meetings were held at high levels with the ownership of both institutions.
An understanding was reached on how the joint venture would be structured and attempts were made to obtain the blessing of Bank of Jamaica and the Ministry of Finance. No encouragement was given.
Directors at the Royal Bank of Trinidad and Tobago must have been ecstatic when they got the full ownership of one of the then best run commercial banks [Eagle Commercial Bank] along with Workers Bank with a clean balance sheet, after Finsac involvement.
It is their good fortune that they were handed such a gift on a platter, because those in charge apparently had no vision about the future of the financial sector, and no understanding of the harmful economic consequences of their action.
In most countries that have experienced turmoil in the financial sector speedy action is taken by the Authorities to intervene and to help restore order. The financial sector is like no other sector. This is what is described as the "commanding heights of the economy", from which there are numerous implications for credit policy and the use of a country's financial resources.
It is because of this reason why then Minister of Finance, Mr. Edward Seaga, embarked on the successful "Jamaicanisation" programme of the financial sector in the 1960s.
It took over 30 years for Jamaicans to develop a comprehensive — and sophisticated — financial sector that Finance Minister Davies dismantled in just about two years.
The revitalisation and building of hotels in the 1990s, including the divestment of Government owned hotels, is the best example of how the financial sector — owned and controlled by Jamaicans — played a vital role in the country's development.
Overseas owned banks sat on the sidelines and escaped the meltdown as ruinous high interest rates and inflation crushed the now maligned indigenous entities which committed resources to helping to develop the country.
What is often overlooked is that in most developed and successful countries there are investment banks which play a dynamic role in fostering investment. Jamaica had none. The development bank did not lend directly but used the commercial and merchant banks as intermediaries to lend to tourism, manufacturing and agriculture. Combined with funds raised from the public, these banks and life insurance companies filled the void by providing much needed investment banking service. But there were risks,and in a volatile financial environment, they ran into trouble.
In my letter of August 5, 2007 to the Jamaica Observer I said that : "The new owners are risk averse and we can expect to see no major initiative being taken to support investments in the productive sector, except in the case of National Commercial Bank" because the controlling ownership is in the hands of Mr. Michael Lee Chin.
"Jamaica can expect no leadership from these entities in the development effort". On his reference to lending, Mr. Persuad misses the substantive point that they will be very conservative by concentrating on "Government paper, trading in securities, providing loans for more consumption and providing mortgages."
Apart from the loss of national control of these "commanding heights" profits from these financial companies — for which total blame must be placed on the Directors of FINSAC and the Minister of Finance — to overseas owners will be a serious and continuous drag on the country's balance of payments.
Jamaica is running increasingly large trade deficits. The country has compounded the situation by increasing deficits on the investment income account to pay overseas owners to whom we have sold off well established and properly staffed financial institutions.
This fundamental strategic mistake is not surprising when one looks at the composition of the Board of Directors of Finsac. None had any successful business experience to be able to deal with the tough task of restructuring the troubled financial sector.
They were all probably well intentioned, but misplaced their priority by relying more heavily on forensic auditors rather than on experienced investment bankers.
This misguided bias no doubt reflected the will of the person ultimately responsible for policy direction, Dr. Omar Davies, who sadly demonstrated no sense of vision for the financial sector and was more bent on finding scapegoats rather constructive rebuilding.
And so Finsac failed in the fundamental task of any meaningful restructuring of thedomestic financial sector, and we have compounded our balance of payments problem by the massive sell-off to overseas companies.
published: Friday | August 31, 2007
Paul Chen-Young, Economist and Investment Banker
Dr. Paul Chen Young on the cover of his book: 'The Entrepreneurial Journey in Jamaica', which details the fall of his finacial group, which he blamed largely on misplaced government policies. - File
In a Letter to the Editor
Having read the recent articles by your business columnist, Mr. Wilberne Persuad, about the demise of the domestic financial sector and Finsac where he has sought to rebut analyses and views that I have expressed, I am responding to a few matters of substance that he has addressed.
It is relevant for readers to knowthat Mr. Persuad served as a director of Finsac and is also a close ally of Finance Minister Dr. Omar Davies. Both were lecturers at the University of the West Indies.
Mr. Persaud was very involved as a policymaker at Finsac and readers can draw their own conclusions as to whether he is biased from the material presented and the tone that is reflected in his writing.
It is instructive to quote the promo to his book, Jamaica Meltdown: "Unwarranted optimism guided Jamaica's indigenous financial sector institutions. They converted cash to speculative investments. Driven more by egos than economics they built grand head offices - dubbed the 'edifice complex' by one of Jamaica's most successful businessmen. Some of their activities skirted legal lines. The Courts adjudged others outright fraud. This general attitude and euphoric behaviours always precede a crash."
Such writing is emotive and in parts factually wrong. I am not aware of any of the principal players being charged with fraud. The mindset of Mr. Persuad is clear. It is not surprising that his writings are strong on opinions but short on objective analyses. This makes them merely polemic.
In one of his columns he made the extraordinary claim that there was no financial crisis in the financial sector in Jamaica. One has to ask whether Mr. Persuad lives in the real world. Any commentary that follows must be clouded by this outrageous assertion.
Firewall
In another column, he quotes extensively from his book and states the following: "The previously existing firewall constructed between and among banking, insurance, money management, and other financial services was jettisoned like so much useless ballast."
In actuality, there has never been any legal restriction against the creation of financial conglomerates and Eagle was foremost in this strategy. Former Bank of Jamaica Governor Bussieres and Minister Davies echoed sentiments against financial conglomerates, much to their disadvantage.
The financial legislation, which Minister Davies enacted, imposes no restriction against financial conglomerates. Today we see such staid financial institutions like the Bank of Nova Scotia expanding into insurance and brokerage services.
In the views that I have expressed about the demise of the domestic financial sector, I have always maintained that management of these entities must share in the blame. Strategic investment strategy mistakes were made, and these did not happen in a vacuum. The financial policies of Minister Davies contributed significantly to the problem.
One of the mistakes made by the nationally owned financial entities was the mismatch of assets and liabilities, that is, using short term funds to lend and invest long.
This is generally to be avoided from a risk management viewpoint. But that is theoretical.
The "Economic Focus" column of the August 18, 2007 issue of the Economist magazine states: "However much marble they lay in their foyers, banks have been brittle institutions. They borrow short [collecting deposits or short term loans that might have to be repaid quickly] and lend long [making loans that cannot easily be converted into cash at anything close to their value at the bank]."
The quotation above correctly reflects how funds are raised and used by the banking system in the real world. In times of stability that mismatch of funds works fine.
But when there is instability in the financial markets, as Jamaica experienced in the 1990s, as a result of unstable financial policies, it is inevitable that financial institutions which do not have a heavy concentration of Government paper in their portfolios will get into trouble. And that was what happened in Jamaica.
In any serious analysis of widespread dislocation of enterprises, a distinction has to be made as to whether it is a problem associated with an enterprise or whether it is a sector problem.
Where it is an enterprise problem, then specific action can be taken against those specific enterprises.
But where the problems are throughout the sector there is a systemic problem, which suggests that the problems that face enterprises are widespread and intervention of the Authorities is warranted.
I have argued that the problems that faced the financial sector were not caused just by managerial investment strategy mistakes, which did occur, but by unstable Government financial policies that resulted in sustained periods of high inflation, high interest rates and devaluations.
The reality is that the problems extended throughout most of the financial sector and was not limited to an enterprise.
The heavy handed manner in which Century Bank was handled created the impression that it was only that bank that had problems. I recall Minister Davies making a public statement that there was no systemic problem. He was to be proven wrong.
And so Finsac was formed.
True that the Government took a very deliberate and costly decision to bail out depositors and insurance policy holders — and not the shareholders of the troubled entities, except to certain entities like National Commercial Bank, where preferential treatment was meted out to shareholders who benefited from the massive Government support to the bank.
The main beneficiary was Jamaica National Building Society while Victoria Mutual Building Society suffered losses from the collapse of Island Victoria Bank.
Mr. Persuad writes that: "The IMF publicly mandated that NCB was to be sold by a certain date."
It is astonishing that he could have used that rationale to draw his conclusions about the sale of financial entities since Jamaica has no formal loan agreement with the IMF. This is a fact about which the Minister of Finance has boasted on numerous occasions.
The issue surrounding Finsac is not about bailing out depositors and policyholders. It is about the mismanagement of a crisis and the failure of Government to provide any leadership to restructure the sector. Simply taking liability for bad loans and cleaning up the balance sheets of the entities before selling them off is not leadership. It was a very costly course to have pursued-both financially and from a balance of payments perspective.
The sector should have been restructured by mergers and consolidation with change in boards of directors and management, where justified, that would allow for strong bargaining for joint ventures with overseas financial institutions.
Joint ventures have been the path undertaken by most countries that have experienced a crisis in the financial sector, as well as those which have liberalised the sector to foreign participation.
It makes sense since the domestic financial sector - and the country - benefits from foreign capital, closer links to the international capital markets, management and technical expertise.
It also has the significant advantage of reducing investment capital outflows, instead of where banks and insurance companies are just sold off.
The Authorities did not encourage joint ventures and took an antagonistic attitude towards those who were at the helm of the domestic financial sector. It was clear that there was no intention by FINSAC to collaborate with those decision makers who were involved. And where any understanding about restructuring was reached they were simply arbitrarily discarded by Finsac as in the case of Eagle. This, I am told, was also the case with other financial entities.
The model of joint ventures was given no serious consideration by the Authorities and I believe that this was a big mistake. I can say for sure that there was definite interest by the Royal Bank of Trinidad and Tobago in undertaking a joint venture with Island Victoria Bank since meetings were held at high levels with the ownership of both institutions.
An understanding was reached on how the joint venture would be structured and attempts were made to obtain the blessing of Bank of Jamaica and the Ministry of Finance. No encouragement was given.
Directors at the Royal Bank of Trinidad and Tobago must have been ecstatic when they got the full ownership of one of the then best run commercial banks [Eagle Commercial Bank] along with Workers Bank with a clean balance sheet, after Finsac involvement.
It is their good fortune that they were handed such a gift on a platter, because those in charge apparently had no vision about the future of the financial sector, and no understanding of the harmful economic consequences of their action.
In most countries that have experienced turmoil in the financial sector speedy action is taken by the Authorities to intervene and to help restore order. The financial sector is like no other sector. This is what is described as the "commanding heights of the economy", from which there are numerous implications for credit policy and the use of a country's financial resources.
It is because of this reason why then Minister of Finance, Mr. Edward Seaga, embarked on the successful "Jamaicanisation" programme of the financial sector in the 1960s.
It took over 30 years for Jamaicans to develop a comprehensive — and sophisticated — financial sector that Finance Minister Davies dismantled in just about two years.
The revitalisation and building of hotels in the 1990s, including the divestment of Government owned hotels, is the best example of how the financial sector — owned and controlled by Jamaicans — played a vital role in the country's development.
Overseas owned banks sat on the sidelines and escaped the meltdown as ruinous high interest rates and inflation crushed the now maligned indigenous entities which committed resources to helping to develop the country.
What is often overlooked is that in most developed and successful countries there are investment banks which play a dynamic role in fostering investment. Jamaica had none. The development bank did not lend directly but used the commercial and merchant banks as intermediaries to lend to tourism, manufacturing and agriculture. Combined with funds raised from the public, these banks and life insurance companies filled the void by providing much needed investment banking service. But there were risks,and in a volatile financial environment, they ran into trouble.
In my letter of August 5, 2007 to the Jamaica Observer I said that : "The new owners are risk averse and we can expect to see no major initiative being taken to support investments in the productive sector, except in the case of National Commercial Bank" because the controlling ownership is in the hands of Mr. Michael Lee Chin.
"Jamaica can expect no leadership from these entities in the development effort". On his reference to lending, Mr. Persuad misses the substantive point that they will be very conservative by concentrating on "Government paper, trading in securities, providing loans for more consumption and providing mortgages."
Apart from the loss of national control of these "commanding heights" profits from these financial companies — for which total blame must be placed on the Directors of FINSAC and the Minister of Finance — to overseas owners will be a serious and continuous drag on the country's balance of payments.
Jamaica is running increasingly large trade deficits. The country has compounded the situation by increasing deficits on the investment income account to pay overseas owners to whom we have sold off well established and properly staffed financial institutions.
This fundamental strategic mistake is not surprising when one looks at the composition of the Board of Directors of Finsac. None had any successful business experience to be able to deal with the tough task of restructuring the troubled financial sector.
They were all probably well intentioned, but misplaced their priority by relying more heavily on forensic auditors rather than on experienced investment bankers.
This misguided bias no doubt reflected the will of the person ultimately responsible for policy direction, Dr. Omar Davies, who sadly demonstrated no sense of vision for the financial sector and was more bent on finding scapegoats rather constructive rebuilding.
And so Finsac failed in the fundamental task of any meaningful restructuring of thedomestic financial sector, and we have compounded our balance of payments problem by the massive sell-off to overseas companies.
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