A basic lesson about money

Like a striptease act, we are slowing seeing bits and pieces of what seems to be one of the greatest global economic dramas unfolding in our lifetime being peeled away. This peek show though is turning out to be a nightmare.

The Philippine central bank continues to assure everyone that our financial system will be able to withstand the collapse that has started in the West, that while there are local banks affected, the amount that will be lost is going to be contained.

Thus, while we continue to keep on eye on new developments in the US, Europe, Japan, Singapore, and even emerging countries like China and India, proposals such as the Asian Fund or the quadrupling of insurance against bank deposits help mute the angst.

Make no mistake, though – our trepidation will continue to linger until the tremors that are shaking the world’s financial system will finally come to a halt. And the end does not seem to be in sight yet.

In the meantime, we are being treated to one of the severest dissections of why this is all happening, including treatises on how the current crisis compares and differs from the Great Depression of the 1930s. Not surprisingly, this is followed by a good number of dissertations that enumerate the lessons we may draw so far from has happened.

System failure

One of the best readings I have so far stumbled on is the text of the testimony of US Securities and Exchange Commission Chairman Christopher Cox before the Committee on Oversight and Government Reform of the US House of Representatives last week.

It gives an insightful view of how the US financial and corresponding regulatory system has evolved and is evolving, explaining in clear terms how the crisis developed and more importantly, how it has affected millions of people whose money were roiled in the process.

Cox also went into detail about lessons learned from the crisis. First, he said, no one – investment banks, commercial banks, or regulators in the US or around the world – had used a risk scenario based on a total meltdown of the US mortgage market, which had been the fundamental cause of the crisis.

Second, Cox pointed out the need to reevaluate supervision standards specifically on investment bank holding companies such as Bear Stearns that did little to prevent its rapid collapse in March 2008.

At the time of its near-failure, according to Cox, Bear Stearns had a capital cushion well above the required standards calculated using the Basel framework and the Federal Reserve’s “well-capitalized” standard for bank holding companies, and yet it still crumbled.

Third, Cox issued a passionate call for US Congress to close the swaps loophole in the 2000 Commodity Futures Modernization Act which specifically prohibited the SEC from regulating swaps. The amount of unregulated financial transactions, according to Cox, is already more than the GDP of every nation on earth combined.

Fourth, Cox asked for legislation requiring stronger disclosure to investors in municipal securities. With the credit crisis having reached the state and local level, Cox said individual investors, who own nearly two-thirds of municipal securities, need to know what they own.

Many municipalities, according to Cox, continue to use interest rate swaps in ways that expose them to the risk that the financial institution on the other side of the derivatives contract may fail.

Cox strongly reiterated his view that voluntary regulation does not always work, as was the case with investment bank holding companies such as Lehman Brothers. And therein lies the risk.

Cox said that the holding company of Lehman Brothers, for example, consisted of over 200 significant subsidiaries, and the SEC was a statutory regulator for only seven of them. The over-the-counter derivatives businesses, trust companies, mortgage companies, and offshore banks, broker-dealers, and reinsurance companies were all outside the SEC’s regulatory ambit.

Conjoined financial system

While we can smugly rejoice in the simplicity of our financial system, and therefore its relatively less risky environment, the failure of Lehman and its undisputedly hurting effect on some of our banks only too clearly illustrates that we are not isolated in this globally linked monetary system.

The complex growth of financial products in the market that have not been subjected to regulation has exposed lethal risks on anyone who has money invested in the financial system, be it simple or complex.

Perhaps the most important change to the marketplace in recent years, from the standpoint of investor vulnerability, is the enormous growth in financial products that exist wholly outside the regulatory system. We simply cannot leave unregulated such products as credit default swaps, which can be used as synthetic substitutes for regulated securities, and which can have profound and even manipulative effects on regulated markets. The risk is too great.

Words of wisdom

What I liked best in Cox’s speech was his wake up call, not only on US legislators, but to all who believe in the basic principles on which the democratic world’s monetary system is based.

“It is time to think anew. We should begin with a clear-eyed view of the purpose of our capital markets. The financial system administered by Wall Street institutions exists to raise money for productive enterprise and millions of jobs throughout our economy, and to help put the savings of millions of Americans to work in our economy.

“It should not be an end in itself — a baroque cathedral of complexity dedicated to limitless compensation for itself in the short-term, paid for with long-term risk capable of threatening the entire nation’s sustenance and growth.

“Transparency has been sorely lacking from enormous swaths of our market. It should by now be abundantly clear that risk in the system which cannot be clearly identified can neither be priced nor effectively disciplined by the market. And it can no longer be tolerated.”

Indeed, words of wisdom. Now, will our legislators and local financial market players listen? Or, will it still be “open season” for glib-talking investment advisers and glitzy investment proposals that prey on naïve, uninformed locals with some excess money? Time to get back to basics on money matters.

Collegiate Champions League update

A reminder to students and collegiate basketball aficionados to watch the exciting zonal championship games at the Makati Coliseum starting November 3 to 6, 2008. Admission is free and the games will feature three regional champions and nine qualifiers from Metro Manila leagues competing for two slots in the FilOil Flying V “Sweet 16” Final Challenge of the 2008 Philippine Collegiate Championship.

The teams are divided into four groups, namely: Group A – Mapua Cardinals; Lyceum-Batangas and University of Luzon; Group B – Arellano University; St. Louis University and UST Growling Tigers; Group C – Lyceum-Manila Pirates; Don Bosco-Mandaluyong and University of Nueva Caceres; and Group D – UE Warriors, EAC Generals, and St. Clare Saints.

The top team in each group will join Ateneo Blue Eagles, San Beda Red Lions, De La Salle Green Archers, JRU Heavy Bombers, San Sebastian-Cavite Baycats, University of Visayas Green Lancers, MLQU Stallions and UCN Golden Dragons in the elite “Sweet 16.”

Students are also invited to log in at www.CollegiateChampionsLeague.net and submit your choices of teams that will advance to the FilOil Flying V “Sweet 16” Final Challenge. Those with most number of correct choices will receive surprise gifts from the sponsors.

For more details about the biggest collegiate basketball event for the year presented by SMART, PLDT, FilOil Flying V and KFC, visit the official website, www.CollegiateChampionsLeague.net and www.gameface.ph, internet media partner of PCCL.

Should you wish to share any insights, write me at Link Edge, 25th Floor, 139 Corporate Center, Valero Street, Salcedo Village, 1227 Makati City. Or e-mail me at [email protected]. For a compilation of previous articles, visit www.BizlinksPhilippines.net.