Tag: Economic and Finance

DELIVERANCE FROM ERROR

The above title comes from a book of a famous Muslim Scholar, Al Imam Al Ghazali (1058-1111 AD); of which has brought a lot of interest to me. While the book serves almost a self written autobiography of himself, it’s core theme was, how Al Ghazali, through his pursuit of knowledge and seeking truth, discover that the quest itself is a never ending process – but only serve as a sincere efforts to raise ourselves away from series of errors. The lesser the errors are the better you are. Human, being an imperfect creature can only achieve thus; and no more – because the final and absolute truth only remains with God. The lesser you err, the closer you are to God (and hence the Truth).

On the same subject, I also read from the Philosopher Prof. Karl Popper, explaining almost exactly the same subject, based on the western philosophical tradition (of Socrates, Plato – of the Greeks; and of Immanuel Kant and others of modern philosophers) in the following manner: that “Truth”, while it should manifest itself, only can be obtained through our efforts to uncover the “Ignorance”; the lesser our ignorance are, the closer we are to the Truth. In fact no knowledge can be said to be absolute, since the absence of any falsifications of it (i.e. any proof of it to err), does not by itself proof it to be correct. It only proof that “thus far” we are not wrong, until someday, someone may proof that it is wrong. In the meantime, it remains the “Truth”, as we best understood it.

The above two philosophical contributions, while sounds obvious (to some) or complex (to some); actually has a lot of relevancy to our daily lives. In particular, about how we organize our society, government, economies and etc. Before I go further on this subject, let me bring an example that most of us who have studied Physics are familiar with – and demonstrate the above fallacy of “Truth”. During the Renaissance, Johannes Kepler, came out with what is known as Kepler’s Law – which explains about the Earth rotating the Sun in an elliptical movement. Off course, Kepler was earlier shunned and rejected by the Catholic Church since it was against the “Truth” that was held by the Church. In another word, Kepler uncovers their errors. It was held for so long that Kepler was right, until Newton came up with the famous Newton’s Law –which rectify some of the errors of Kepler’s Law (the movement was not exactly elliptical, but close to it, following the Newton Law of gravity). Everyone then touted that Newton’s finding is the final and absolute Law; that is until Einstein, started to challenge this notion, and finally come out with his “Theory of Relativity”. Which in effect rectify the errors in the Newton’s Law. We have to realize that Einstein do not claim his finding as the “Law”, because he knows that it is only “true” to a limit, until further discoveries and findings in the future that can rectify any errors left in his theory. It is also noteworthy that people live and accept Kepler’s Law for over two hundred years, before Newton came out with his; and another 150 years more, before Einstein corrected Newton. In another word, we can live with erroneous assumptions for hundreds of years!

Now let me come back to the subject of our concerns today. In order not to go too deep in discussions, I would lie to bring only two issues to highlight. First is about the capitalistic economic system, and second, about the methods of governance (namely democratic system) – and all the facets of the systems that we are practicing today. It is assumed and accepted by most people that this are the two best systems and presents the triumph of mankind over the quest for economic system and governance. The question is: are the human beings committing the same “error” as I described above? Unfortunately, that is exactly what has happened, and are all too pervasive in today’s society. In particular, the obvious case is the United States and all western powers that existing today.

What’s wrong lie with the assumption that we have found the perfect solution to our problems – namely Capitalism and Democracy. We all know that Marxism, Socialism and other’s didn’t work (and hence errors); and it is even much more wrong to assume that we should go back to those tried and failed systems. The fact is: the two systems that are “best” actually remain imperfect; and therefore, at no point we should rest on our laurels and safely assume that everything will work accordingly. It is now becoming clearer that Democracy, could and only works well with other systems such the media, education, and other supports systems works together with it. The case of capitalism is even worse – it breeds a lot of fragility, crashes and instability throughout the world.

The fact that, how certain things can go wrong in a big way, and escape the attention of almost everyone over a long period of time; is rather frightening. For example, how could the US housing bubble can grow so large (into trillions of dollars over ten years), without anyone even realizing that it could blow up in a devastating manner; is rather troublesome. This happened, despite the internet access, media, extensive data collection systems, countless professionals and bankers in the field. It begs the question why? Off course it is easy to come out with simplistic theory such as the US conspiracy (or Jewish etc); but I found that to be rather absurd. In my observation – the whole thing goes back to what I started with earlier: ignorance of our errors. Everyone has become so confident that the systems will work and will self rectify and self correct through the efficient market mechanism. That fundamental believe is at the core of the problems. This arrogance and over confident is the root of all evils that make us to be blind.

Capitalism and Democracy, while stands as the best available solutions, are in fact second best. We should never stop in modifying and challenging both systems in order for us to get a better system. This is the same manner that human should not stop at Newton’s finding, and hence there would be no Einstein. Similarly, nobody should stop at Einstein, and we should continue to pursue perfection of our knowledge (though as Al Ghazalli says, that itself is a never ending quest).

If we apply the same logic to the case of Malaysia – is an even more daunting and clear. Our democracy is way from perfect – even at its most basic element: we have no free media; voting arrangements and independence of the apparatus such as the police, civil servants, election commissions, and the judiciary are not present. Furthermore, of late, we have seen that some parts of the Constitutions are being challenged (since we rarely get into such situations before – and only now we realize that such things exist); the role of the Monarchy is being challenged and questioned. And off course, we have UMNO and BN – which are in deep “ignorance” of their own. At the same time, we also have less than perfect oppositions in the forms of Pakatan (PKR, DAP, PAS). And even more still we have people who enter into politics (from both sides) – with varying motives and targets; most are personal, while some are truly commendable.

When we talk about economic system and management – it is even worse (in my opinion). There are very little, if any, clear and coherent economic arguments and thoughts that went into almost all policies of the Government. Open and serious economic debates among the leadership and the society are almost non-presence. The assumptions that things will work by almost in verbatim adoption of other peoples approach and methodology is rampant.

If any lessons that we can take, it could be summarized as follows: as a society, we have to acknowledge that it is our task not to err, or to err as less as possible. Blind faith, acceptance without reasons and questions is bad practice. To succeed and thrive, we need to “deliver ourselves from errors” on a continuous basis. We as Malaysians today, are indeed on many path of errors that need to be corrected. To be critical, thinking with sound judgments and acceptance to reform – is probably where we all should start with. Arrogance and over confidence – on the other end; only further the cause of “errors” and breed crisis and collapses of the societies.

Note: The Arabic title of Al Ghazalli’s book is “Al Munqidh Min Al Dhalal”.

TOO BIG TO FAIL & MORAL HAZARDS

Of late, when you hear the news of bailouts by Governments, it will be linked wit the words that it has to be done because the banks are “too big to fail”. It may make one to wonder why if it is too big, then it cannot fail. If failure only applies to small players, then it seems that the playing field is to advantage of big players. It does not matter what you do, as long as you are a big player, the governments would not allow you to fail. This is the message that is what’s troubling me.

In this article, I would like to, first explain on what is meant by “too big to fail”; then explain about the problem that it poses in the long haul in regard to what is termed as the “moral hazards” as the economist generally used to explain it; and finally relates to what we can learn from the ongoing issues in regards to these “bailouts, too big to fail, and moral hazards” business.

Why Citibank, the big three US automakers, AIG, and others who are “too big” cannot be allowed to fail? The answer is very simple: the ripple effects are so large that it will be a total systemic failure (in case of banks – to financial system; in case of automakers – to the industrial base of the country). The banks (e.g. Citibank), are part of the symbiotic and intricate financial system, that practically is present in almost every facets of other banks and financial system. If they fail, it will cause a massive bank runs, and it will trigger and starts an overall panic that will make the whole system to crash. It is simply a scenario that won’t be acceptable to anyone and by any means: because when that happens, even the governments won’t be able to do anything, and the damage will be so severe. In regards to US automobile industry, it may be a bit different, because it is not the financial system that is at risk, but the overall industry is. Therefore, despite the emergency calls by these companies, the US Government is not as fast to just readily agree to their bailout program. The difference here is one is systemic failure, while the other is not.

The question that may be raised (which somehow has been avoided in the mainstream media): is why the governments did allow these companies to grow so big, and became almost a “monopolistic entity” to begin with? Why do we have such “monster” companies that eventually became something that eventually point the gun to the governments and tax payers that says: “save me, if not I am going to kill you”, kind of thing?

If that is the case, we can also imagine that one day, for example, in the case of Malaysia, the IPP (independent power producers) can say to us that, we have to save them if not the nation will have an immediate blackout! Or we can have the telecommunication companies that will ask us to save them, if not we will be totally out of communication systems, and so on. We may not realize it that in Malaysia, our TNB is almost at the mercy of the IPP’s by certain measures. Similarly we cannot UEM fails because almost the entire nation’s highway system will “go along with it”. In fact the government did save Renong (the predecessor to UEM) after the 1997 crisis, because it was at a clear risk of falling into foreigner’s control (at the time).

This is where the issue of moral hazard came into the picture. It is well known among economists that moral hazards are bad for the economy and is very costly. First, let me just explain what moral hazard is about: it is about when someone (in this case, the management or shareholders of the company), takes decisions (whether risky or not) for the company that will benefits them; and yet let some one else bear the costs of their decisions should anything went awfully wrong with their decisions (in this case the taxpayers); and they will walk away freely (with possibly some smaller losses on their part, compared to the cost to the taxpayers). All these “bailouts, and too big to fail business”, are clear examples of moral hazards. The funny part is that all of these are done, accepted, and approved by everyone, including many economists and governments alike. Most of them fail to see or raise the issue that all these moral hazards are a result of the design of the system: that is to favor the big players. That is the asymmetry that I would like to point out.

In the case of Malaysia, we have many examples of highly concentrated dependence and reliance on “big players”. For example, our banking system has been always geared towards only big banks. The mergers and acquisitions by local banks over the last 15 years are to create “lesser number of banks, with much bigger sizes”. The same trend is also true: we create one massive plantation company by the name of “Synergy Drive” and in the process eliminate two plantation and property companies, by merging them into one. Today, by having the palm oil prices at a new low, the whole Synergy Drive Group is badly affected. Similarly, by having big government owned companies who has the capacity to monopolize the market, we are squeezing the smaller players into disadvantaged positions. So are we going to continue on this trend, and may be one day we will face the same question that it may be too big for us to let it fail? Are we then inviting moral hazards to come into play? By having only a few to decide on what can happen to the company, and if any major trouble come, they will just let the taxpayers to have it?

I believed that in light of what’s going on, we should seriously review these policies and approach. The mantra that “big is better” may not necessarily hold true; and may only be the case in exceptional situations. Anecdotally, in the case of construction industry, I have seen smaller Malaysian companies thriving and performing well in overseas market, compared to the mammoth of UEM, which most of the times failed to perform in an open market environment. May be we should review our policy by supporting smaller and more vibrant players from our market as they venture overseas and developing markets and jobs for Malaysians abroad. May be, we also allows smaller and organized players to enter into domain that are generally thought should be allowed only for big entities, such as in the financial services arena. While these suggestions are general in nature, I believe that they have merits to be thought out and deliberated properly so that we can take lessons from what’s going on and hopefully use for our own advantage.

If statistics is of any help: the law of large numbers say that if an average 30% business will fail; then if we have 100,000 businesses, 30,000 of them will fail; while the number sounds a lot, their failure will not affect others. But in case of when we have only 10 companies, if 3 of them fail, and furthermore since they are not independent from each other, all the 10 will fail as well – is a not acceptable scenario.

MARKET CONTAGION & MALAYSIAN ECONOMY

Over the last few days we have seen the stock market throughout the whole world tumbled down like falling snow avalanches. On average, the markets throughout the world has dropped anywhere in the range of 30% to 40%. The total amount of value that has dissipated is in few trillion dollars. The trend will continue for a while and it seems that there is no abatement anytime soon. Why did the market dropped? This is the question that deserve some answers.

The key word is: contagion. This is the same disease that afflicted the East Asian markets in 1997 (and all other financial crisis of the past), that, when one market started to fall due to some reasons – investors believe that others will fall too – and this believe feeds into investors psychology, and everyone believes that everyone believes in the same things – then everyone will start to rush for the exist (or stampede) and sometimes it will become a major panic scenarios.

When the US markets fell, which is due to sell-offs by banks and fund managers, as flight to quality (or increased “risk aversion” attitude), the Dow took the heavy plunge. This is probably one of the “unintended” consequence of Basel II (and all the Risk to Capital requirements), as the Banks capital got eroded by the crisis, they have to get rid off riskier assets off the book, in order to meet the minimum Risk/Capital ratio requirements. Once the Wall Street crashes, the rest of the markets follow suits as the contagion spreads on, and then the whole process continues unabated and a self-feeding mechanism took place.

So, why am I worried? (Since I am not a player in the markets – if you are a market player, off course you should be dead worried). I am worried about the long term impact of the stock market drops on the economy (global and domestic). Losses of this magnitude (few trillion dollars -is roughly about 15% to 20% of the World GDP), will have a massive impact on the Global economic growth. This impact is not immediate, and will have about one to two years lag. Which means that we will see the full impact of it in the years 2009 and 2010 onwards. This will bring us a Global as well as local recession, which translates to unemployment, loss of income, slower business environment, and so on.

Will Najib (or whoever the new leadership of the country under UMNO) be prepared to brace for these upcoming tough environment? Under Pak Lah, we have seen how the economy was “poorly managed”: for example, the fuel subsidy. It was done in a haste (as if the Oil prices will remains above $100 for a while), whereas now we can see that it has come down below $100 – and yet we have put in motion an inflationary trend that was the highest in our history. If better calculation was done, probably, a lesser negative impact could be accomplished.

At the same the fiscal management of the country has never been that much in good shape. Hardship times calls for scaling down and curtailing things that are excessive (which should not be there in the first place). One of the example is the so-called PFI (Private Funding Initiatives) program – which as the title implied, government projects to be funded by private money. An example of such project is Syarikat BLT, which got the award for many government projects such as police quarters etc., to be build-lease-the transfer to government. BLT then parcel out and awarded the various contracts to various “politically linked” parties to perform the jobs. But where does the money comes from? Employee Provident Fund and Bank Pembangunan. EPF funds the equity and Bank Pembangunan gives loans to the contractors.

If this is what is meant by PFI, then it is a total mockery -as EPF is never “private” under any definitions, as all the money belongs to the public contributors. The same scheme was also structured for the various “development corridors” – which fortunately (case of PGCC is an example), cannot continue due to changes in state governments.

Let us hope that the crisis and contagion has much limited effects on Malaysia, so that the impact will be lesser. However, hope alone will be futile, as we also would require good leadership, to rest our hope upon.

THE US FINANCIAL CRISIS – CONTD

Today the US lawmakers rejected the US700 billion “bail-out” package proposed by the Bush administration. With that the US stock market plummets by about 7%, single largest drop in the last many years. At the same time we hear news of failed banks in Europe which are being nationalized – Fortis Bank, Bradford & Bingley in UK, and HRE in Germany is next line. In the US Washinton Mutual failed by end of last week, and we have Wachovia bought over by CitiGroup. I am very sure that these won’t be the last news that we are going to get.

What’s happening is exactly as I have explained before, “settlement risks”, which seems to be getting even tighter: no banks willing to extend any line to other banks. An almost a total collapse of confidence, which drive liquidity almost totally dry. It also seems that any amount being thrown in by Central Banks (which it seems that globally that’s whats being done), are of little effect to ease the problem, since any amount thrown in, will be kept by the Banks to themselves to fend off impending runs. It is just like throwing things into a sinking hole, you never know when it will fill up.

Now come the question, what will happen next? It seems clear to all that somehow the US will get a bail-out package done, albiet, a slightly different version sometimes within this week. In the meantime, it will be a real-time “stress test” that bankers always talk about to the maximum (“the stress tests shows that even such and such happens – this investment products will not fail”). Under this scenario, the US stock markets will tumble down on a roller coaster and drag along the global markets with it; as the “stress-test” continues, many more banks and institutions will fail – being taken over or nationalized of some sort. So far we have not seen losses of confidence by the Global “Sovereign” investors yet, such as China Central Bank or the Middle East funds, dumping US treasury bonds. I can bet that despite all the things said, their nerve is under severe tests as well. Despite all of these, I do not think that we are at the risk of total economic meltdown. Globally, there is enough money to go around and economically speaking, the real sector are still generally robust. One of the final result that I am sure of is that the US Banks and financial institutions global dominance is almost over.

Finally, just to answer one curiosity: why US700 billion? and is it enough to solve whatever problems that exists? The answer to both: ambiguous. The closest answer that is logical is that that is the amount that will get the “settlement” risks uplifted; another answer is that it represents 5% of total US mortgage outstanding (US14 trillion); and so on. Will it solve the problem? Nobody knows, as the whole measure is more of confidence building or “strong signal” to the market to get back into working order. As I explained above, it is a sinking hole that you want to plug rather fast, but you can’t never be sure how.

For now, at least our economy and markets, looks better then them; and may God continue to keep it so.