Friday, February 06, 2009

Victims of Global Financial Dis-Order

Victims of Global Financial Dis-Order – Credit Linked Financial Products investors

The present financial-economic crisis that we are experiencing now is mainly due to the collapse of the Global Financial Order. The present Credit Crunch is just the result of the total loss of confidence in the Global Financial system.

Financial innovations fuelled by drastic financial deregulations carried out by numerous governments around the world has created an artificial boom in the financial economy. The multiple leverage created by the various new financial derivatives has provided an enormous multiplier effect to the growth of the global financial system. It has also become the fuel to greed and socially irresponsible actions by various individuals and institutions.

Moral hazards were breeding rapidly among a system that puts too much emphasis on monetary performance but resulted in the total neglect on moral obligations of financial institutions to the health and public confidence to the whole financial system.

Products like CDOs created moral hazards which result in irresponsible lending by financial institutions, which transfer risks to other investors in the process. Credit Risk swaps and complex structured products are basically created to remove risks from financial institutions which in return, created moral hazards in allowing them to take more risk than they could bear in normal circumstances in search of higher returns while transferring risks to unsuspecting investors.

The unhealthy competition among cities and countries in wanting to position themselves as “regional financial centres” has caused reckless deregulation process in these places. Hong Kong and Singapore are prime examples of such reckless deregulation due to overzealous of their governments in competing to become regional financial centres.

Minibond and other similar credit-linked structured investors are victims of this financial dis-order created by the combination of Financial Moral Hazards and the reckless deregulation initiated by various governments seeking to become regional financial centres.

High risk and dubious structured products which are being rejected by many countries to be sold to retail investors finally find their ways to these places which welcome them with wide open arms. How could these complex structured products which has high risks as well as potentially damaging financial moral hazards embedded passed through these respective regulatory bodies is still a huge mystery.

The irony is that these products are being disguised as “low-medium risk” products by using deceiving credit ratings, product names as well as big corporate names to create psychological delusions to investors. In some cases, it is really amazing that big financial institutions could “buy insurance” from retail investors which in return, provided these institutions huge funding that they used to invest in high risk financial products. These financial institutions, using a combination of credit risk swaps and investment in high risk CDOs, seek to reap off high returns using totally risk free funds provided by retail investors. Instead of paying for the insurance they seek (or just that this scheme of using big credible reference entities is just a smoke screen utilized to hoodwink unsuspecting investors?), they are actually trying to make money out from the insurance they are buying!

Legal Disparity

Law is the basis of stability and order for the society, country and even the whole world. Law could become such a tool of social stability basically because it commands respect and trust from ALL people that comes under its prerogative. The respect and trust of this legal system comes from the fact that the Law is supposed to PROTECT the interests of ALL people, not just SOME people. In order to do this, everybody is supposed to be EQUAL under the law.

However, what happens in this crisis is in total contrary to what we used to believe. Law has become the accomplice of this financial dis-order.

Imagine that an investment bank like Lehman Brothers could circumvent the law of its country of origin, USA, to open an empty shell company in some small country in pacific ocean to issue huge amount “NOTES” which are named misleadingly as “Minibonds” and sell them to retail investors who are thousands of miles away in the other end of the world.

And when Lehman Brothers went bust, its receiver could actually go to an American Court to protect its interests over the supposedly banned financial products! Furthermore, due to the complicated process whereby these products are created, normal retail investors will find it hard to have the resources and means to seek legal redress.

The prospectus are so well written that not many people could possibly know exactly what these products are, but they did very well in protecting the interests of the issuers in every ways. The Law effectively protects the interests of the issuers but ignore the fundamental common sense of natural justice and the potential huge injustice embedded in the moral hazards of these products.

The situation is being aggravated by the fact that places like Singapore and Hong Kong do not provide a cheaper, efficient and effective avenue for investors to get legal redress. Unlike USA, Hong Kong and Singapore's inheritance of the Commonwealth legal system does not provide class action litigation for these victims.

If such injustice and imbalance of care provided by the Legal system would definitely erode the confidence, respect and trust of the people at large. It would further enhance the perception that the Law is basically a tool to protect the interests of those big, rich and powerful institutions rather than providing a fair and just platform to protect the interests of everybody else.

Over Sold Credibility

Once upon a time, the global citizens at large would trust the Banks to provide them a safe haven for their hard earned money. But this crisis is so serious because Banks and financial institutions have over sold their credibility.

Banks and financial institutions play a very important role in modern world economy as intermediaries for money to be kept within a system that could provide efficient transfer of savings into investment for the global economy. This provide funding for businesses to invest and function with certain leverage. For example, if there are no banking facilities as breaching funds for trading companies, world trade may be adversely affected. Part of the world's problems now is due to the rapid contraction in the role of Banks and financial institutions in financing trading.

Of course, there are huge part of the funds in these institutions that are used in speculative investment in highly leveraged structured financial instruments and derivatives like futures and options.

Traditional banks may only act as an intermediaries in taking money from depositors, paying them an interests and then make loans to businesses and individuals for their investment in properties, machineries, vehicles etc. But all these have changed in the 1990s and up to the early part of this century with deregulation.

In the old days, depositors have trusted banks with their money for safe keeping as well as providing them a certain interest return. Most of the depositors do not want to invest their money in medium-high risk products like stocks, shares, commodities, foreign exchange or even bonds. This is primary reason why these depositors preferred to keep their money in the banks, some in fixed deposits.

But due to the financial deregulation and the shifted paradigm in the role of banks coupled with greed and desires of banks to earn “easy-quick” money, banks begin to sell investment products. Banks have tremendous credibility built up with their clients but in search of higher return, less risk and quick money, banks begin to abuse such trusts. In the beginning, they started off selling seemingly “safe” unit trust funds then insurance-investment products. These products allow banks to earn a percentage from the sales immediately without the need of the banks to take the risks of lending out money to businesses or individuals. The logic is pretty neat. Instead of taking in deposits from depositors and lend them out and bearing risks of bad loans, it would be easier to earn money by selling these financial products!

Couple with low interest rate in the new century, banks begin their aggressiveness in earning quick money. They abuse their position as safe-keepers of depositors' money, getting privileged information on the amount of money their clients put into fixed deposits and embarked on a systematic targeting of clients that have huge sum of money in fixed deposits in their accounts.

The worse part is that, there seems to be evidences from the combined information we get from Minibond-DBS High notes and other structured credit-linked victims that the banks have deliberately trained their front line sales persons to use specific misleading words to sell these products to their clients. They understand their clients as those who would prefer to put their money into low risk fixed deposits, thus, phrases like “just like fixed deposits with fixed interests”, “can guarantee get back capital because it is capital protected”, “very low risk because the reference entities are all very stable companies” etc. These sales talks are specifically designed and targeted at this specific group of fixed depositors.

Many people accuse these victims as greedy investors but in our view, the banks and financial institutions are the most greedy ones. They have misled their clients to buy something that their own sales persons may not even understand totally and resulting them to take up higher risks than any fixed depositors would want to take. Their clients took all the risks while they themselves bear no risks but earn immediate return as high as their clients!

Unwittingly, these banks and financial institutions have over sold their credibility this time round. Making the first mistakes as irresponsible sellers of these products to clients that trusted them is already a bad move. Brushing aside all responsibilities and refusing to bear social and financial responsibilities to their clients after things went bad is really an act of putting a nail in the coffin of their fragile credibility.

Implications of Credibility Crisis of banks and financial institutions

It seems that many of the world governments do not see the seriousness of this Minibond crisis. The world is facing a serious crisis of confidence and liquidity crunch. But the more serious problem lies in the credibility crisis of the whole world banking and financial order.

If the world's banks and financial institutions are now being viewed as untrustworthy entities in their dealings with depositors' and investors' money, what will happen next would be a rapid withdrawal of money from the whole world's financial and banking system.

It is easy for governments of the world to deal with potential bank runs and the domino effects of bank runs by giving 100% blanket guarantee to deposits. But it does not solve the growing discontent, distrust and erosion of confidence in the banks and financial institutions. Investment in financial instruments which act as a very important financial intermediaries that provide funds to world businesses will drop drastically. Unit trusts, fund managing services, insurance, hedge funds will start to shrink or even collapse.

This will effect a snowballing de-leveraging process which may eventually result in the collapse of the whole world's financial order. This may sound a bit exaggerating to many people but the truth is, the second wave of this financial crisis may just develop into that direction very soon.

Rebuilding the World financial order

It is important for the world's governments to come up with a complete solution to this financial chaos that we are facing. The Minibond saga may be a small part of the puzzle of the whole financial chaos but it is an important part in this part of the world because the credibility of the banks and financial institutions are at stake.

Just like what happens in the collapse of the Gold Standards in the early part of last century, we are now in a period of transition from a massive financial chaos created by the destruction of confidence and credibility of the banks and financial institutions to a new era of new financial order.
While the world search for a new order and solutions to maintain stability within a globalized financial system, the most critical part in saving the dying credibility of the banks must be carried out. A world political solution must be provided to rebuild and regain public confidence in the whole banking and financial systems in this world.

The task of bringing change and making these financial institutions to be responsible to their ill-considerate actions of greed should be born by governments of the world, especially so for Hong Kong, Taiwan and Singapore governments. This is because with the flaws of the legal system and the apparent legal disparities that exist within the system, the victims will have little power bring these financial institutions to task.

Fair settlement

Moral hazards exist while financial institutions, in search for highest returns by using other people's money. Moral hazards also exist when investors invested irresponsibly with their money seeking for highest return but knowing that they could get away from taking responsibility for the risks they take.

Thus to me, a fair settlement for the Minibond saga must address adequately the problems of moral hazards of BOTH sides. It must also address the responsibility of the regulators.

I would suggest the following allocation of responsibilities to each parties:

1) Banks should bear 50% of the responsibility as they earn fees from such transactions and they are suspected to use unethical sales tactic which may amount to serious systematic mis-selling.

2) Investors should bear 30% of the responsibility. Investors must learn the basic rule of investment, no risk no gain. When the return of a product is higher than their fixed deposits, there must be higher risks involved. Thus, in order to prevent future improper investment decisions by other people as well as reducing Moral Hazards of investors, they should bear part of the responsibility.

3) Governments, as regulators, should bear 20% of the responsibility for the lapses in their role.

In my opinion, such settlement would be a fair settlement for all and it addresses the respective allocation of responsibilities among the main players. Such a fair settlement may set a good reference example for the future New Financial Order for the world. An important message must be sent to all these financial institutions that they just could not hide behind a barricade of legal disparities and wash their hands off from irresponsible dealings.

Social Justice as the basis of Social Confidence in Financial Order

It is important to maintain social confidence in times like this crisis of confidence. The only way to maintain social confidence is for us to see social justice is being upheld.

The New World Financial Order needed much of the social confidence from the whole world to function. But before such social confidence and credibility of this new order to be established, Social Justice of inappropriate financial dealings must be seen to be done.

Minibond saga is one of the most prominent financial injustice that needs to be solved immediately, in order for the world citizens to start regaining their confidence in the global financial system again.

I would urge the world's governments to look into this matter seriously to effect a just and fair settlement to the Minibond saga. The Minibond saga is significant because it involves global financial workings and processes. It exposes the inadequacy in the global legal framework in dealing with such complex financial dealings which involve multiple parties across the world. It affects victims from multiple places and countries and IT IS A GLOBAL FINANCIAL PROBLEM.

The complexity of the Minibond saga is far greater than anyone's imagination. The implications of this Minibond saga is far greater than the world thought. If this Minibond saga is not solved fairly, I do not think there will be any confidence left for the present and future financial world order.

Goh Meng Seng

No comments: