Wilberne Persaud, Business Columnist

persaud

FINSAC, I believe, by agreement of the major political parties, was kept out of political debate in the 1997 elections. At the time it was thought too sensitive an issue for waning confidence in the economy to be the subject of partisan political debate.

But it is an issue that should be debated. I have already committed to print, my views on the process and problems FINSAC sought to address. I did so because the crisis that period of our financial development represents has major lessons for us - lessons we dismiss at our ultimate peril. Also, if we fail to define the problem accurately, we are likely to take the wrong lessons from the exercise.

I should like to lay out the issues as I see them. Of course, this is prompted by Paul Chen-Young's letter published in the Observer of Sunday, August 5. I believe there are issues of fact and elements of his analysis of the crash and FINSAC that do not capture the reality of what actually transpired.

Chen-Young sees FINSAC as a "total failure". Analysis of failure is extremely important, whether the field is structural engineering or social and economic phenomena. For engineering disasters wiggle room for competing technical disagreement is generally small. Not so for economic phenomena. But if we must analyse failure, we need to define the characteristics, the objective of the material - as in the space shuttle - the bridge, the building, the dam which broke, or the process that we deem to have failed.

Indigenous financial crash

Jamaica experienced an indigenous financial services sector crash in mid 1996. We know what a space shuttle is, what it is meant to do. We know when it has failed. What is a financial services sector? What is it meant to do? How does it fail? It is that part of the institutional operations of a modern economy that intermediates between and among savers and excess spenders in an economy. It garners loanable funds, seeks and places investment, assesses and issues loans, manages pension funds, provides insurance services calibrated to provide efficiently and optimally for risk.

In capitalist economy, financial services are the most regulated of all business types. Fundamentally founded on trust, uniting in contractual arrangements highly unequal knowledge and understanding among people, this is only to be expected. Even so, throughout history, bubbles have been created and burst. Invariably after a bust, new rules are created to avoid the causes of the last one. That we can all agree.

We can all agree too, that the crash relates to indigenous institutions since foreign banks did not collapse. How should we define crash? Well, the busted institutions were unable to deliver the services they were created to provide. They were unable to meet depositors' withdrawals, pay pensions and settle insurance claims. In other words, they became insolvent. This is the failure we must first analyse. Second, to determine if Chen-Young is correct, we must assess FINSAC relative to what it was created to do.

In trying to understand failure, we can identify proximate, as opposed to fundamental, root or ultimate cause. So insolvency is a proximate cause of the crash. But what led to insolvency - the inability to cover depositors' withdrawals, pay insurance claims and service pensioners contracted payments? If we can answer this question, we will have arrived at ultimate cause. This is where opinions differ. Chen-Young has consistently placed responsibility for the failure on government monetary and fiscal policy. If this were true, then all of the financial sector should have crashed. Since this was not the outcome, it is not possible for fiscal and monetary policy to have been the ultimate or root cause of the crash.

Complex interaction

The ultimate cause is a complex interaction among government policy, legislation and oversight and decisions taken within that framework by borrowers, lenders, fund and investment managers and risk assessment professionals - to the extent they existed - in the indigenous financial sector.

As mentioned, an instructive detail too often overlooked is the fact that foreign-controlled banks did not fail. Operating under the same conditions as the indigenous financial institutions, they remained conservative, stuck to 'safe' activities, core business and did not create in-house vehicles dedicated to risk taking and speculation. They also avoided 'developmental' but risky activities. On the other hand, extant legislation and oversight coupled with government policy encouraged the indigenous part of the sector to shift from 'safe core activities' and move to developmental activities for which they were ill-equipped. Following upon this, intense competition among groups created funding difficulties which they 'solved' by intra-company lending and issuance of expensive short-term obligations - all in the context of high and rising interest rates.

A quote from my book, Jamaica Meltdown: Indigenous Financial Sector Crash 1996, explains the development of conditions leading to the crash:

"During the late 1970s and early 1980s, the existing financial system exhibited discernible gaps in providing financial services. The need to fill such gaps could be exploited by enterprising companies. Local entrepreneurs began considering participation on the stock exchange, fee-based money management, 'deal-making' and financial intermediation in general, all woefully underrepresented activities in domestic financial operations. Here were potentially exceptional profit-making activities, crying out for fulfilment in the burgeoning market economy. Existing legislation and its associated regulatory framework permitted formation of merchant banks and building societies with relative ease, indeed almost effortlessly. This period might accurately be described as being characterised by the creation of competing 'stables of financial intermediation', 'financial arcades' or 'malls' …

"The previously existing firewall constructed between and among banking, insurance, money management, and other financial services was jettisoned like so much useless ballast. In reality, operation of the 'group', as owners, principals and their corporate lawyers preferred to name them, literally demolished the firewall between banking and real sector activity - real estate ownership and speculation, operation of farms and other types of businesses. Invariably within a 'group' there would reside a merchant bank, insurance company, commercial bank, building society and perhaps a mutual fund or unit trust. These developments led and coincided with strong growth in the country's financial services sector. However, the real sector was not recording commensurate growth. Furthermore, the number of financial institutions was truly mushrooming. By mid-1990 Jamaica boasted eleven commercial banks, with more than 170 branches and/or agencies. There was one commercial bank branch or agency for every thirteen thousand persons - men, women and children - in a population of barely 2.4 million."

Financial services provided approximately four per cent of GDP in 1975. By 1987 its value was seven per cent and by 1994 it reached a high of 16 per cent. All of this occurred while the real economy was either not growing or growing at less than three per cent.

wilbe65@yahoo.com