Moral hazard

Mar 01, 2009 Features / Columnists, Ravi Dev

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Whether we like it or not (and most of us do not like it at all) even the most diehard optimist has to accept that, with CLICO (Guyana) now placed under “judicial management”, even our backwater status did not isolate us from the financial meltdown that started up north. Alas, this is one of the benefits of the “development” of our financial sector, which was forced to “liberalise” under the good offices of the World Bank/IMF. All well-intentioned, we are sure.

This liberalisation of financial markets was an integral component of the neo-con world-view that swept the developed world since the 1980’s, and it may be useful to examine the latter a bit as we ponder what may (or should) be the fate of CLICO (Guyana).
The neo-cons did not just push for a “night-watchman” state that would shrink the government’s role in the economy but one that rejected governments taking any responsibility for alleviating the condition of the poorer elements of society. On the other hand, the loosening of the regulatory framework over the financial sector that had been painstakingly installed after centuries of struggle were all jettisoned on the altar of “small government”.

This retreat from social responsibility, which resulted in the most dramatic transfer of wealth to a small segment of every country that adopted the new dispensation, did not raise many eyebrows. The bottom ninety percent (to be kind) would be satisfied with the spills that “trickled down” and dream of sitting one day at the top table. It fitted in perfectly with the ethos of the age:
That ethos was articulated a half-century ago by the influential thinker Ayn Rand, summarised in her novel “Atlas Shrugged”, which still sells 150 million copies annually.

Basically Rand derided altruism (“breeds immorality and evil”) and trumpeted selfishness (“the highest virtue”). “If you saw Atlas, the giant who holds the world on his shoulders, if you saw that he stood, blood running down his chest, his knees buckling, his arms trembling but still trying to hold the world aloft with the last of his strength, and the greater his effort the heavier the world bore down on his shoulders — what would you tell him to do?”
“To shrug?”

She lionised the human ego, rejected God as an artifice for the expiation of human failures, extolled the separation of state and the economy, and promoted governmental deregulation. Rand inspired a devoted band of followers including Alan Greenspan. He was given the opportunity, following the crucial neo-con takeover years, as Chairman of United States Federal Reserve -1987-2006, to put their theory into practice.

And it seemed to work. By the nineties, after Clinton completed the gutting of substantive financial regulating by allowing banks to join the securities investment frenzy, the bullish stock market silenced all but a few who were derided as Jeremiahs — until the house of cards came crashing down by 2007.
Basically, the flaw with the neo-con model went to the very core of their central premise – the exaltation of selfishness. They miscalculated the power of its corollary – greed, which had been kept in check, however tenuously, by the old regulatory framework. A chastened Greenspan now admits the “flaw” in his model: self-regulation in an arena of greed unbound is performatively a recipe for disaster, which has now reached our shores.

In practical terms, the model raises what is known in economics and related fields as the issue of “moral hazard”. Ironically, in view of CLICO’s collapse, it was in the insurance industry that the concept originated. It identifies the ever-present dilemma posed when people who are insured become more inclined to take risks since they believe that they are protected. Where does one then draw the line?
Business and entrepreneurial behaviour is at the bottom, a matter of taking risks – and society is willing to have those who take risks receive the rewards – if on the whole the entire society benefits. And this last point was the motive behind governmental regulation.

For instance, early on, when the corporation was invented as a “legal body” to encourage investments without threatening personal assets, there were laws enacted to ensure that the facility was not flagrantly abused. Closer home to the present crisis, banks were heavily regulated to ensure that depositors’ money were secure because the state had given them a virtual and literal power to create money. They were forced to be conservative but steady.

However, in the deregulatory orgy of the nineties, many other institutions were allowed to solicit funds from the public and deploy them in highly speculative ventures. The low interest policy of Greenspan encouraged borrowing, which grew into mind-boggling proportions with the governmental subprime policy. Banks wanted a piece of the action; the law was changed and they were allowed to enter the world of high-flying investments – including the newly discovered Philosopher’s Stone – derivatives. If not directly, then through various and sundry financial affiliates – some created specifically for this purpose.

And this is where Mr Duprey and CLICO enter the regional picture. Under the friendly UNC regime in Trinidad, Mr Duprey unleashed a business model that was in the best reflection of the high-flying acolytes of Ayn Rand up north. He wheeled, dealed and leveraged the assets of his inherited insurance company into a bewildering string of businesses that at its peak was worth – on paper – T&T$100 billion. And when the paper was called in, he ran to the Central Bank of T&T. Which brings us to the moral hazard question once again: if the government bails out CLICO which wallowed in the profits from its earlier “risk-taking”, why should the company be rescued for its mistakes now? There is, of course, the ever-present argument of “too big to fail”.

And now, on to CLICO (Guyana). There are several moral hazard questions on the fiasco. Firstly, in the face of internal dissent, CLICO was allowed to reportedly borrow G$7.8 billion from the NIS three years ago – at 5.25%. As with the subprime scenario in the US, CLICO had very little incentive to be cautious with such cheap funds. The company turned around and broke several laws (such as percentage of assets to be held locally) that regulated the insurance industry here when it invested $6.9 billion of that money with its Bahamian affiliate, at some 11% interest. When the regulators here did not impose sanctions for its transgressions further moral hazard issues were raised.

At this stage we are recommending that we send a strong signal to our financial sector that they will have to bear the consequences of their actions by transforming the “judicial management” status of CLICO to a full liquidation – stipulating that the first claim on assets be the pension fund investors. We have to stop encouraging moral hazard.

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