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The Gleaner - July 27, 2000

 

Chen-Young and FINSAC

LARGE-SCALE financial sector failures have bedevilled a number of countries in recent years, not least Jamaica. I recently read an account of what happened there by one of the bankers most severely affected, and then talked with the author himself.

Dr. Paul Chen-Young's monograph is entitled, With All Good Intentions: The Collapse of Jamaica's Domestic Financial Sector.

It was published a year and a half ago by the Centre of Strategic and International Studies (CSIS), a respected think tank here in Washington (www.csis.org).

Although much has happened since, the author tells me his views have not changed.

But how, you ask, can a man whose personal loss was so substantial analyse the events of 1996-1997 without bias? I cannot say that Dr. Chen-Young is a dispassionate observer, only that his explanation of what went wrong, and his views on how the government dealt with the matter, make interesting reading.

Dr. Chen-Young describes the bleak economic background against which the sector failed. "Money supply fluctuated sharply, inflation and bank lending rates were high, and exchange rates plummeted." Growth was only 0.3 per cent between 1990 and 1997. Businesses had a hard time servicing debts, and this spilled over into the banking sector.

Banks, I think he would agree, suffered doubly because they had not been as rigorous in screening borrowers as they should have been. It was in this climate that both merchant banks and life insurance companies made a bad miscalculation: they invested in real estate and tourism. The merchant banks did so to earn the US dollars that would protect them against high inflation and a falling exchange rate. The insurance companies had those reasons and another one for their foray into properties.

They had traditionally maintained their cash flow by selling highly profitable endowment (whole life) policies. In high inflation periods, however, the public tends not to buy these, demanding higher rates of return. This prompted the insurance companies to offer high returns on short-term investment instruments. Then, to pay for these funds, they invested in long-term ventures which did not generate enough to service their interest costs. That proved their undoing.

The former banker is forthright about his own case. "The investments by Crown Eagle Life Insurance Company in the real estate sector proved to be untimely and were the main cause of the eventual collapse of the Eagle Financial Network."

So far, I imagine, many would agree with the author's analysis. Then Dr. Chen-Young's paper steps into controversy. First, he defends financial conglomerates and disputes the idea that a 'Chinese wall' is needed between banks and insurance companies (clearly the policy that the Financial Sector Adjustment Company, or FINSAC, is now implementing).He says, too, that international trends support this view.

What went wrong, he contends, was that financial entities invested not only in one another but in commercial enterprises. The cure in his view is not to do away with financial conglomerates, but to regulate more strictly the kinds of investments they can make while enforcing the limits on lending to connected parties.

Second, Dr. Chen-Young notes that FINSAC saved entities like National Commercial Bank and Life of Jamaica, while letting others, like the Eagle Financial Group, fail. All, he argues, would have folded without FINSAC's assistance; or, put positively, "any one of Jamaica's troubled financial institutions could have been saved with (government) support."

Arbitrary decisions

Why did FINSAC act as it did? "Only FINSAC has the information necessary to justify its discretionary treatment of the various troubled financial entities." Elsewhere, however, the author implies that the "size of the insolvency" may have been a criterion in the government's eyes, a criterion he rejects. "An entity is either solvent or insolvent, and the size of the insolvency should not be used to justify which entities deserve to be saved." What is important, he adds, is a company's future viability and its management's capacity to succeed.

Third, Dr. Chen-Young raises FINSAC's treatment of directors, asking why directors of the FINSAC-saved firms should be regarded as "fit and proper" while others are not. They all would have been in the same boat, he told me, without arbitrary decisions by FINSAC to rescue some institutions and not others.

There's a good deal more. Anyone interested in Jamaica's financial sector will find this monograph stimulating reading.

 

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