 |
| Olu Akanmu, courtesy FinancialNigeria |
It
is important to lend additional voice and question the rationale behind
the federal government N22.6 billion bail-out of some capital market
operators. It is tantamount to rewarding bad behavior and excessive
risk-taking at public expense. For the stock broking firms that will
benefit from this largesse, if their investments have been profitable
and they made a kill in the capital market, they would not have shared
their profit with the public. The action of government is therefore
tantamount to endorsing the privatization of profits and the
socialization of losses if you have the lobby and the political
connection to dumb your losses on the Nigerian people. By setting this
precedent, the government has further ossified the moral hazard problem
in our financial system. If an investor taking an investment risk knows
that he can appropriate his gains but can pass his losses to another
party, he will take excessive unreasonable risk as he has nothing to
lose.
This
moral hazard problem was at the heart of the misbehaviour of investment
bankers in the recent global financial crisis, when they could made
huge bonuses if their bets worked out but pass the loss to shareholders
if it didn’t. This coupled with the implicit guarantee of their risk by
the public especially if they were “too big to fail, essentially a
public subsidy of their risk further compounded their bad behaviour.
They created a tower of complex financial instruments that had little
bearing to their underlying assets, played roulette and casino at public
expense, made initial huge gains which they pocketed until their
financial derivative instruments fell like a pack of cards.
Where
these investment banking businesses shared a common capital base with
retail banking as one organic financial institution, essentially
leveraging public deposits in their banks to trade, they created assets
that wiped off the bank’s capital and public retail deposits in their
institutions. Where they were big banks, sometimes with a century of
public retail deposits, the financial system was put a systemic risk of
collapse and the state have had to intervene to bail them out largely to
protect public deposits. This experience has fuelled calls for the full
organic separation of investment and retail banking in the financial
system. It is difficult to understand how this logic of bail out applies
to the stock brokers who will enjoy N23 billion government largesse. A
public bail out of a financial institution is justified only if they
pose a systemic risk to the financial system should they fail. A
systemic risk is the risk that the entire financial system will fail and
collapse and it is different from the risk of financial failure of an
individual or group within the financial system. The first question to
ask is whether the failure of the selected stock broking firms being
offered this government largesse can pull down the entire financial
system or pose a systemic risk. Certainly not! These stock broking firms
are not banks and their size relative to the whole financial ecosystem
poses no fundamental systemic risk. What then is the rationale for the
bail out?
Two
fundamental conditions must exist for the public bail out of financial
institutions. They must either be either be “too big to fail, the TBTF
test or must be “too interconnected to fail”, the TICTF test. The TCITF
test measures whether a group of institutions represent critical
connected dependencies with no existing market alternative in size and
function such that their failure will pull down the financial system.
The public bail out of a financial institution or a group of financial
institutions must pass these two tests to justify the test of a
systemic risk. It is difficult to see how the group of stock brokers who
will enjoy these N23b public largesse could pass the “too big to fail”
or the “too interconnected to fail” test. Their collective size does not
pose significant systemic risk to the financial system. In the last
three years, since these firms have had to deal with their margin loan
challenges, the financial system has carried on. The capital market
measured by the Nigeria Stock Exchange All Share Index has witnessed a
year to date gain of more than 25 percent. This is because there are
alternative market transaction agents whose collective size moderate any
potential “too interconnected to fail” effect of the stock broking
firms being bailed-out by government. Whither then is the logic of
government action?
Capital market operators specifically stock broking firms operators are
no banks. They are capital market transaction agents. They do not
warehouse public assets or owe public liability like the banks that hold
public deposits that could create a collapse of the financial system if
a critical number of them fail. The stock asset that the public buy is
not warehoused by the stockbroker but by the public themselves directly
and the company from whom the stock was bought with a clearing system
maintained by the independent Central Security Clearing System (CSCS).
Stock sales are transactions between the company, the stock seller and
the stock buyer with the stockbroker acting as intermediary, a broker
and a transaction agent. It is the same relationship as that of a real
estate agent who collects a fee brokering a deal between a house seller
and a house buyer.
The
real estate agent just like the stock broker should ordinarily not
warehouse housing-stock unless he decides to use his market knowledge
for additional private gain and become an investor, acquiring his own
housing stock. If we stretch the analogy further, would it be right to
use state fund to bail out or forebear the loans of a group of real
estate agents who took a bank loans to buy houses and kept, hoping to
make a kill when the house stock appreciates, and unfortunately house
prices fell? If the state does that, should the same logic and largesse
not be extended to every citizen investor who bought housing stock when
house prices fell? Therefore apart from rewarding bad behaviour, the
action of government also raises public equity and fairness issues. For
the ordinary retail investor who also lost money on the capital market
like the stock broking firms who took margin loans, where and what will
be his own bail out or loan forbearance? What is good for the goose must
also be good for the gander.
There
have been attempts to justify the bail out of the stock broking firms
as a special intervention in the capital market as it has been done
recently in aviation and agriculture. Special sector intervention funds
in Nigeria have largely not delivered tangible results as they work
against market logic. The art of giving public funds to firms at below
market rate, below its true market price distorts market mechanisms and
leads to scarce resources being allocated to firms that will not best
utilize them. Have we seen yet the tangible and visible gains of the
recent special intervention funds in agriculture and aviation? Such
intervention funds have largely festered a regime of crony capitalism
with all its attendant ills, where you get access to funds below market
rate if you are connected to government and can even divert them to
other more profitable sectors outside the intervention fund. The market
punishment of bad investment decisions, a return of losses for poor
risk decisions and vice versa as gains for good investment risk
decisions is critical to the effective functioning of markets. Special
intervention funds where there are no proven market failures, where it
cannot be proven that markets lack the mechanism to self-correct and
cleanse itself in its organic cycle of bulls and bear that ensure that
resources are efficiently allocated to those who will best utilize them,
can only but lead to more imperfect market outcomes.
Government
has done very well by intervening and bailing out the banks whose
failure truly posed a systemic risk to the financial system. It has
however overreached itself in the N23 billion bail-out of selected stock
broking firms. The logic and rationale of its decision fail public
interest, fairness and social equity tests. If the concern of government
is about the liquidity of the capital market, it cannot be addressed by
rewarding excessive risk behaviour that could further jeopardize the
future health of the financial system. This bail out of selected
stockbrokers by government cannot be morally and economically justified.
It should therefore be seriously reconsidered.
Olu Akanmu, a company executive, publishes a blog on Strategy and Public Policy on http://olusfile.blogspot.com .
ITREALMS Online ... delivering news for ICT4D
