Beware of boasting
At the press conference of January 30, held in Trinidad, and discussed in last week’s column, Chairman Duprey of the CL Financial Group had indicated that the credit squeeze caused by German bankers refusing the company credit was a main reason for its troubles. Just prior to that, however, his statements in regard to the effects of the global economic crisis on the group’s business were very boastful. Duprey claimed there were very good business opportunities arising from the global economic crisis.
Indeed he stated in newspaper reports “with the global economy in tatters and companies everywhere bracing for a reversal in fortunes” his group was poised to “take advantage of the world-wide financial crisis to snap up underpriced assets.” There was clearly nothing to worry about.
He further promised that his brokerage subsidiary (Caribbean Money Market Brokers Ltd), would become the base for developing a world-wide network of brokerage firms. At the time the CL Financial Group had four brokerage firms located in the Caribbean, Central America, New York and London. The development of a global network, he suggested, would transform Port of Spain, Trinidad, into a major global financial centre and along with this the fortunes of the CL Financial Group would rapidly expand.
As he explained it, these developments were to be based on leveraging the network created by the brokerage firms centred on Caribbean Money Market Brokers Ltd.
At that time the Trinidad and Tobago Guardian had also reported that the brokerage houses already in the group controlled an asset value of US$1.3B. This was projected by Duprey to grow by a factor of about 2.3, to US$3B within five years.
That such grand schemes could fall apart so soon after, bringing disaster to the group rested on a very faulty assessment of the global economic crisis and the unprecedented risks which it posed.
At no stage of the crisis so far has it truly represented “a unique opportunity to acquire assets at greatly undervalued prices” as Chairman Duprey put it. This was dangerous rhetoric for a group whose very existence was predicated on continuing prosperity because of the business model it employed.
The moral of all this is to beware of boasting. Let your achievements speak for themselves. Idle boasting has been the ruin of so many.
Flawed business model
From what has been revealed so far, the group’s business model was flawed in several major areas. First, as the Governor of the Trinidad and Tobago Central Bank pointed out, it was too reliant on inter-company related-party transactions. As he puts it: “excessive related-party transactions pose contagion risks.”
When the economy is prospering and rapid growth is taking place, such a mode of operation looks good. A virtuous cycle is set in train. However, as soon as the economic environment turns sour, reliance on related-party transactions puts the entire group at risk. Contagion ensues and the virtuous cycle becomes vicious.
Second, the corporate culture of the group and its unorthodox styles of corporate governance were far too commandist, secretive and lacking in transparency. Modern ethical standards, befitting a global corporation are very different from those the group practised, as its meltdown across the region reveals.
Third, because of poor corporate governance, as the Governor of the Central Bank further pointed out, the group was only too willing to engage in excessive leveraging of assets. I would add to this also, regulatory arbitrage. There is now no doubt that the group routinely exploited regulatory loopholes within and across Caricom jurisdictions.
Excessive leveraging of assets reduces the likely proceeds from disposal of these assets, if it becomes necessary.
Finally, through the practice of regulatory arbitrage the group operated deposit-taking schemes, premised on the payment of unusually higher interest rates than the financial markets would seem to be able to afford. As an example of this aggressive high interest strategy for acquiring funds, a relatively large value of highly liquid high-priced deposits flowed to its insurance subsidiary in Guyana, (CLICO).
This firm, however, was not registered to engage in deposit-taking as a commercial bank is entitled to do in Guyana.
It did so, however, with the knowledge of the regulatory authorities. It did not, however, come under either the regulatory jurisdiction of the Central Bank of Guyana, or the Commissioner of Insurance in regard to its deposit-taking schemes.
As soon as the global financial crisis erupted last September inflows of deposits faltered. And, worse, withdrawals soon began. This experience exposed the flawed business model.
In conclusion, two very important questions arise. One is, why did the Government of Trinidad and Tobago feel it necessary to provide a rescue package for such a firm? The second is, what is being done to correct the regulatory loopholes at the trans-Caricom level? In the former case the answer centres on the notion that the CL Financial Group is “too big to fail.” For the second question, I shall review efforts at the Caricom summit recently held in Belize to address these concerns. These matters will be treated in later columns.
CL Financial Group: Meltdown and bailout
As promised last week, this week I begin a review of the CL Financial Group meltdown. I shall start with a broad description of the company structure and main operations just prior to the meltdown.
Structure and operations
The CL Financial Group is a holding company headquartered in Port of Spain. It had more than 70 subsidiaries and affiliated companies at the time of its meltdown. The group operates in over 32 countries. The principal regions are the Caribbean, Central and Latin America, North America, Europe and the Middle East (mainly Oman, Saudi Arabia and Qatar). In the Middle East, its main focus is on methanol plants, and plans were afoot at the time for more of these to be established in that region.
The assets of the CL Financial Group have been estimated at about US$15B. These include a wide range of operations in finance (mainly banking, brokerage, and insurance); energy and related products; real estate in several countries including the USA and Caribbean; manufacturing (mainly beverages); forestry and agriculture; and, a variety of services. Its largest subsidiary operation in Caricom is in Barbados (estimated at US$500M).
Readers would know by now of the fate of its CLICO financial operations in Caricom (The Bahamas, Belize, Guyana, Suriname and of course Trinidad and Tobago). These companies are all in dire straights. The Belize and Guyana operations are under judicial management. The one in The Bahamas is being liquidated. In Trinidad and Tobago the group is being administered through a Memorandum of Understanding (MOU) between the group and the Government of Trinidad and Tobago and its Central Bank.
The bailout/rescue package
Two months ago (January 30) several measures were announced at a joint press conference held by the Minister of Finance and Governor of the Central Bank of Trinidad and Tobago, along with the Chairman of the CL Financial Group − Lawrence Duprey. That press conference announced measures to govern the future operations of the CL Financial Group, in exchange for the bailout/rescue package that was to be provided.
Five key measures formed the basis of the MOU. Together, these were aimed at protecting the many depositors, policy-holders and creditors of the group and its subsidiaries and affiliates.
The first measure was the divestment to the Trinidad and Tobago Government of the CL Financial Group’s shareholdings in Republic Bank, Caribbean Money Market Brokers and Methanol Holdings (Trinidad).
Second, in the event this was not enough to secure the revenue expended in the government’s bailout of the group, the divestment of such other additional assets as was necessary to ensure this would take place.
Third, in light of the above two measures, the government committed to provide whatever additional bailout funds were needed to attain the objective of returning the group to a healthy state.
Fourth, the assets of CLICO Investment Bank which were held by the CL Financial Group, were to be transferred unencumbered to the state-owned First Citizens Bank of Trinidad and Tobago. The CLICO Investment Bank would be wound up and any additional assets would be assumed by the Central Bank of Trinidad and Tobago. Its banking licence was also revoked.
Finally, the government would appoint its own board of directors and management team to operate the assets it took over.
At the time of the press conference held on January 30, the Chairman of the CL Financial Group had offered four explanations as being responsible for the group’s difficulties. One was the global credit crunch which had created a freeze on credit made available to it by German bankers. The second was the fall in energy and energy related prices. Third, was the fall in real estate prices. And finally, the Trinidad and Tobago parliament had recently legislated restrictions on inter-party transactions which adversely affected the group.
At the same press conference, the Governor of the Central Bank was at pains to point out that it was an unusually large number of depositors in the CL Financial Group’s Trinidad and Tobago operations who had cashed in their holdings, which had precipitated the collapse of the company.
Among those seeking to withdraw was the state-owned National Gas Company. It sought to withdraw US$250M of its deposits and was only able to obtain US$14M. As the saying goes, this turned out to be perhaps the proverbial straw that broke the camel’s back.
At a subsequent press conference held in mid-February, the Governor of the Central Bank announced that the new board, management team, and CEO had been appointed as agreed to in the MOU. Regrettably, however, he declared that it appears as if “the financial position of CLICO was much worse than he had envisaged.”
More pertinently, the CEO appointed by the Central Bank had on a separate occasion reported that he was failing to locate billions of dollars of assets held by affiliates of the group.
The Central Bank Governor further claimed that CLICO was a major source of cash for financing investments held by, and in the name of, the group’s affiliated and subsidiary firms. CLICO, he said, has ended up as “guarantor for many of the group’s assets most of which are heavily pledged.” These pledges clearly limit the proceeds that can be realised through sale of the group’s assets.
At the end of January 2009 CLICO Trinidad, had policy surrender requests on maturing obligations of TT$650M. It also had a “sizeable bank overdraft” and its bank balance was only TT$15M!
As we shall see in the coming weeks the explanations offered by the group’s Chairman Lawrence Duprey for its troubles were, to say the least, odd. Before the group’s troubles started he had revelled in its strength and boasted of the exemplary growth performance and dynamism of the group as captured in its related-parties business model. Furthermore, the Chairman also lauded the outstanding opportunities for the CL Group created by the very shocks and challenges occasioned by the global financial crisis, credit crunch and economic recessions, which he was then blaming.
Next week I shall explore this and other contradictions.
Invest at your peril: Why did the SEC fine the Stanford Group two years ago?
In this week’s column I shall conclude the discussion on Stanford Financial Group started last week. Following that, over the next few weeks I shall undertake a review of the CL Financial Group, Trinidad and Tobago. As we shall see, like in the case of Stanford Financial Group, there are many important lessons to be learnt from the Guyana standpoint in that firm’s financial meltdown.
Lessons to be learnt
From last week’s discussion of the Stanford Financial Group readers should draw four very important lessons about investing in Caricom financial markets. First, investing individuals and firms should not be greedy and lose sight of the bigger picture. Higher returns on investments always translate to higher risks. This is an invariant rule of financial market behaviour. And, indeed we might also say that, when financial markets are undeveloped and the returns seem too good to be true, beware of a scam or swindle, as in all likelihood these lurk behind the investment.
Second, the practice of due diligence is not simply confined to a formulaic or pro-forma type balance sheet analysis. It requires serious investigation and scrutiny of the corporate culture of the financial firm you are planning to put your money into. Professionals for sure, but also ordinary individuals, should realise that prudence on their part, requires as much close attention to issues of corporate culture and governance, as to the balance sheet details. In other words, one needs to get behind the numbers put into the balance sheet to assess where the information comes from, as well as the reputation in the market of those providing it. To ignore this injunction in Caricom’s financial markets certainly means putting your investment at peril.
Third, even if one were inclined to dismiss the many scandals surrounding the Stanford Financial Group over the years as mere rumour, the global financial crisis and credit crunch, which started last September were so fundamentally challenging to the region, as to warrant an immediate search for safer investment havens, even though these would have been less profitable.
Finally, to reiterate, it seems to me quite difficult for any careful observer of Caricom’s finance and business to avoid being exposed to the many misgivings and doubts surrounding the Stanford Group. In my judgement, greed had to override caution for investors to persist with the group for long.
Not only Hand-in-Hand Trust
Hand-in-Hand Trust is the best known firm, which was taken in by the Stanford Group. However, there is a great likelihood that other firms and individuals in Guyana were also caught up in this scam. My experience has been one where credit unions, trade unions, acquaintances, friends and family had all inquired of me as to the soundness of investments held with the Stanford Financial Group (and CLICO also) after I had begun writing about the threatening nature of the global financial crisis since last September (SN September 25). In every instance, I had cautioned persons not to be greedy. I further advised an immediate pull-out from these investments. I was at great pains to point out what I am saying here that the higher returns would prove illusory if one lost the money that was invested.
The SEC fines the Stanford Group in 2007
Of course by last September the media had already reported that some time ago (2007), the United States Securities and Exchange Commission (the financial regulatory body in the US), had imposed a fine on the Stanford Group (Stanford International and Stanford Trust) for failure “to adequately state the risks involved in the sales of certificates of deposits.” Any investor worth his or her salt could not seriously ignore the warning implied in the fine. To continue, despite this, to hold about US$4M in certificates of deposits (not to mention other sizable pension holdings) is to my mind unpardonable.
Panic in Antigua
The Stanford Group swindle hit Antigua the hardest, in the Caricom region. There was panic and a run on the Antigua bank operated by the Stanford Group. Fortunately, the Organisation of Eastern Caribbean States (OECS), which includes Antigua and Barbuda, as well as Dominica, Grenada, Montserrat, St Kitts and Nevis, St Lucia, St Vincent and the Grenadines was able to take action to contain the crisis.
Under the coordination and guidance of the Eastern Caribbean Central Bank, a new company was formed to take over the Antigua bank operations of the Stanford Group. This is the Eastern Caribbean Amalgamated Financial Company. It is 40 per cent owned by Antigua. The remaining 60 per cent is held by four other financial firms in the OECS states. These are St Kitts and Nevis-Anguilla National Bank, National Bank of St Vincent and the Grenadines, National Bank of Dominica, and Eastern Caribbean Financial Holdings. All of them are either partly or wholly-owned by OECS governments.
Containing the disruption in Antigua is testimony to the significantly higher level of regional integration which has been achieved in the OECS when compared to Caricom, the parent body. The OECS operates a common monetary policy. It utilizes a common currency and practises “reserves pooling” across the seven OECS states. It has a common central bank that is responsible for these. It also practises cooperation in other areas, such as joint external missions. An OECS Secretariat exists to administer the affairs of the sub-grouping.
The resilience and prompt action exhibited by the OECS stand in contrast to that exhibited by Caricom to date, to cope with financial contagion in the larger region.
Next week I shall begin a review of the lessons to be learnt from the meltdown of the CL Financial Group (Trinidad).
The Stanford Financial Group: Scandals and scams
Smelling the stench
In recent years, individuals who have had their ears close to the ground in Caricom’s financial, accounting, business, professional, and other expert circles, could not avoid being aware of the sordid doubts and deep misgivings swirling around corporate governance at the Stanford Financial Group. Even if some persons were inclined to give the group the benefit of the doubt, certainly there were enough misgivings around for prudent persons to exercise caution when dealing with the group.
If persons on their own could have gathered the need to exercise caution, then certainly reputable financial firms wanting to invest substantial sums in the group could have gathered a similar awareness of these misgivings. This could have been arrived at through various techniques, including selected interviews, surveys of expert opinion, and the hiring of financial investigators.
Stabroek News/London Daily Mail
The Stabroek News of March 15, 2009 has provided some results of an investigative report on the Stanford Group printed in the London Daily Mail. That report provided names, addresses, the sums of money involved, and other pertinent details in support of general concerns already being expressed in Caricom circles.
Consider some of these. First the claim that Stanford re-located his first bank, Stanford Incorporated from Montserrat to Antigua in 1985 because of clashes with British regulators, has been dispelled. In the SN article a much more sleazy escapade was indicated as being closer to the truth.
Second, that sleazy escapade revealed a portrait of Sir Allen Stanford, the group’s principal, which differed vastly from the highly promoted image of a ‘do-gooder’ and philanthropist who came to Antigua’s help at a time of need.
The SN article attributes to him “five outside wives.” Without seeking to offer any moral judgement on this, it was common knowledge throughout Antigua that he was, as the article says, “a womaniser.” The aspect of concern in this to a potential investor is that the same article continues to point out that the “common knowledge in the company was that all his women, like his employees were financially dependent on him and subjected to his controlling manner.” To a prudent investor this reputation should immediately raise suspicions about the rectitude of financial information coming out of the group.
Third, the SN article also portrays several other disturbing deceitful actions. One is Stanford’s attempt to forge lineage with the prestigious Stanford family, which established Stanford University, in California USA. That attempt was so heinous, the university was forced to file suit to protect for infringement of its logo.
As if this was not enough, a suit was filed in US courts and later settled last August, which provides ample details of his lifestyle. All this is public record in the US, and, any good search engine could generate information leading to these sources.
One would not expect that in practice, many individual investors would do their own due diligence in these areas. Certainly, however, an astute corporate investigative arm would seek out information on corporate governance at the institution in which it plans to place large sums.
Who are the suckers?
As a rule, Ponzi-type schemes such as that alleged by US authorities as operating at the Stanford Group, have been more successful in duping individual investors and privately owned and controlled companies than corporate organisations with professional staff capable of doing the investigation and financial modelling required to test the veracity of these schemes and discover how they earn their returns.
Individual investors are gullible. They are also vain about their ‘investment savvy.’ They are thus easily flattered by operators of such schemes in regard to their financial intelligence and business acumen. Worst of all, they are consumed by greed. This encourages them to downplay the risky nature of their action.
The old adage is very true. If the returns offered seem too good to be true, when compared to others in the market, then they are not true. Greater returns always embody greater risk. If an investor (Stanford Group) offers rates of return close to double what one can get from long established and well-known institutions, one must beware. We have seen this recently in the praise given by Dr Luncheon for the NIS returns from CLICO investments, when compared to others. The reason for the higher returns is that the risks are greater.
Firms are better suited to exercising caution. As a rule, they are expected not to be taken for a ride when they are holding other persons money in trust. For, if monies are lost through a financial swindle in an institution in which it invests then by definition it has failed to exercise proper due diligence.
In the case of Stanford Financial Group, as I have outlined above, suspicions have been around for some time now. Moreover, I would add, even if the trustee ignores these suspicions and as the saying goes, is taken in, once the financial crisis erupted last September, this should have led to an immediate pull-out from the firm and the search for safe investments, albeit at lower rates of returns. Trust companies cannot exercise greed, lose other people’s money, and then claim they have practised ‘due diligence.’
As we shall see next week in the discussion of the CL Financial Group, although no criminal charges have been laid against its principals so far, that group has also made the fundamental error of underestimating the negative impacts and the contagion precipitated by the eruption of the global financial crisis and credit crunch last September.
Conclusion: Due diligence
Readers should observe from the above that a due diligence exercise is not a simple standardized pro-forma exercise in balance sheet analysis. It involves also testing the credibility of the reported performance of an enterprise in every important dimension, including for financial institutions, its corporate governance as well as the character, probity, and confidence deposed by others in the principals of that institution.
The harsh truth is that if a corporate financial institution is swindled then due diligence could not have been adequately exercised.
Losses through financial swindle are different from losses incurred in ordinary trading.
That is buying and selling goods, services, and financial instruments on organised markets.
The phantom economy and the crisis of credibility
In last Sunday Stabroek I had started a discussion on what I described as the “crisis of credibility” facing actions by the government and its functionaries on economic matters. This credibility gap runs throughout the entire gamut of economic matters, from review and analysis of the current situation and recent trends to the setting of targets, framing of policy proposals/programmes/projects, and the efficient execution of these.
I have so far considered two of the factors that I believe have contributed to this outcome. First, the glaring weaknesses of official statistics: late dissemination, hoarding, and the widely assumed ‘massaging’ of these in order to conform to the preferences of the administration. The second factor identified is the repeated instances of revealed inconsistency and incoherence in the execution of public policy. This latter has generated much confusion and distrust among a wide swathe of economic actors, including small and large businesses, waged-labour, the self-employed, and civil society organisations.
In this week’s column I begin with introducing a third factor. This is the common knowledge or belief that a significant proportion of economic transactions in Guyana are inspired by criminal motivations. Among these are repeated instances of 1) general corruption and fraud 2) generating and distributing proceeds from organised crime 3) illegal capital flight 4) tax evasion and 5) foreign currency substitution (US dollar) in day-to-day transactions.
Such criminal motivations do raise doubts about the genuine nature of much of today’s economic activity. They are also more broadly linked to the modus operandi of the criminalised state.
I reminded readers last week that there is a symbiotic relation between political elites and organised crime bosses, who together form the ruling cabal over events unfolding in the economic sphere. A state that has tolerated the extra-judicial execution of hundreds of young men, cannot be expected to pursue uncorrupted economic policies. This would seem to be too much of a contradiction to be at all possible.
Let us examine the case of the underground economy, to see how this unfolds. The underground economy in Guyana emerged into prominence during the years of the PNC administration. Estimates that I had made showed that the underground economy was very large, ranging in size between 26 and 99 per cent of official GDP for the 1980s. This high estimate was independently confirmed in a study by Bennet published in the same journal (Social Economic Studies) in which my study appeared.
The 1980s underground economy was principally centred on 1) smuggling of goods banned by the PNC administration and 2) black markets for foreign currency (mainly the US dollar).
The latter arose because of legal restrictions on residents holding foreign exchange. As a consequence of these restrictions, a huge gap developed between the official exchange rate and the black market rate, providing a fertile outlet for illicit trading in foreign exchange.
With the liberalisation measures that came into place after 1989 under the ERP; and, in particular, the removal of foreign currency restrictions and the licensing of cambios, it was expected that the underground economy would have been effectively phased out.
It did not. At last estimate the underground economy averaged 47 per cent in Guyana for the 1990s up to 2000, according to a 2001 Working Paper published by the IMF (Faal, 2001). Along with other colleagues at the university’s Institute of Development Studies (IDS), I am currently updating the estimates of the underground economy for the period 2001-2007, using the methodologies employed in the three previous studies by Thomas, Bennet and the IMF (Faal).
Although not yet complete, so far there are no surprises to the estimates we are obtaining. The dynamic of the underground economy, however, no longer revolves around the evasion and/or avoidance of government prohibitions. Today it centres on the proceeds of organised crime: narcotics trafficking, organised smuggling, and trafficking in persons, arms, ammunition, and high-priced items. This portion of the underground economy I had previously termed as the ‘phantom economy.’
Assuming as I do that 1) the size of the underground economy remains more or less the same as the IMF estimate of 47 per cent and 2) between 25 and 75 per cent of this represents the proceeds of organised crime (phantom economy), then a considerable proportion of real and financial activities are controlled and/or contaminated with criminal endeavours. This estimate would range from about 12 to 35 per cent of Guyana’s official GDP at market prices (or roughly 130 to 380 million US dollars).
This estimate would make it reasonable to assume that significant portions of transactions in the economy are guided by illegal and illicit motives. If so, this clearly distorts and complicates the operation of both private and public enterprises. Persons are therefore, forced to treat public policy with the proverbial grain of salt.
There are other factors contributing to the present crisis of credibility. Some are also linked to criminality. Good examples of these are capital flight and money laundering. Both of these require systematic corruption and the undermining of due process in order to make them work. To date no serious efforts have been made to bring to the local courts major cases on these matters, despite the widespread public assumption that there is an extensive presence of criminal pathologies in economic activity in Guyana.
Other factors are more benign. A good example is the role of remittances. Weak information on these, however, has created a significant blind spot in the economy. This makes it difficult to give credibility to official pronouncements and/or actions in regard to the economy.
Next week I shall turn to a discussion of the pervasive stench surrounding the CL Financial and Stanford Financial Groups, which has been around the region for some time now.
A crisis of credibility
No easy remedy
Behind the sound and fury in public debates, self-serving government pronouncements, and the studied misdirections and deceptions in statements made by various economic authorities, readers should be reminded that presently we are witnessing the confused economic responses of a state, whose essential dynamic continues to be a vehicle for criminal enterprise. As such ostrich-like and make-believe public policies, the real risk of regulatory meltdown, and the crisis of credibility in regard to public policy are systemically integrated facets of the criminalized state operating at a time of unprecedented global economic crisis.
I have elaborated in previous Sunday Stabroek columns on the degeneration of the Guyana state into a vehicle for criminal endeavours. I will not repeat those discussions here, as my only concern is to remind readers that we are not faced with random and unrelated occurrences. As I shall show in the weeks to come, all are directly linked to the state’s pathological condition. There is therefore, no easy remedy.
Last week, I argued that the country faces a real risk of regulatory meltdown, if the Commissioner of Insurance continues to feel compelled to act outside existing legal regulatory provisions. Pervious action (inaction) on her part has been rationalised on the ground of protecting “policy holders.” This is absurd. When a regulator feels compelled to act in this manner, then clearly the regulatory provisions should be amended forthwith. If this does not happen, firms will know for the future that the particular regulatory provision is effectively inoperable, as was the case with CLICO. They could therefore, act accordingly without risk of penalty.
This is a situation of moral hazard, which all regulations have a duty to prevent.
Further, by identifying the interests of “policy holder” as the crucial consideration, the Commissioner fails to publicly address the fact that a key purpose of regulation is to contend with “trade-offs” among different stakeholders in the regulatory process. There is a professional obligation to show that, not only the interests of “policy holders” are being considered, but in this instance those of 1) “investors” in CLICO’s depository-banking operations (disguised as insurance business) 2) the “general public,” and 3) the integrity of the entire financial system. The reason why “policy holders” were prioritized should then be explained.
Based on recent events, there is the further issue of “due diligence.” It does not augur well that the central bank let senior management of Hand-in-Hand Trust Corporation plead that several other depositors in the Stanford Financial Group got burnt, as if this were justification for their failure to do “due diligence.” Effective banking regulation requires that the first priority must be that those who hold funds in trust are responsible for them, and must perform effective “due diligence.”
The central bank should always stand ready to publicly refute utterances from financial managers, which introduce rationalisations for their failure to fulfil their bounden duty.
It would be a sad day for Guyana, if without regulatory rebuke, such pathetic claims continue to be publicly offered as solace to investors whose funds have been compromised, as in the Stanford Financial Group’s Ponzi scheme.
From the perspective of the criminalized state, recent events betray a not surprising and continuing crisis of credibility. However, for financial markets to work effectively, public policy must be credible. In Guyana this is clearly not the case, and, we may therefore, ask: why?
For the remainder of this column I shall introduce some of the main factors, which have contributed to this sad state of affairs.
Official statistics: Missing, misleading and massaged
On several occasions in the past I have drawn attention to the weaknesses of official economic and financial statistics. This is a major factor in credibility. Statistics are routinely published late. Often, key data are either published very irregularly or not at all. Good examples are unemployment and poverty data, and estimates of the underground economy capital flight, and remittances. Moreover, all too frequently, when finally published, inadequate notation makes the meaning of several of these statistics unclear, as in the Appendix tables to the 2009 National Budget. Worst of all, many persons now believe that published official statistics are massaged to conform to the wishes of the administration.
Indeed these circumstances have been going on for decades. In the years of the PNC administration this was excused by claiming the “high cost” of data dissemination. Today, with the Internet, this particular excuse is no longer tenable.
Inconsistency and incoherence
A second factor behind the credibility crisis is the many revealed inconsistencies and incoherence of public policy. Consider a few examples thus:
1) Right up to last October (2008) when it was officially signed, the government had consistently focused on the detrimental consequences of the Cariforum-EC, Economic Partnership Agreement (EPA). Four months later, to the astonishment of many persons, the 2009 National Budget did not address the EPA. To say the least, this omission has confused economic actors about government’s intent.
2) In similar vein the National Budget does not offer a serious discussion of the global financial crisis, credit crunch and economic recession. Yet, in the National Assembly debates, under intense pressure from Opposition parliamentarians and other public commentators, this ended up as perhaps the single most referenced topic in the debates!
3) When the Value Added Tax (VAT) was introduced many assurances were given that the tax would be “revenue neutral.” Being a regressive tax, the government knew that the greater burden of the tax would fall on the poor. With a rate of 16 per cent, assurances were thus given that the VAT would not raise more revenue than that raised by the taxes it replaced. Yet, despite being almost daily confronted with this earlier promise, the government has continued to reap a bumper harvest from the regressive VAT tax, with no regard to “revenue neutrality.”
4) Finally, we may further ask: does anyone in Guyana believe that a credible sugar “turn-around” plan can be produced in the one month the government has allotted for this task, when appointing the new Guysuco Board? Does anyone believe that after the long secular decline of the industry since the late 1960s when sugar output was about 370,000 tonnes that a production “turn-around” can be achieved in two years? Does anyone believe that a government can be sincere when predicting a growth rate for the economy this year, which is greater by more than one-half that of the previous year, (that is, 4.7 vs 3.1 per cent).
There are several other instances, which reveal that government’s economic actions are not treated as credible. Next week I shall continue from this point, developing the idea that the crisis of credibility is a mirror-image of the risk of regulatory meltdown and the practice of make-believe economics. In turn, these derive from the more general condition of the state.
Moral hazard and the Guyana regulatory meltdown
When a sectoral regulatory authority, in this instance for the insurance sector, takes the position that regulatory intervention as prescribed by law would be prejudicial to a party that is involved in regulatory evasion and abuse, because such intervention “would have precipitated the demise of the company to the immediate detriment of policy holders,” it means one of two ghastly things, both of which reveal a deeply flawed legal-regulatory-institutional oversight framework.
First, the regulatory provision is obviously flawed. And, if this is the case, then the regulatory authority has a bounden duty to secure the timely amendment of it. Secondly, such regulatory inaction encourages ‘moral hazard.’ That is, offending firms can operate with impunity because of the certainty that violation of the legal provision has no regulatory consequences. This is an appalling situation for Guyana to find itself in, at this time of collapse of global financial markets, due largely to weak regulation and oversight of past years.
Readers should by now be fully aware that the galloping global financial crisis, credit crunch, and economic recession are taking a heavy toll on the financial sector of Caricom. In Guyana, the effective collapse of CLICO (Guyana), as well as the cloud hanging over Hand-in-Hand Trust Corporation, the New Building Society and the National Insurance Scheme, all have their origins in the global crisis, which has put Ponzi-like swindles under immense financial/economic stresses. The implosion of the CL Financial Group (Trinidad) and the wrecking of the Stanford Financial Group (Antigua) fall into this category.
With Ponzi schemes, as long as new investors are coming into the enterprise, all appears well. Better-than-average rewards are paid to early investors, which encourages new investors. An apparently virtuous cycle of new funds, high rates of return, and satisfied investors is set in motion. Once the inflow of new funds is halted, the fraudulent basis of these schemes becomes obvious. This inflow of funds was abruptly halted last September, as the global financial crisis emerged.
With the global crisis, most firms and wealthy individuals became less well-off. Some sought to recover their monies from these schemes. As their numbers grew, the inflow of new funds dried up, leading to firm failure. Only government intervention (‘bailout’) could prevent legal liquidation and/or administration by the courts of these firms. Investors lose. Immense personal tragedies ensue as life savings evaporate. But, it is the case that only governments with very deep pockets can afford bailouts.
Greed and panic
At this stage it is useful to recount that history has conclusively shown that the two worst behavioural traits to be found in capitalist financial markets are greed and panic. Greed is driven by the objective of making as large a profit as soon as possible, and to do so at all costs. Making a profit, therefore, justifies any means by which this is attained. With this outlook, illegality and immorality become the norm.
Not only individual investors and owner managed firms, but corporate firms through their agents (executives and managers) develop a culture of anything goes. In such circumstances, greed becomes systemic. Business ethics go by the board. Unthinkable excesses occur. Systematic evasion of the checks and balances institutionalised in regulatory and legal provisions becomes routinized. It is this greed that lay behind the Enron exposures of a few years ago and now the Madoff and Stanford frauds.
However, it is precisely to protect against such abuses caused by greed that countries have institutional-legal-regulatory and oversight frameworks.
Panic is as destructive as greed. The major difference is that greed is more insidious. It is, however, no less damaging. Panic stems from irrational behaviours aimed at protecting one’s wealth and income. Like greed, this is true for individual investors, self-owned (mainly small and medium-sized) enterprises, as well as corporate firms, whose stockholders assign agents to run their business.
At this point, it should be recalled that the main benefit from capitalist markets lies in what economists term the ‘animal spirits’ or ‘entrepreneurial drive’ these markets produce in order to do things smarter, better, more efficiently, more productively, and therefore, more profitably. With such ‘animal spirits’ around, there is an inherent risk of panic.
Panic is both irrational and contagious. This can be clearly seen when something starts a panic reaction in a herd of animals and then how quickly this can spread like a contagion throughout the entire herd. Indeed, there are many instances where such panicked herds run headlong to their death, literally stampeding over the edges of cliffs. Again, the regulatory system should be designed to short-circuit such self-destructive actions.
The earlier references to moral hazard, panic, and greed, link to the equally fundamental consideration of how credible markets view governmental actions pertaining to the economy. All successfully functioning financial markets require clear laws, rules, regulations, and efficient institutions to ensure their effective implementation. Together, these comprise the overall regulatory and oversight framework.
I shall address this matter more fully in my next column. It is important, however, to note at this stage that for this framework to operate effectively government and its economic authorities have to be perceived as credible. If they are not, then when rules and regulations are issued, individuals and firms in the market will not act on them.
Next week I shall continue from this point by reflecting on the crisis of credibility, which the government and its economic functionaries face in Guyana today.
A cautionary tale: To be forewarned is to be forearmed
The grimness of the global economic environment is so intense that those who shout “make-believe” economics will sooner, rather than later as the saying goes: “have to eat their words.” Last week, (SN February 22) I expressed incredulity that the 2009 National Budget could be so much in the land of “make-believe” as to predict (target) a rate of growth of real GDP for this year at 4.7 per cent.
As I pointed out in that column, this rate of growth is nine times greater than the global average of 0.5 per cent, predicted by the World Bank for this year. More outrageously it is also more than 50 per cent greater than the official growth rate of real GDP in 2008 (3.1 per cent). I know of no country, which has projected such a rise in its growth rate for this year over last year. And, to make matters worse, this predicted growth rate is treble that achieved in Guyana as the annual average rate of growth during the decade (1998-2008).
Readers should bear in mind that the World Bank has predicted that, if the present global economic trajectory is maintained, developing countries as a group, could suffer a “lost decade” for economic growth, job creation, and improvement in living standards.
This is an important indicator of how serious are the global challenges facing Guyana.
The suggestion in the Budget that the Guyana economy is somehow recession-proof and insulated from the worsening global economic recession, financial crisis and credit squeeze, is not only implausible, it is also I believe a dangerous posture for the government to have adopted in framing the National Budget for 2009. This implausible prediction conjures the wrong impression. It sets up a worrying situation in which claims and expectations will grow, in the belief that more will be available this year than in the previous one. That indeed the threatening economic or financial challenges can be easily overcome. Regional hardship: Why not Guyana?
To my mind a healthy dose of realism would have been far better. The priority now is to prepare all economic actors in Guyana for the serious challenges which lie ahead. Already, they are aware that the global crisis has brought considerable hardship to sister Caribbean territories, and they ask: so why not Guyana?
Trinidad and Tobago, although a huge beneficiary of the oil boom, has seen a massive fall in export earnings due to declines in the price of natural gas and oil way below the notional level of US$70 per barrel its government uses in preparing its own national budget. It has also had to deal with the collapse and bailout of the CL Financial Group.
The travel and tourism sectors have been very hard hit throughout the region, but moreso in those countries like The Bahamas, Jamaica, Antigua and Barbados, which are heavily dependent on these industries. Further, as I have continually warned in these columns, wealthy Guyanese and Caribbean folk, pension and trust funds holding significant external financial assets would have already been made worse off by the global crisis.
So too would have been those who participate in the organised crime that fuels a large portion of the underground economy. Both these legal and illegal groups usually channel and/or launder resources through regular financial connections between firms located in the Caribbean, and those in North America, Europe and Asia.
Financial scams and leverage
As the global crisis has progressively worsened, a number of frauds and scams are being unearthed. The two most recent are the Madoff US$50 billion Ponzi–like swindle and the Stanford Financial Group, US$8 billion fraud. The latter is located mainly in Antigua and the US. Both these frauds have directly affected Caricom and Guyanese nationals badly.
The recent press release by Hand-in-Hand Trust Corporation of Guyana confirms the local impact. However, the threat has been downplayed by the company. As with CLICO (Guyana) it is representing that there are small to minimal losses: “less than 10 percent of its assets.” However, until the company lets the public know how much it is leveraged, there is little comfort to be gained from this statistic. We have only this week seen where CLICO (Guyana) has ended up!
Additionally, the disaster of the CL Financial Group in Trinidad and Tobago will certainly have progressive negative reverberations throughout the Caricom region. I shall discuss in coming weeks more fully, aspects of this regional financial fallout and how it is likely to affect the financial sectors in Caricom and Guyana. As we shall see one of the key considerations to ponder as we consider the damage to local financial firms is the extent to which they are leveraged.
The global crisis has, as I have reported, significantly affected the flow of remittances to Caricom. In Guyana this is particularly important, because of our heavy dependence on it, due to present low incomes and past low rates of growth. Commodity exports have also been badly affected. Thus the export of bauxite and alumina has been dramatically reduced in Jamaica. Despite its deliberate underplaying in Guyana the same is occurring as global demand for commodities fall with the global recession. Declines in commodity exports including, as we saw, natural gas and oil, have also impacted on Belize and Suriname. In addition, throughout Caricom, foreign aid, private investment inflows, as well as trade and other types of credit, have been virtually frozen.
If anyone had mistakenly believed that the Guyana economy is, or could be made insulated from the global crisis, the mounting evidence in recent weeks, if not days, should have disabused them of this idea. As we see with each passing hour, even global financial scandals are negatively impacting directly on Guyanese firms and individuals. The risk we face is that the Government of Guyana does not have the financial resources to facilitate depositors/investors if a substantial run takes place on local financial firms.
The present position adopted by the authorities that the threatened institutions are “small,” “insignificant” and “marginal” is unhelpful. Usually runs on financial firms are contagious and generate panic and extreme frenzied action, affecting both sound and unsound firms. No government in the world could afford to take ‘make-believe economics’ to the point of treating this threat lightly.
At this point, it is my fervent hope that the Regional Financial Action Task Force that I referred to in last week’s column, while pursuing preparedness at the regional level, might well rub-off on Guyana. This will be because of contingent commitments the authorities are going to be asked to give in order to frame coordinated regional responses.
Next week I shall continue from this point.
Budget 2009: From ‘voodoo’ to ‘make-believe’ economics
Economics is essentially a discipline based on commonsensical principles and ideas. These are then expressed precisely, with logic and theoretical rigour. And, more often than not, they are supported with the use of mathematical techniques, and statistical analysis and inference. It is for this reason I believe that when government and its functionaries make economic pronouncements which violate common sense, ordinary Guyanese dismiss these as ‘voodoo economics’ or in other words, rubbish. The 2009 National Budget brings us face-to-face with an even more disturbing companion of ‘voodoo economics,’ that is, the economics of ‘make-believe.’
By ‘make-believe’ economics I refer to situations when the government and its functionaries put forward economic statements and prescriptions, which bear little or no relation to the realities of the everyday life of Guyanese. This happens because, like the proverbial ostrich, the government wilfully or otherwise ‘buries its head in the muck’ that surrounds it, systematically ignoring in the process uncomfortable economic occurrences that are unfolding on a daily basis.
Since January 25, I have been detailing in my Sunday Stabroek columns, the impact of fourteen major exogenous shocks/challenges, mostly externally-driven, which have rocked the Guyanese economy during 2008 and as a consequence damaged its prospects for 2009. The budget presented to the National Assembly on February 9 has devoted little attention to this. Hopefully, during the debates, opposition members would be able to force this topic to the top of the agenda.
Because of this stand, the budget makes two incredible claims. These are 1) that GDP grew by as much as 3.1 per cent and inflation by as little as 6.4 per cent during 2008 and 2) projects for 2009 GDP growth at 4.7 per cent and inflation at 5.2 per cent.
The growth rate of 3.1 per cent claimed for 2008 is double the average annual rate of increase (1.5 per cent) over the period 1998-2008. Indeed for four of the years during the past decade, annual real GDP growth has been negative. Further, the growth of 3.1 per cent for 2008 is about one-third that of the two previous years 2006-2007, implying that the economic shocks and challenges the country faced made no real difference. This is an unbelievable outcome.
We must bear in mind that the economic shocks/challenges in 2008, include the devastation of the floods and the near-collapse of the sugar industry during the second crop. Indeed, the sugar sector declined by 15 per cent during 2008. It was the same for forestry and worse for the diamond industry (37 per cent).
Prognosis for 2009
The element of make-believe economics is even more dramatically pronounced in the projection of Guyana’s economic growth for 2009 at 4.7 per cent.
Worldwide, estimates of real GDP growth for 2009 have been declining, with each more recent estimate. The most recent estimate of global real GDP growth for 2009 is 0.5 per cent. This makes the budget projection of 4.7 per cent, embarrassing and ridiculous. Can it be that in Guyana the growth rate for 2009 can rise by more than 50 per cent above the growth rate for 2008!
Bear in mind that the analyses I have presented in these weekly columns since January 25 show that the global economic slowdown is getting worse – not better. Job losses, real GDP declines, investment flows, and consumer spending are trending down, everywhere. How therefore, could the performance of Guyana’s very open economy defy this trend, when even the mighty Chinese and Indian economies cannot? As time passes, the expectation for the global economic turnaround is now being projected further and further into 2010!
Blatant as these make-believe elements of the budget appear, there are other very important ones. For the budget preparation, the Ministry of Finance refused to engage in the traditional consultations with stakeholders, such as the trade unions, private sector bodies and consumer organizations. Whatever point the ministry was seeking to make, we now know for certain that by refusing to consult this time, it has served to confirm the fact that previous consultations were not considered useful and therefore had nothing to offer to the analysis and proposals in the National Budget.
In any event, for those following my SN columns the question that should be now asked is: why did the government not make a concerted effort before to provide guidance to Guyanese on the potentially devastating effects of the global crisis that started at least four months ago?
In Caricom, where critics have been calling for urgent regional action, a regional task force was put together before the budget. The budget, with its make-believe elements, does not engage seriously or directly analyse the impact of the global financial crisis, credit crunch and economic recessions on Guyana.
This is a serious omission, particularly as efforts to deal with these exogenous occurrences in the rich developed economies are showing signs of economic nationalism, protectionism, beggar-thy-neighbour policies and inward-focused development. All of these imply neglect for the many priority items on the global agenda, which concern Guyana: climate change; nutrition and poverty; environmental sustainability; and, the achievement of the Millennium Development Goals.
A sad and perhaps poignant reminder of how ‘make-believe’ is the economics of the 2009 budget is its (non) treatment of the EPA (Cariforum-EC, Economic Partnership Agreement). Before, during, and after the government’s signing of the EPA in October last year, the EPA dominated discussions on the prospects for Guyana’s future economic development. Despite the National Consultation and the strong progressive public stance taken by the government on the EPA, this agreement fails to find mention in the first National Budget of the Guyana government, produced four months after its signing. If proof were needed that the budget was all about make-believe with scant attention paid to the serious day-to-day realities of the lives of Guyanese people, this surely provides it.
To most Guyanese the prices they have to pay for goods and services relative to their incomes and wealth constitute the sharpest reminder of how their lives are faring. As we shall see in next week’s column, the National Budget ignores the households who make up the nation and focuses on the government’s accounts, as its priority consideration. I shall explore how this flawed development approach has hurt the people of Guyana.
Taking their toll: external shocks and the Guyana economy
In last week’s column I had introduced the first of eleven economic shocks/challenges that rocked the Guyana economy in the second half of 2008. That was the “financial crisis and credit crunch” which erupted in the United States during September-October 2008. The epicentre of that first shock/challenge was the bursting of the US private housing market bubble. In retrospect, we can now observe that early signs of this untoward development passed virtually unnoticed as far back as the latter half of 2007. Remarkably, this shock/challenge continues to worsen.
Official acknowledgement of the desperate situation in the US only followed on the heels of spectacular threats to its financial system. Well established, and indeed hallowed financial firms, collapsed or approached the brink of collapse, necessitating unprecedented “bail-out” actions by the US government. Toxic mortgage-based assets in the US financial system, generated from the private housing market bubble have been estimated at several trillions of US dollars. In response to the situation, the US government hastily put together a massive 700 billion dollar “toxic assets relief program (TARP)” to help stabilize its financial system and unfreeze credit markets.
The financial firms caught up in this debacle included such famous ones as America Insurance Group (AIG), Bear Stearns, Merryl Lynch, Morgan Stanley, Washington Mutual (WAMU) and CitiGroup. This catastrophe led to a dramatic collapse of confidence, which allowed the credit squeeze to tighten its grip on the US banking system.
There can be no doubt that these developments have had negative impacts on the Guyana economy at the outset. Worldwide, trade credit and banking credit became harder to get and more costly. This raised the transactions cost of external commerce for Guyana. Moreover, a considerable proportion of Guyana’s wealth and income generation traditionally derives from the underground economy. Here organized crime proceeds, which had previously illegally passed through American financial firms, were now adversely affected. This in turn affected the ability of those who made their livelihoods through underground economic activities, to continue to do so. In turn, this further affected the livelihoods of Guyanese not directly connected to the underground economy but yet dependent on its expenditures.
In addition to this group of persons, wealthy individuals, not at all connected to organized crime, came under duress. By its very nature the impact of these reverses on wealth and income generation among the wealthy in Guyana is not easily measured and remains unknown. As a rule, the authorities seem to make little or no effort to monitor this aspect of the economy.
The repercussions of the financial crisis and credit crunch on US and global stock exchanges were also dramatic. Indeed volatility became the order of the day, as stock prices seemed out of control. The general trend, however, was downward, resulting in trillions of dollars worth of capital value being lost by US firms, which traded on the main stock exchanges, the Dow Jones, Nasdaq, and S&P 500.
The volatility in stock markets was repeated in the foreign exchange markets, particularly where this involved the US dollar exchange rate to the Japanese yen, British pound, the euro, and the Canadian dollar. However, because the Guyana dollar is traded at a more or less fixed rate to the US dollar, all these changes in the US exchange rate were immediately mirrored in the Guyana dollar exchange rate, without any reference to Guyana’s economic needs or development context.
Further, a more general consequence of this volatility in financial and foreign exchange markets was a substantial loss of confidence. The business environment consequently deteriorated rapidly. And, as confidence worsened, worldwide uncertainty ensued. As readers would be aware uncertainty is a mortal enemy of market-capitalism.
Guyana was no exception to this increasing uncertainty, although the authorities sought to imply at the time that these externally-driven economic reverses could not reach our shores.
Remittances, travel &tourism and investment
Most Guyanese dependent on remittances are painfully aware that these are now under stress. The foolish claim has, however, been made that the decline in remittances is concentrated in countries whose overseas migrants chiefly perform unskilled labour. It is claimed that migrants from Caricom and Guyana are better-off, being skilled or semi-skilled.
Typically it is said they are teachers and personnel working in offices at the local, state or city level. But anyone familiar with the pattern of lay-offs in the US would know that if this statement is true, lay-offs are heavily concentrated among public schools and state/city employees due to budgetary shortfalls.
Guyana’s fledgling travel and tourism industry, based largely on vacationing visits by overseas-based Guyanese has been heavily impacted — although information on this sector is scanty. In the broader and more organised Caricom, data on travel and tourism show that visitor numbers have fallen by about one third. Empty hotels and large staff lay-offs have been announced in many countries, particularly Antigua-Barbuda, Barbados, The Bahamas, Jamaica and St Lucia. Even in Trinidad and Tobago where this industry is small in comparison to its massive energy sector, the impact of the economic reverse in the US is significant in Tobago, which reported a hotel occupancy rate of only one bed in three. These negative effects in the region also included the postponement of several previously announced major investment proposals in the sector.
All types of investment flows to Guyana also came under pressure, because of the loss of confidence and growing uncertainty. This continues today and includes official development assistance, private foreign direct investment, and investment from overseas-based Guyanese. The only exception to this trend is investment flows from regional and international financial institutions able to obtain counter-cyclical funds.
The impacts of the ‘financial crisis and credit crunch’ in the US have rapidly merged with the twelfth and thirteenth shocks/challenges to hit the Guyana economy in the second half of 2008. A US recession, albeit unrecognized at the time, had indeed started way back in December 2007. The financial meltdown and economic recession quickly spread around the world producing systemic shocks to globalization itself. This now directly challenges the dynamic basis of the world economy, as it has evolved over the past three decades.
I shall continue from this point in next week’s column, taking into account the national budget’s (mis)treatment of these issues.
Faculty of Social Sciences
- University of Guyana, Turkeyen Campus
- +592 222-4927