That FINSAC issue

IT seems as if the Finsac issue will never settle down, as it has been debated by both sides of the political divide and civil society since the 1990s. This is why I strongly supported the need for some study/ commission, as it is necessary to understand the causes of the greatest financial collapse in Jamaica. After all, this was the era that reversed Jamaica's economic improvement, as all data shows that up to the mid-1990s, the economic indicators were looking good and entrepreneurialism was strong.

In my view, it was therefore very important to do a proper study of the period and understand what went wrong, not to cast any blame but to understand fully an era that resulted in the beginning of our economic stagnation and debt crisis. And so I welcomed the commission of enquiry, but have always felt an objective, academic study of the period was necessary before any testimonies were taken.

This approach is essential in order to avoid what is happening now — a lot of crosstalk and blame being thrown around. For at the end of the day, what do we really achieve apart from political and other point scoring? Will we truly find out what went wrong, and even if we do come up with the truth, the whole truth, and nothing but the truth, will it be believed by most people? The sad truth is no. As we are seeing today, this Finsac issue is going to be argued along party, business, and banking lines.

It is therefore going to be even more difficult for us to arrive at the truth of what happened, and my prediction is that whatever report the enquiry comes up with will be believed by 50 per cent of the country, while the other 50 per cent will disagree. So at the end of the day we will have ended where we started.

There is, in my view, some truth in what is being said by all sides to the story, but there are also half-truths and lies. The only way for us to salvage some objectivity and arrive at an answer, at this juncture, would be to set up a group to do an objective study, made up of the members that are acceptable by government, opposition, business community and civil society. And this group must not include anyone who was affected by the meltdown, as it is too emotional a subject.

I will attempt to provide a synopsis of what went wrong, based on the research I did while writing my book.

The platform for the financial meltdown was created with the premature move to liberalise the Jamaican economy, as stated by Ralston Hyman. The fact is that the economy and our resources were not ready for the onslaught of global competition. One reason we were able to achieve growth towards the end of the 1980s was the protection provided to the economy. It is not that our economy was much more efficient than today, but we were at the time restricting foreign exchange movement and therefore local producers were protected. This is why a fixed exchange rate regime could work then but couldn't work today.

With the coming of the 1990s and freer world trade, there was a push by organisations like the WTO and the IMF for countries to liberalise their trade policies and foreign exchange movement. In fact, one can remember that the mantra of the IMF was always to get competitive through currency devaluation. This, however, was never going to be easy for a country like Jamaica that had a broken market economy and an internationally uncompetitive private sector. Our labour force was also relatively unskilled and unproductive. So in the 1980s, for example, the only way to attract the garment industry to Jamaica was through cost incentives.

The liberalisation policies in the early 1990s, therefore, resulted in significant exchange rate depreciation followed by high inflation. Faced with high inflation, businesses, including banks, would invest in assets such as real estate and land that rose significantly in value each year, and when these assets were revalued on their balance sheets, the equity would always increase even without doing anything else but just holding them. Business owners borrowed money from banks at rates in the high-teens to low-twenties, and purchased real estate and US dollars, or if put into the business they would just increase prices every year and recoup from the poor consumer.

This, of course, was unsustainable and would have come to a stop either from government policy or deflation, as disposable incomes would have fallen in real terms sooner or later.

Faced with this situation, the government correctly used monetary policy, through high interest rates, to halt inflation and bring the exchange rate under control. The problem the government faced was that if it reduced interest rates, then the inflationary cycle would take hold again. So what should it do? And so it continued with the policy of high interest rates. This was against a background of inadequate foreign exchange supply and reserves, low productivity, and an uncompetitive private sector. The correct move would be to reduce money supply, reform the public sector bureaucracy, and in the interim attract foreign exchange (borrow or FDIs) to stabilise the economy. The choice was to continue with the high interest rate policy, and the following were the resulting factors:

* Persons who borrowed at around 20% now saw loan rates of up to 90% and there was no way that businesses could support that interest cost, and it was therefore just a matter of time before the businesses started to collapse; and

* Asset values started to stagnate or decline, resulting in much tighter liquidity and declining capital reserves on the balance sheet of banks. Banks also faced much higher interest cost on overdraft facilities at the BOJ, which they needed to support the worsening liquidity situation.

There was a liquidity crisis and so the government had no option but to step in, through an entity such as Finsac, to provide liquidity support for the banks. So the truth is that it was the continued high interest rate policy that resulted in the liquidity drain, but there were other factors that set the platform for this, such as (i) poor financial regulations; and (ii) bad business practice, in terms of balance sheet, and more specifically debt and risk management both at the level of the business and banks.

But what happened after Finsac exacerbated the problem. Finsac should never have taken control of the assets and businesses in the way that it did. What should have happened is what occurred in the US, after the recent financial crisis, which is that the government through Finsac should certainly have provided the liquidity support for the banks but should have (i) allowed control of the operations to remain with the private sector, if even a new management team was hired, which would deal with the assets instead of Finsac; and (ii) if the government was going to sell the debt it should have been offered to local entrepreneurs at that price, through an objective body.

There is a lot more that could be said, but space does not permit and any more details require financial analysis. What is clear, though, is that without an objective study we will never have significant acceptance of any findings, and that things not only went wrong with government policy but there was bad management practice in both the businesses and banks.