从金融危机中得到的教训（二）

Conflict of Interest

    But as governments get more involved in the financial system, whether it is in pushing for the much needed financial reform or subsequently in actually regulating it more intensively, I think there is a phenomenon in finance that they should always bear in mind. There is a fundamental conflict between the private interest of the financial intermediaries in maximizing profits in whatever they are doing and the public interest of ensuring financial stability and promoting financial efficiency. Put simply, and some of you may not be happy to hear this, the bigger the profits and the bonuses for the financial intermediaries, which de facto means a higher intermediation spread, the less efficient is the financial system in financial intermediation. Indeed, with the middle man taking quite a big cut, the rate of return for investors must necessarily be lower and the cost of funds for the borrowers higher than would otherwise be the case.

    Thus lesson number three is for financial authorities to manage that conflict pro-actively, remembering that the public interest should at all times prevail. Finance is about financial intermediation – the channeling of money from those who have a surplus of it to those who are in need of it. It is the all important function that supports economic growth and development. An efficient financial system is one that provides attractive risk-adjusted rates of return for investors and provides funds at relatively inexpensive costs to those in need of them; in other words, an efficient financial system is one with a narrow intermediation spread. If you can concurrently observe, on the one hand, financial intermediaries and those working in them respectively making astronomical profits and bonuses year after year, and, on the other hand, investors are getting high returns and borrowers getting cheap funding, something might be wrong. The anomaly needs to be explained. The authorities need to satisfy themselves that this anomaly, which may be welcome by all, was not made possible at the expense of deterioration in the structural robustness of the financial system.

    Let me illustrate with an example. The anomaly, with the benefit of hindsight, was quite obvious over a period in the United States before the crisis of 2008-09. But virtually no one raised any query on it. Rather, the regulators were quite happy that financial innovation, in the form of credit risk transfer through securitization, was enabling the different risk appetites of investors and the risk profiles of fund raisers to be matched more efficiently. Sub-prime and other CDOs were giving investors a higher rate of return at apparently no higher risks. Many more people were able to borrow money to buy their own homes, even those who were not able to come up with any down payment, and borrowing costs came down generally. And the intermediaries, for their innovative efforts, were seen to be getting their just reward, or so they claimed.

    The deterioration in credit standards was tolerated, because the specially structured financial products, attested by the rating agencies, were able to transform those credit risks and have them transferred to those in a position to assume them. The banking supervisors did not raise any objection to the creation of sub-prime mortgages by the banks, since these were quickly taken off the books of the banks and so depositors’ money was not at risk, overlooking of course the possibility of re-intermediation when guarantees provided by the banks for the repayment of market funding to SIVs sponsored by them were called upon when stress developed. And so the production lines of toxic assets were kept running and toxic assets were exported to the rest of the world to gullible investors awash with liquidity.

    Regulators should not stand in the way of financial innovation; and they did not. Finance was allowed to attain a life of its own. It very much became an industry that generates wealth on its own. And along with wealth came political influence and regulatory forbearance or benign neglect, and leaving it all to the almighty, free market. Soon that life of its own became one that gave bigger and bigger emphasis to, or even priority in, serving the interests of the financial intermediaries over the public interest in performing the basic function of financial intermediation that originally justified their existence. It also gained a degree of potency that turned out, as we all learnt, to be quite destructive.

Central Bank Independence and Mandate

    It is for public officers to protect the public interest, but they must operate within a framework that enables them to do so effectively, supported by an incentive system that attracts the necessary skills and standing to do a proper job. This then is the fourth lesson. It takes a lot of courage for regulators just to ask the simple question that “if it is sub-prime, why lend?” Similarly, for example, for regulators to insist on a 70% loan to value ratio for mortgages, when property prices are on the rise; or, in relation to certain innovative activity, to say that: “I don’t understand this, so you shouldn’t be doing it”.

    While central banks and others with responsibility over the financial system are rightly concerned about compensation practices in the financial industry, they too should be concerned about their own. In establishing the Hong Kong Monetary Authority in 1993, one of the things I insisted was to benchmark remuneration packages against those of the private sector. Although politics have led to this policy being watered down considerably over the years, I would like to think that it has contributed significantly to Hong Kong successfully coping with the two financial crises, and the collapse of the property bubble and other destabilizing events in between.

    Independent central banks that work to a well defined mandate are obviously another important element of that framework. I do not think that the recent financial crisis has led to any significant erosion of central bank independence. But a number of central banks have, nevertheless, been called upon by their governments to help maintain financial stability and ensure that financial systems continue to operate to support the economy, although these functions have not been explicitly defined in their mandates.

    Given the severity of the situation and the damage being inflicted on the economy, all responded positively to these requests, coming up with imaginative and unorthodox policies, to the extent that they are not prohibited by law. Some have interpreted this cooperative attitude of the central banks as an erosion of central bank independence. Others expressed concern about the central banks straying too far off well established mandates, warning against, for example, the dangers of inadvertently going down the slippery slope of monetizing budget deficits.

    These comments are well intentioned. They perhaps point to the desirability of introducing suitable modifications to central bank mandates, such as the inclusion of explicit responsibility over financial stability, and correspondingly granting central banks the necessary authority to enable them to deliver. Quantitatively defined single objective mandates for central banks, such as inflation targeting, seem now to be too simplistic in the increasingly complex financial environment of today. They also limit the scope in which the central bank can contribute to making the monetary and financial systems work better for the community, such as promoting economic growth. Asset bubbles are not just relevant to central banks because they affect the inflation rate. And the control of the central bank over the quantity and price of base money need not, at all times, be exercised only for targeting inflation, even though inflation is not an issue of current concern.

Rough Seas

    Lest anybody asks me whether I hold the same view in respect of targeting exchange rates, let me hasten to add here that not all jurisdictions can afford the luxury of having its central bank operating with multiple objectives and being flexible in pursuing monetary and financial policies in the public interest. Free and open emerging markets continue to be vulnerable to the potency of international finance, particularly when there is so much liquidity being generated as a matter of domestic policy in the developed markets, which pay very little attention, if at all, to the effect of their action on the rest of the world. This then is the fifth and final lesson that I wish to leave you with. Emerging economies that embrace free and open markets continue to face a difficult task in the maintenance of monetary and financial stability.

    The volatility of international capital demands the maintenance of relatively large prudential and financial cushions if they are to cope and not be tossed around in these rough seas, hence the substantial accumulation of foreign reserves in the last decade or so. It also sets a higher standard for the macroeconomic policies being pursued. For some, a credible currency anchor may be the only practical option available to them. The alternative of imposing selective controls or taxes on capital flows, whenever there is a need to do so, is another option that can be considered; but it entails possibly lower efficiency in the international allocation and use of capital, which is not particularly suitable for a jurisdiction serving as an international financial centre. The long term solution is, I think, a multi-polar international monetary system that offers greater diversity and flexibility than the arrangements we have now. But this is the subject for another day.