Friday, April 24, 2009

The Seemingly Unacceptable but Only Way Out of This Financial Mess.

On Tuesday, 10 February 2009, the Obama administration, Federal Reserve and Senate announced the seriousness of their attempt to solve the deepening economic crisis in the US, an attempt which entails public and private money to the tune of more than $3 trillion. In response the Dow Jones industrials dropped 382 points. This disappointing response to the above initiatives points to a number of possible implications.

First implication is that the USD 3 trillion was judged by the market to be inadequate to solve the crisis. The problem is that nobody is able to figure out exactly how much is needed. It could very well be an additional USD10 trillion. Nobody really knows. But if the eventual amount is thought by the market to be too huge, then this can trigger a perception that the debt burden of the US taxpayer is beyond redemption. This could very well lead to a loss in confidence in the US economy thereby leading to a worsening of the situation.

Second, that the plan of action by Obama lacks the necessary details on how the huge sum of money is eventually going to solve the financial and economic crisis. But to expect Obama and Geithner to be able to come up with a crystal clear and convincing plan is simply illogical. After all if it is indeed possible to create a clear `road-map’ on how to get out of this crisis, then that will imply it was possible in the first place to create a plan that would have prevented the crisis.

Third, that the market players realize that whole world is in a deep financial quagmire, the solution of which requires a totally new and radical way of thinking and that the current solutions being offered are considered by them to be neither new nor radical enough. Well, actually that is what a lot of people are saying including our own governor of Bank Negara who, during the recent Bank Negara High Level Conference, reiterated the need for renewed thinking to reform the global financial system. Unfortunately, the reality is that these calls for reforms in the global financial system or `architecture’ are not new. More than a decade ago, during the Asian financial crisis, we heard similar choruses of calls for reforms to the global financial architecture. According to most people, there has not been any significant reform and that is one possible reason we were unable to prevent the occurrence of the present much bigger and wider crisis.

In reality what is needed is an acceptance by all that the current system is fundamentally flawed and must be abandoned. At their core, financial crises are problems of over-borrowing, over-lending and over-leveraging. Financial crises are also the outcomes of a relatively recent innovation which is the legalizing of the activity of lending for profit which led to the growth of the lending-for- profit industry. Prior to the 15th century, lending in almost all societies and communities in the world were motivated by altruistic reasons. Lending was thus engaged in for the sake of helping people in need. As a result the scale of this type of activity was small. Only the most desperate people were in debt and, significantly, there was no interest charged on the debt. However, since usury was legalized, lending is now an industry and a massively huge one too. In fact it is the most important industry and the driver behind all other economic activities.

Lending and debt is now so embedded in people’s life that to be debt-free is an exception and to be in debt is the norm. From individuals to corporations to football clubs to countries, everybody is now indebted. Major corporations in the US are so highly indebted or leveraged that they cannot function without being able to borrow money. The moment credit lines slow they are in trouble. If the credit lines freeze, they become zombies. And since interest payments are due on outstanding debts, a highly indebted individual or company that is in trouble can easily become strangled by the debt. And if there is nobody willing to help, the strangle-hold becomes tighter and tighter by the day. For individuals, personal bankruptcy and all its worst implications stare in the face. For those who are not willing to face them, a bullet in the head or a rope around the neck seems the only option.

Help may come in the form of more loans to tide out the problem. However due to the interest that will be charged on those additional loans on top of existing unpaid and accumulating interest payments, those actions are simply equivalent to giving a person more rope to hang himself.

If we really want to help a person who is strangled in debt and unable to engage in meaningful economic activities, the best way is to freeze all interest charges. Better still is to forgive the interest charges and only ask for the principal back. If the debtor is unable to pay back the principal owed, the lender must give him time until his situation improves. This is how we unravel the knots around the neck of borrowers.

However, for this to take place the paradigm must change. Our actions described above must be motivated solely by a desire to help borrowers who are in trouble rather than to profit from their troubles. Lending must be seen as an opportunity to be benevolent rather than as an opportunity to enrich oneself. If we are unable to make that paradigmatic change in how we see the purpose of extending loans, then the solution I am offering will make no sense and will appear to be completely unacceptable and bizarre. But be cognizant of the fact that there is no other solution that can solve the situation and at the same time prevent future financial crises from happening again.

This article was published by Star on May 5, 2009 with the heading "Crisis Shows Financial System Must be Abandoned" ( )

1 comment:

  1. After reading your paper above, I do concur to your view that the current economic/financial systems are flawed and amassed with trench holes that enslaved the debtors.