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Take prudent stock, don't make bold moves

By Lau Nai-keung (China Daily)
Updated: 2008-09-26 14:53

My correct prediction of the exact cause, the precise timing, and the enormous severity of the current US-led world recession in this newspaper as early as October 2005 can perhaps lend me a little weight on how to deal with the situation when we are now clearly in the middle of this financial crisis.

For a long time, I was naive enough to believe that those 15 percent returns on the equity of American financial centers were real. To maintain their brand superiority and dominant market positions, financial media charlatans have so far been very successful in perpetuating our inferiority complex with the vaporware peddled mainly by the United States, and the United Kingdom.

China believed in the superiority of American management too. Chinese bank shares were sold for a song not so long ago to foreign banks. This is the price we have to pay to learn from the masters on how to manage modern financial institutions, they say. This is a hefty price indeed, to the tune of $1,000 billion of hard-earned money.

Hank Greenberg, the former AIG CEO who settled with the US government for $120 million for "fraud" a few days ago, saw his AIG shares and those of Starr, his private equity firm, shrink from about $14 billion at the beginning of the year to around $600 million. Of course he did not know what was coming.

It is now clear that the "great" global financial system dominated by the US is all smoke and mirrors. Lesson one: If you can keep fraud under wraps long enough, it can become a gold standard. Lesson two: There is nothing to protect anyone from fraud.

Here is a fair question: How could someone sophisticated in financial matters be conned into believing a 15 percent to 20 percent return on equity is reasonable? In the real world, oligopolies, cartels, powers to set standards (contracts, custodianship and clearing), dominant market positions, etc are all competitive advantages, all of which American and British financial firms have a plentiful supply of. Now that China does not possess that competitive advantage, we should restrain our greed and settle for a lower number.

However, the entire real global economy is stuck with this system. Such schemes can soon boomerang back into high unemployment and a global recession. And that is why developing countries like India and China do not want the US and EU to call all the shots in the global economy.

To all intents and purposes, expecting powerful US and UK banks to regulate themselves own risks is now a thing of the past. When US financial institutions expand their operations into Hong Kong and the Chinese mainland, from here on, firewall requirements must be imposed.

A way to do this is to require all Western financial subsidiaries, wholly owned or otherwise, to maintain separate balance sheets. Capital adequacy requirements must be subject to the oversight of local regulators. Violations of this, somewhat along the old Basel prescription or even more stringent, should be subject to criminal statutes.

China set to be key player

Given US and UK banks' rapacious appetite for gobbling foreign assets on their way to total dominance in the global financial services, the Fed is now working overtime with its profligate printing press to save the system.

Presumably, those foreign countries that own the devalued dollars should be allowed to own a few of the US financial jewels. Just remember, the ground rule in the old Shanghai foreign concessions still applies to China's purchase of foreign assets: "Chinese and dogs are not allowed." It is time for China to draw up some new ground rules.

But China should not be too eager to go on a spending spree. Even after the US government cast out its trillion-dollar mammoth restoration package, financial institutions around the world still have to scramble to put their houses in order, and they are not going to be a lot more expensive for a long time. One should also bear in mind that only time will separate the wheat from the chaff.

In bad times, the best strategy is hold on to your cash. This is especially true when quite a large bit of it is hot, meaning it is not truly yours and it may make a dash across the border at any moment.

Nobody knows exactly the magnitude of the problem, and estimates vary from tens to hundreds of billions of US dollars. Such amounts of hot money making an exodus is going to cause some severe damage that needs to be urgently addressed.

This large amount of hot money has already caused some trouble on the property and stock markets, and reaped some windfalls. It came in through various underground channels, and international speculators are now planning its illegal exit. They should be taught a painful lesson not to mess around in China.

Measures should be taken to enforce regular reporting from the banking system to monitor any suspicious movement of funds. High-profile crackdowns on underground remittance operations should be systematically undertaken and publicized to plug the loopholes and deter accomplices. Nail down the money, and make it illiquid; and when its liquidity is dampened, it can no longer be hot.

No speculator would like to be found in such a predicament. Even when they finally manage to get their money out of the country, they will have to go through a lot of trouble, and at a cost much too high to justify doing it again. Anyway, if the hot money just drains out gradually over time instead of pouring out all at once, the system can very easily accommodate such an outflow without much damage. Our objective is achieved.

In the meantime, further financial liberalization should be temporarily halted. The near total collapse of the international financial system demands careful monitoring and scrutiny, especially now that China is set to become a key player in its future development, and the crisis is far from over. It is time to take prudent stock, not to make bold moves.

The author is a member of Hong Kong Special Administrative Region Basic Law Committee of the National People's Congress Standing Committee