Prof Mohd Nazari Ismail Faculty of Business and

Prof. Mohd Nazari Ismail Faculty of Business and Accounting University of Malaya FINANCIAL CRISES: CAN THEY BE PREVENTED?

Prof. Paul Krugman , Princeton U. Winner of 2008 Nobel Prize for Economics

Alan Greenspan Chairman of US Federal Reserve Board, 1987 -2006

Prof. Jeffrey Sachs Director Earth Institute, Columbia University

Plenty of brains… still cannot solve problem? So how? Massachusetts Institute of Technology

Hmmm…. . How are we gonna solve this problem?

I don’t have a clue too…

Presentation Outline Reasons for concern Different types of financial crises History of finance industry Central argument Conclusion

…. financial crises at their core are outcomes of over-lending and overborrowing and are thus integral to the industry itself. CENTRAL ARGUMENT

Asian Financial Crisis – Worse Economic Damage…

…compared to the Asian Tsunami !

US Sub-prime crisis…

… impact in all corners of the world

We are victims of the Jews ….

Honest, it wasn’t me…

Financial Crisis “a disturbance to financial markets, associated typically with falling asset prices and insolvency among debtors and intermediaries, which spreads through the financial system, disrupting the market’s capacity to allocate capital” B. Eichengreen, 1986

Economics Crisis Financial crisis

Other Causes of Economics Crises Wars Earthquakes Floods Draughts Plagues

Types of Financial Crises Currency crisis Banking crisis Market crashes

Asian Financial Crisis

Overinvestment in Real Estate

Asian Financial Crisis

Inflow of foreign funds prior to crisis

Bank Run

Source: Worldbank

Argentina Fiscal indiscipline Public debt: 1983 USD 46 billion 1989 USD 65 billion 1999 USD 130 billion Trade deficit Bank run

Argentina riots… Sorry, you cannot withdraw any money today…

Open up the bank! We want our money back….

Argentina Foreign Debt in 2007: USD 127 BILLION!

Market Crash

Bubble…

Examples of Market Crash Japanese property crash (1990) Dot. Com crash (2000) Sup-prime mortgage crash (2007)

Japanese Crash – A Puzzle? Successful exporter Trade surplus High savings rate Hardworking and skilled workforce

Japanese problem banks over-borrowing debt speculation

Here is how it happened… Savings/funds deposited into banks Banks increased lendings Asset prices skyrocketed ?

land surrounding the Imperial Palace in Tokyo estimated to be worth more than whole of California…

…. created a massive bubble…

… which soon burst!

Effect of Bubble Burst Trillions of yens wiped out in markets Spending slowed down Economy sputtered to a halt

Japanese Poorest and Weakest

A side of Japan that is not often seen…

Sub-prime Mortgage Crisis Low interest rates, excess liquidity in 1990 s Banks lent to Sub-prime borrowers Housing boom CDOs act as booster

Sub-prime Mortgage Crisis (cont. ) Housing prices skyrocketed Interest rates rose CRASH! Borrowers go bust

Total UK and US debt to GDP ratio of 300 %

… 20% of total economic output used to pay interest

Sub-prime Mortgage Crisis (cont. ) Housing prices skyrocketed Interest rates rose CRASH! Borrowers go bust

Sub-prime Mortgage Crisis (cont. ) Lenders go bust Credit Crunch Global Recession?

All in Serious Trouble…

How serious is current crisis? USD 16. 3 trillion wiped out deep and prolonged recession Major economies slowing down

US$700 billion bail-out plan

US FEDERAL GOVERNMENT’S TOTAL ACCUMULATED DEBT IS NOW MORE THAN USD 10 TRILLION

JAPAN’S PUBLIC DEBT MORE THAN 195. 5% OF ITS GDP

If bailout plan does not work… Global Recession…

starvations, homelessness, chaos…

Financial crises… how and when did they all start?

600 YEARS AGO…

Human existence started 2 million years ago…

Human History of 2 million yrs no finance industry 16 th century

DURING PREVIOUS 99. 97% OF HUMAN HISTORY THERE WAS NO LEGITIMATE FINANCE INDUSTRY!

USURY In ancient India it was looked down upon by both Buddhists and Hindus.

Ancient Philosophers against Usury Aristotle Cato the Elder

". . . THOSE WHO PLY SORDID TRADES, PIMPS AND ALL SUCH PEOPLE, AND THOSE WHO LEND SMALL SUMS AT HIGH RATES. FOR ALL THESE TAKE MORE THAN THEY OUGHT, AND FROM THE WRONG SOURCES. WHAT IS COMMON TO THEM IS EVIDENTLY A SORDID LOVE OF GAIN. . . “ ARISTOTLE

“what do you think of usury? " - "What do you think of murder? Cato the Elder

USURY Judaism forbids it (if practiced among fellow Jews)

“interest-charging same as people who have shed blood…” Ezekiel

USURY The medieval Christian church condemned it

“Now money, according to the Philosopher was invented chiefly for the purpose of exchange: and consequently the proper and principal use of money is its consumption or alienation whereby it is sunk in exchange. Hence it is by its very nature unlawful to take payment for the use of money lent, which payment is known as usury: and just as a man is bound to restore other illgotten goods, so is he bound to restore the money which he has taken in usury” Thomas Aquinas

Old Testament’s descriptions of usury practitioners shedder of blood the defiler of his neighbor's wife the oppressor of the poor the spoiler by violence the violator of the pledge the idolater extortionists Sabbath-breakers who vex the fatherless and widows dishonor parents liar the unrighteous the backbiter the slanderer and perjurer the meanest and lowest of men the vilest of criminals

Islam condemns usury

USURY IN ISLAM “Those who charge usury are in the same position as those controlled by the devil's influence. This is because they claim that usury is the same as commerce. However, God permits commerce, and prohibits usury. Thus, whoever heeds this commandment from his Lord, and refrains from usury, he may keep his past earnings, and his judgment rests with God. As for those who persist in usury, they incur Hell, wherein they abide forever” (Quraan – 2: 275)

USURY IN ISLAM “God condemns usury, and blesses charities. God dislikes every disbeliever, guilty. O you who believe, you shall observe God and refrain from all kinds of usury, if you are believers. If you do not, then expect a war from God and His messenger. But if you repent, you may keep your capitals, without inflicting injustice, or incurring injustice. If the debtor is unable to pay, wait for a better time. If you give up the loan as a charity, it would be better for you, if you only knew. ” (Quraan 2: 276)

John Eck (1486 -1543)

John Calvin (1509 -1564)

Adam Smith (1723 -1790) Jeremy Bentham (1748 -1832)

“The interest or the use of money…is the compensation which the borrower pays to the lender, for the profit which he has an opportunity of making by the use of the money. Part of that profit naturally belongs to the borrower who runs the risk and takes the trouble of employing it; and part to the lender, who affords him the opportunity of making this profit” Adam Smith 1776

“…debt forgiveness is not in our vocabulary. But we can help them by giving them additional loans. ” Senior executive, ADB

John Whipple

"If 5 English pennies. . . had been. . . at 5 per cent compound interest from the beginning of the Christian era until the present time, it would amount in gold of standard fineness to 32, 366, 648, 157 spheres of gold each eight thousand miles in diameter, or as large as the earth. " John Whipple (1836) in “The Importance of Usury laws”

Wow….

"…the purpose of money is to facilitate exchange. It was never intended as an article of trade, as an article possessing an inherent value in itself, (but) as a representative or test of the value of all other articles. It undoubtedly admits of private ownership but of an ownership that is not absolute, like the product of individual industry, but qualified and limited by the special use for which it was designed. . “ John Whipple 1836

Crash!

Innocent victims

Another victim of financial `accident’?

Tulips Mania Crisis 1637

London in 1720

South Sea…

Crisis….

Overend, Gurney & Co

City of Glasgow Bank

Financial crises in the US, too

Bond Certificate

US Stock Market Crash 1929

The Great Depression

World War II expenditures moved the US economy again

Stock market boom ROARING 1980 S

Leveraging! Or `borrowing’

Merton Miller Franco Modigliani

1980 s Leverage buyouts, mergers, takeovers and junk bonds

Crash! USD 500 billion gone!

Savings and Loan Scandal/Crisis

Other Financial Crises Long Term Capital Management 1998 Russian currency crisis Mexican financial crises 1982; 1994 -95 Brazilian Financial crisis 1999 European financial crisis 1992 Iceland financial crisis 2008 Etc. , etc….

DEREGULATION?

But still failed to prevent occurrences of crisis after crisis… USA HAS THE BEST REGULATORY FRAMEWORK

Repeal of 1933 Glass. Steagall Act and Bank Holding Act in 1999

Before: Heroes of Deregulation & Growth Robert Rubin – Former Treasury Secretary Sanford Weill - Citibank Alan Greenspan – Former Fed Chairman

After: Culprits of the Crisis

Dr Zeti

DERIVATIVES? CDOS? CDSS?

CDS (credit debt swap) US$62 trillion at the end of 2007

DERIVATIVES IS OUTCOME OF DYNAMIC AND DEVELOPED FINANCIAL MARKETS!

Abandonment of Gold Standard?

Gold standard abandoned completely in 1971 Nixon Vietnam War

GROWTH OF FINANCIAL INDUSTRY REQUIRE ABANDONMENT OF GOLD STANDARD

Gold Standard will constrain growth of finance industry

Optimistic Risk-taker?

Buddies now…

“Perception of greed as being responsible for the current financial crisis is a misplaced perception. ” Prof. Barry Eichengreen U of California, Berkeley

Heroes now…. . Nazir Razak, CIMB Amirsham, Ex-CEO of Maybank If there is a crisis…. . greedy villains?

Before – “Admired” John Meriwether, LTCM Dick Fuld, Lehman Bros. Chuck Prince, Citigroup After – “Greedy”

Clear Cases of Greed Nick Leeson – Baring Bank Jeff Skilling - Enron

“It's so difficult to pinpoint one person or two people…It really was the whole system” Reena Aggarwal, Professor of Finance, Georgetown University

Findings of Study by C. Reinhart & K. Roggof asset prices real economic growth and public debt

Charles P. Kindleberger Ford International Professor of Economics at MIT

`OVER-TRADING’

`FINANCIAL DISTRESS’

`CONFIDENCE’

“Sometimes in the next five years you may kick yourself for not reading and rereading Kindleberger’s Manias, Panics and Crashes. ” Paul Samuelson, Nobel Laureate and Professor Emeritus at MIT

At their core, financial crises are problems of overleveraging, over-lending and over-borrowing

sadly, the problems are not going to go away as long as the financial industry is legally part of our life.

"I've been around long enough to see that we have these cycles. These guys get their cigars and champagne. They have a great time. The whole thing blows up. But then they re-emerge years later. This one is a really, really bad one. But I don't think Wall Street is dead” Andy Serwer, the managing editor of Fortune Magazine