Economists George Akerlof and Paul Romer, entitled a 1994 National Bureau of Economic Research [NBER] working paper: 'Looting: The Economic Underworld of Bankruptcy for Profit'. They considered why firms in financial services seemed to take such risky decisions. They concluded that "an economic underground can come to life if firms have an incentive to go broke for profit at society's expense (to loot) instead of to go for broke (to gamble on success).

Bankruptcy for profit will occur if poor accounting, lax regulation, or low penalties for abuse give owners an incentive to pay themselves more than their firms are worth and then default on their debt obligations."

Accepted concept

This was beautiful, plain English and since then, their term "looting" has become an accepted concept in the literature. Others used their lead to consider related lending, ownership structures that resemble pyramids where related firms prop up weak sisters and so on. We have had in Jamaica, examples of all these structures, systems and behaviours these researchers have explored. They find related lending tends to be on less stringent terms with likelihood of default very high. These findings should surprise no one.

Today though, it's interesting to look at Jamaica's indigenous mid-1996 financial services meltdown compared to Wall Street of 2008. What are the similarities and differences?

Regulatory failure

First both crashes derive from regulatory failure. To put it more accurately, both crashes have regulatory failure as a big part of their cause. In Jamaica, required legislation, institutional structures and personnel were non-existent as financial innovation proceeded. However, on Wall Street, the players consciously engineered destruction of the regulatory framework that would later allow, or enable the meltdown to happen. Glass Steagall, the 1933 Act that created firewalls between commercial banking and investment banking and stock brokerage operations and the like was abandoned in 1999. This development occurred because, in part, American financial services firms saw themselves at a disadvantage with British competitors who operated with much less regulation, benefiting from deals they were not allowed to make.

There was also a bit of an ideological tinge to it, in that it sung the praises of the 'free market'. Interestingly, at the same time Glass Steagall was being jettisoned, Jamaica was doing the opposite - erecting firewalls. Some thought this was silly. Why not benefit from huge scale economies like those Citibank was gaining by merging with Travelers?

If we agree on regulation failure, what about process? Jamaican financial firms became part of groups or conglomerates. Financial arms of groups took other peoples' money legitimately and generally loaned it to related parties, or invested in schemes administered or run by the group. For instance, the Eagle Group had a unit trust which promptly used its subscription to purchase real estate held by Eagle Companies, as part of the investment holdings of the trust. This outcome could have been achieved by Eagle selling shares to the public. But this would have been a different proposition altogether. This could have possibly meant dilution of control and potentially, or ultimately, take over of the company/group by others. By creating a unit trust, the group gains access to funds, unit purchasers knowingly take a risk, but can never get control of the issuing entity.

The idea of financial services regulation inheres in the need to protect 'other peoples' money' from at best profilers and incompetents, through to gamblers and at worst, predators, crooks, sociopaths and/or fraudsters like Bernie Madoff. So Jamaica's case is an exhibition of euphoria as groups engaged in real estate and other speculations as inflationary trends and lax regulation allowed imprudent and risky decisions to seem like safe, future money in the bank. I daresay there was never a Bernie Madoff-type in that scenario, although some such behaviours surfaced as things got bad.

With Wall Street the process was more like my mother's crochet chains, patiently knitted together in plain white for the tablecloth or variegated hues for the bedspread - but, of course, without the love she emotionally embodied in them.

The Wall Street chain did take time to create, beginning with lobbying and political contributions before the 1999 deregulation, its predatory prowess took a good five years to emerge in full flow. Their chain stretched from mortgage lenders and brokers, real estate brokers and evaluators, mortgage servicing companies, title companies, rating agencies, 'Quants' - the mathematicians and physicists turned Wall Street gurus, investment houses and insurers. The list is long, and global. We need go no further than to indicate that a huge part of AIG's losses seem to be the work of its small London office which was snaring European bankers into believing their capital adequacy was solid because risk was insured.

What do we do? Regulate we must. Examples of possibilities abound, many rules are old and abandoned not new and unheard of. Revert to the spirit of Glass-Steagall and attract competent talent into regulatory agencies. Do not allow financial services CEOs and other operatives to take profits as compensation and bonuses when they are unearned - place them in some kind of escrow. If a mortgage lender can sell off his mortgage to be collateralised after merely two weeks he has no interest whatsoever in making sure his borrower can repay. If a rating agency gets paid by the issuer whose bonds and derivatives it assesses, there is conflict of interest - the analyst who raises questions is fired!

Time is Limited

So we do know generaly what to do? Question is, shall we? For CARICOM, time is limited. The assault on offshore financial services has begun from the unusual places in the OECD - shots have already been fired across that Cayman forward deck. Never mid it is misplaced and predicated on anything but this current meltdown, it is real. Our policy makers need sober, somber, competent and creative initiatives to deal with what is coming down the pike fast. After Bernie Madoff and Sir Allen slumped in Antigua expect no less!

wilbe65@yahoo.com