DEREGULATION OF FINANCIAL SYSTEM IN THE NAME OF INNOVATION

PAVED THE WAY FOR GLOBAL FINANCIAL CRISIS

NAJAMUL SAQBIB, FORMER AMBASSADOR OF PAKISTAN SPEAKS ON THE ORIGINATION OF CRISIS WHICH HIT THE ENTIRE WORLD

AMANULLAH BASHAR
Mar 9 - 15, 2009

ABNORMAL RISE IN REAL ESTATE VALUES

To know about the nature of global crisis is important because many have no idea about the nature and the root cause of the global crisis and where from it originated? The world facing is the global crisis of unprecedented proportion since the great depression of 1930s.

Since the world today living in the globalized economy hence the crisis are also globalized crisis and not fined for a single country of the world. The scale of the complexity of the crisis is unprecedented since the depression of 1930. The second point is that this is a system crisis which means it has interconnecting called system crisis having linkages what is happening in the world. The third point is that the crisis was happened by the destabilization in the financial sector of the world. The origination of the crisis is the financial sector. The financial sector crisis have been triggered by the abnormal rise in real estate prices in the United States and they called it the sub-prime crisis but the real crisis stemmed from the abnormal rise in the real estate values and this virus spread in the US, UK, Ireland and France.

SECURITIZATION OF THE COLLATERAL CREATED COMPLEXITY

Najamul Saqib Khan, whose exposure to the international financial system and the world economy is spread over 30 years during his professional career as the world class diplomat while commenting on the global financial crisis observed that the entire crisis that we have seen this sheds light on the lack of regulations, lack of externally imposed rules etc. So this has focused attention that the world needs hidden tough regulatory framework both domestically and internationally. The globalized economy cannot function without basic rules or without a regulatory framework. Now put it in a longer or timeframe you have to look at the previous 30 of the regulators for about by Reagan and Thatcher administrations. Reagan administration in the US and Thatcher administration in the United Kingdom, as the idea was to deregulate the financial sector and this is also known innovation in the financial sector and the share of the financial sector in the economy registered a marked rise and the sector was deregulated.

Najamul Saqib on the back of his in-depth financial study on world financial system, outlined the root cause of the problem by pointing out that the deregulation of the financial sector especially in United States and the Western economies led to what it is called the innovation and innovation meant that you designed more and more complex stocks more and more complex derivatives, collateralized debt obligations which one of the leading investors Mr. Buffet has called them as the weapons of mass destruction to all these collateralized debt obligations because their value depends on so many variables and you would never know at one time that what the real value is. It the complexity was introduced into the system in the name of innovation which led to uncertainty about the real value of things. So this is collateralized debt obligations. Usually the house mortgages in the past were a fixed rate for about 30 years and were retailed by the lending institutions. Now what happened was the securitization of the mortgages? Variable rate and in some cases requiring no down payment in an attempt to broaden the base of home ownership without careful scrutiny of the potential home owners. So what was done was that these mortgages with very little down payment or small down payment at variable interest rates were securitized and they were given AAA ratings but credit rating agencies and sold to banks and financial institutions all over the world. The banks which had securitized them they just transferred the liabilities on other institutions just to become sub-prime loans meaning loans given to those who were not first rate lender who were just weak borrowers and lending back just securitize them and they were given AAA rating and they were sold all over the world. So we see how these crisis were not confined to the United States and how it becomes a pervasive crisis. The financial crisis also hit the stock markets as well because of the complexity of the crisis.

SYSTEMIC ERROR

A lot of analysis was conducted by the computers, many people strong in mathematics as they tried to analyze or computerized forecasting of stocks based on the experience in the past. What might have had happened in the past was no longer applicable to the profoundly changed realities of the present day world. And those computerized analysis turned down to be erroneous, widely optimistic. There was an idea that if you want to be innovative you have to be more complex and since you become more complex you don't know the real value of these products being analyzed by these computer analysts.

LARGE DOSES OF EFFORTLESS MONEY

As the markets quoted this downward movement, global equities have now shed all their gains they had earned during Asian economic crisis of 1997-98 and the onset of the beginning of credit crisis in 2007. Warren Buffet, the sage of Omah, has made an exciting remark on the on going financial meltdown. He was quoted as saying "Nothing sedates rationality like large doses of effortless money".

PAKISTAN

As far as Pakistan was concerned, we are facing the crisis in the shape of inflation and the inflation in the prices of basic food stuffs which affects the common man. In Pakistan because our economy is not centrally dependent on credit like in the West, therefore the manifestations of the crisis are different. If economy is facing 25-30 percent of inflation in which the food prices have really shot up which creating misery for the common man, hence the misery index goes up because of its rise. Our economy was already in the weak condition or was very vulnerable by the global crisis. Our poverty index has gone up from 24 percent to 36 percent in the past two three years. In the face of rise in poverty index, we are witnessing the mounting inflation in the food prices. Another point is the heightening shortage of energy as we failed to increase our power production to catch up the rising demand of power in the past which now affecting our industry and production due to imbalance between demand and supply. The abnormal increase in international oil prices had a severe impact as we did not pay the debt to various energy contributing IPPs and power generating units in the past which accumulated the circular debt to the level of Rs700 billion. That stuck up amount of debt also resulted in deteriorating the quality of power generation as well as power supplies. Under the IMF program, the stuck up payments are being retired and the energy production is also believed to be increased in the days to come that would help increasing the industrial production hopefully, he concluded.

PAKISTAN'S LIQUID FOREIGN RESERVES POSITION

The total liquid foreign reserves held by the country stood at $ 10,138.3 million on 28th February, 2009. The break-up of the foreign reserves position is as under:-

i) Foreign reserves held by the State Bank of Pakistan: $6,687.1 million
ii) Net foreign reserves held by banks (other than SBP): $3,451.2 million
iii) Total liquid foreign reserves: $10,138.3 million