By Olu Akanmu
It is important to lend additional voice and question the
rationale behind the federal government N22.6 billion bail-out of some capital
market operators. It is tantamount to rewarding bad behavior and excessive
risk-taking at public expense. For the stock broking firms that will benefit
from this largesse, if their investments have been profitable and they made a
kill in the capital market, they would not have shared their profit with the public.
The action of government is therefore tantamount to endorsing the privatization
of profits and the socialization of losses if you have the lobby and the
political connection to dumb your losses on the Nigerian people. By setting
this precedent, the government has further ossified the moral hazard problem in
our financial system. If an investor taking an investment risk knows that he
can appropriate his gains but can pass his losses to another party, he will
take excessive unreasonable risk as he has nothing to lose. This moral hazard
problem was at the heart of the misbehaviour of investment bankers in the
recent global financial crisis, when they could made huge bonuses if their bets
worked out but pass the loss to shareholders if it didn’t. This coupled with
the implicit guarantee of their risk by the public especially if they were “too
big to fail, essentially a public subsidy of their risk further compounded
their bad behaviour. They created a tower of complex financial instruments that
had little bearing to their underlying assets, played roulette and casino at
public expense, made initial huge gains which they pocketed until their
financial derivative instruments fell like a pack of cards.
Where these investment banking businesses shared a common
capital base with retail banking as one organic financial institution,
essentially leveraging public deposits in their banks to trade, they created
assets that wiped off the bank’s capital and public retail deposits in their
institutions. Where they were big banks, sometimes with a century of public
retail deposits, the financial system was put a systemic risk of collapse and
the state have had to intervene to bail them out largely to protect public deposits.
This experience has fuelled calls for the full organic separation of investment
and retail banking in the financial system. It is difficult to understand how
this logic of bail out applies to the stock brokers who will enjoy N23 billion
government largesse. A public bail out of a financial institution is justified
only if they pose a systemic risk to the financial system should they fail. A
systemic risk is the risk that the entire financial system will fail and
collapse and it is different from the risk of financial failure of an
individual or group within the financial system. The first question to ask is
whether the failure of the selected stock broking firms being offered this
government largesse can pull down the entire financial system or pose a
systemic risk. Certainly not! These stock broking firms are not banks and their
size relative to the whole financial ecosystem poses no fundamental systemic
risk. What then is the rationale for the bail out?
Two fundamental conditions must exist for the public bail
out of financial institutions. They must either be either be “too big to fail,
the TBTF test or must be “too interconnected to fail”, the TICTF test. The
TCITF test measures whether a group of institutions represent critical
connected dependencies with no existing market alternative in size and function
such that their failure will pull down the financial system. The public bail out of a financial institution or
a group of financial institutions must pass these two tests to justify the test
of a systemic risk. It is difficult to see how the group of stock brokers who
will enjoy these N23b public largesse could pass the “too big to fail” or the
“too interconnected to fail” test. Their collective size does not pose
significant systemic risk to the financial system. In the last three years,
since these firms have had to deal with their margin loan challenges, the
financial system has carried on. The capital market measured by the Nigeria
Stock Exchange All Share Index has witnessed a year to date gain of more than
25 percent. This is because there are alternative market transaction agents
whose collective size moderate any potential “too interconnected to fail”
effect of the stock broking firms being bailed-out by government. Whither then
is the logic of government action?
Capital market operators specifically stock
broking firms operators are no banks. They are capital market transaction
agents. They do not warehouse public assets or owe public liability like the
banks that hold public deposits that could create a collapse of the financial
system if a critical number of them fail. The stock asset that the public buy
is not warehoused by the stockbroker but by the public themselves directly and
the company from whom the stock was bought with a clearing system maintained by
the independent Central Security Clearing System (CSCS). Stock sales are
transactions between the company, the stock seller and the stock buyer with the
stockbroker acting as intermediary, a broker and a transaction agent. It is the
same relationship as that of a real estate agent who collects a fee brokering a
deal between a house seller and a house buyer. The real estate agent just like
the stock broker should ordinarily not warehouse housing-stock unless he
decides to use his market knowledge for additional private gain and become an
investor, acquiring his own housing stock. If we stretch the analogy further,
would it be right to use state fund to bail out a group of real estate agents
who took a bank loan to buy a house and kept, hoping to make a kill when the
house stock appreciates, and unfortunately house prices fell? If the state does that, should the same logic
and largesse not be extended to every citizen investor who bought housing stock
when house prices fell? Therefore apart from rewarding bad behaviour, the
action of government also raises public equity and fairness issues. For the ordinary retail investor who also
lost money on the capital market like the stock broking firms who took margin
loans, where and what will be his own bail out? What is good for the goose must
also be good for the gander.
It has been argued that the
action of the government is not really a bail-out but a forbearance as no cash
is being passed to anyone. This is a sematic argument. The simple fact is that
the firms who are benefiting from this government goodwill are simply walking
away from their loans and their private financial repayment obligations at
public expense. AMCON, the Nigeria public Asset Management Company, who bought
the bad margin loans from the banks, is going to pick up the cost of this
forbearance. Essentially, the taxpayers and the people of Nigeria have
picked-up the losses of the bailed-out stock brokers. The more than N2 trillion
loss declared by AMCON in its most recent financial report, essentially its
purchased loans from banks that cannot be recovered, might have become the
biggest subsidy of the excesses of the “rich” at the expense of the poor and
the public in Nigeria. Only the rich in Nigeria borrow big time from the banks.
When they do not pay back and the public treasury has to pick up the bill, it
is essentially passing big time subsidies to the rich when that resource could
have been used to build schools, hospitals, roads and infrastructures for the
Nigerian people. The sanctions being imposed on the bailed out stock broking
firms that they will not participate in future AMCON deals and transactions is
nothing but a slap on the wrist. It is not and cannot be commensurate with the
size of the issue and its moral and economic implications.
There have also been attempts to justify the bail out of the
stock broking firms as a special intervention in the capital market as it has
been done recently in aviation and agriculture. Special sector intervention
funds in Nigeria have largely not delivered tangible results as they work
against market logic. The art of giving public funds to firms at below market
rate, below its true market price distorts market mechanisms and leads to scarce
resources being allocated to firms that will not best utilize them. Have we
seen yet the tangible and visible gains of the recent special intervention
funds in agriculture and aviation? Such
intervention funds have largely festered a regime of cronyism capitalism with
all its attendant ills, where you get access to funds below market rate if you
are connected to government and can even divert them to other more profitable
sectors outside the intervention fund. Crony capitalism is becoming a serious
problem in Nigeria. A regime of unfair market practices favouring cronies at
the expense of the Nigeria people such as the scandals that we have seen in the
oil subsidy programs, the non-transparent allocation of oil prospecting licenses
and now the targeted subsidy or bail-out to stock brokers who took excessive
risk in the capital market. With cronyism becoming a key success factor for
business in Nigeria, it is not surprising that every failed business or sector
from automobiles, pharmaceuticals and even thriving Nollywood film industry is
pressurizing for special intervention funds. The market punishment of bad
investment decision, a return of losses for poor risk decisions and vice versa
as gains for good investment risk decisions is critical to the effective
functioning of markets. It implies that the market must go through a cycle of
self-cleansing that we know as boom and bursts and bulls and bears. Special intervention funds where there are no
proven market failures, where it cannot be proven that markets lack the
mechanism to self-correct and cleanse itself in its organic cycle of bulls and
bear that ensure that resources are efficiently allocated to those who will
best utilize them, can only but lead to more imperfect market outcomes.
Government has done very well by intervening and bailing out
the banks whose failure truly posed a systemic risk to the financial system. It
has however overreached itself in the N23 billion bail-out of selected stock broking
firms. The logic and rationale of its decision fails public interest, fairness
and social equity tests. If the concern of government is about the liquidity of
the capital market, it cannot be addressed by rewarding excessive risk
behaviour that could further jeopardize the future health of the financial
system. This bail out of selected stockbrokers by government cannot be morally
and economically justified. It should therefore be seriously reconsidered.
Olu Akanmu is an executive in the telecommunications industry. He was
previously Managing Director, Retail and Consumer Banking at BankPHB. He
publishes a blog on Strategy and Public Policy on http://olusfile.blogspot.com .
