Retooling for the Post Financial Crisis

“Retooling For The Post- Financial Crisis”
MAPping the Future, Philippine Daily Inquirer, October 27, 2008
By Felicito C. Payumo


Warren Buffet managed to stay out of trading of derivatives because he did not understand them and viewed them with suspicion. He called them “weapons of financial mass destruction”. In good times, one cannot know who’s been taking excessive risks, he once said, “It’s only when the tide goes out that you will know who’s been swimming naked.” That’s his folksy equivalent of “In a bull market, everyone is a genius.”

In the local scene, the propensity of public officials, including a few Presidential aspirants to comment on every passing issue only expose not a few vacuous minds. As a non-banker trying to understand how a super bubble is inflated almost unnoticed until it pops, I found both helpful and hilarious a cartoon illustration “ A Subprime Primer” that went around the email circuit even before the financial crisis. In the primer, a banker is shown looking at a pile of stinking mortgage loans. He calls a smart guy from New York and asks how he could get rid of them. The smart guy (who must be from JPMorgan?) had a brilliant idea.

Smart guy: We will create a new Security and use these smelly mortgages as collateral. We will call it a CDO. We sell that to investors and promise to pay them back as the mortgages are paid off.

Banker: But crap is crap. Who will buy them?

Smart guy: Individually, they are. But if pooled together, only some will go bad. And since housing prices always go up, we have little to worry about. We will slice the CDO into three pieces and call them “the good, the not so good and the ugly.” We will promise to pay first those holding the good ones, the not so good, second and the ugly, last. And since the investor that holds the good piece has the least risk, we will pay him a lower interest rate than the other guys. Plus, we will buy bond insurance for the good ones, so the rating agencies will give them AAA to A, the not so good, BBB to B rating.

Banker: You’re a genius. So, we will now have AAA to B rating out of these stinky, risky mortgages. But who do we sell to?

Smart guy: Not to worry. We will not sell to widows and orphans but to sophisticated institutional clients, like insurance companies (like AIG?), banks, small towns in Norway (or Iceland?), school boards in Kansas, to anyone looking for high quality, safe investments. And you don’t have to worry about carrying them in your Balance Sheet- we will set up a shell company in the Cayman Islands to take ownership of the mortgages so the crap goes into their Balance Sheet. We call that a SPV (Special Purpose Vehicle).

In his new book, George Soros said that CDOs were even repackaged into CDOs of CDOs -called CDO square. The securitization mania spread from mortgages to other forms of credit called Credit Default Swaps (CDS). This synthetic market grew exponentially to an estimated notional value of $43 trillion. Alan Greenspan has kept the Funds rate at 1 per cent since 9/11 for so long that it was profitable to insure the same mortgage multiple times. There was nothing wrong with spreading the business and the risks for as long as home values were going up, but as it turned out it was also the fast way of spreading the woes. To put matters in perspective, he points out that this synthetic market is equivalent to the entire household wealth of the US. The capitalization of the US stock market is $18.5 trillion, and the US treasuries market is only $4.5 trillion.

And so, that’s how we got, not just the boom-bust housing bubble but a longer term, and more complicated super bubble which now affects not only Wall Street but Main Street, not just the US economy but the world economy, because, as Thomas Friedman says, “the world is flat.” He did not really apologize for stating a case for globalization, but for not realizing that the world is even flatter than he thought. “Who would have thought that hedge funds would come from the glaciers of Iceland,” he asked. He advised that we must prepare for the long haul. Quoting a historian of financial crises, he said that men think in herds. “They go mad in herds, while they only recover their senses slowly, and one by one.”

So, shall we sleep soundly when our public officials say that we are insulated from the crisis because our economy stands on sound fundamentals and that we have already done a restructuring of our financial system after the Asian Contagion?

Shall we not worry about our exports when the economy of our major trading partner, the US, is slowing down? No? Because we have a diversified market for our minerals and raw materials, like China? But doesn’t China also sell its manufactured products to the US and Europe which may slip into a recession if the credit freeze does not thaw? Shall we not worry about our workers who will be displaced in the export manufacturing sector, our major employer-sector?

Will our unemployment problem at home not be compounded by returning OFWs due to the possible contraction of the overseas job market? Let us do some slicing this time to see the distribution of our 8.2 million OFWs: we find that 2.9 million have permanent residence mainly in the US, 3.4 million have temporary work contracts in various countries, and 1.5 million are illegally staying, mainly, in the US and Malaysia. Though slightly lower in number, those residing in the US contribute 60 per cent of our total overseas dollar remittance because of the higher paying jobs there. A slowdown in the US economy will surely affect the remittance flow. But where are the temporary workers deployed? Household helpers and related workers category which account for 28% are Filipino maids in Hongkong, Singapore, Italy, and other countries. Singapore is technically in recession; the dailies carry accounts of maids worrying they might be sent home because “ the master has been coming home irritable since he lost his job.”

Construction workers account for 14 %; they are mostly in the Middle East working in oil-gas related projects in Saudi Arabia or Kuwait, and high-rise commercial buildings in Dubai and the Emirates. With the world- wide recession driving down the price of crude to below $70 per barrel, new construction projects could be put on hold.

Another 14% consists of factory workers such as those in manufacturing plants in Taiwan and Korea. Their products similarly go to the West. Then, we have nurses, physical therapists and caregivers for the ageing population of Europe, UK and the US. Their services will continue to be needed, but competition from other countries and nationals of the host countries have slowed down the deployment of our nurses. Building services requirements absorbed 5.8% of our workers, while Hotel and Restaurant workers account for 5.1%. Will travelers, specially the business executives, continue to fly and dine in style or will they now skimp on their reduced expense accounts? Finally, the performing artists make up for 2.4%. This group includes not only Pinoy band players in hotels and night club lounges but also GROs, a euphemism for Pinay night club workers in Japan. A weakening world economy does not bode well for them either. But will our seamen sail on smooth waters? Wouldn’t the reduced commerce, also reduce the number of cargo ships and tankers sailing the oceans. Even Luxury Cruise ships will not be able to escape a darkening horizon. That portends gloom not only for our seamen but also for Filipino musical bands, waiters, chambermaids and cooks that are ubiquitous in these cruise ships.

This is not a case for the perpetuation of the Filipino diaspora. While I have no problem with sending skilled workers, engineers, scientists and other professionals to hone their skills and enhance their knowledge in other countries so that they can apply them at home, I see no redeeming value for sending out teachers as maids and young girls as club entertainers. Teachers come home not enhanced but “deskilled” from years of scrubbing floors and cleaning up kitchens abroad.

But only after knowing the gravity and extent of the problem, can we offer our prescriptions for the future. As companies take a market slump as an opportunity to retool, countries must prepare their economies for the rebound. How? By putting our infrastructures- both hard and soft- at par with those of other countries.

1. It is obvious that our airports, seaports and roads suffer in comparison with those of other countries. Now that the SCETX has been connected to the NLEX, what we need is a direct highway connection between the NLEX and the SLEX so that motorists travelling to either north or south will be spared the traffic congestion in EDSA and C-5. But first, we have to put the SLEX out of the disgraceful state it is in. With this direct connection, it will also be easier to transfer passengers from NAIA to DMIA in Clark which is due for upgrading in view of plan to move our International Airport to Clark. With only one runway, NAIA cannot serve as a model international airport.

2. The Food Crisis seems to have been forgotten. But it is sure to come back as the world population increases and global warming continues unabated. Our ability to increase our rice production is severely limited because we have only irrigated 45% of our irrigable areas. The remaining 55% either have irrigation facilities which are silted and in state of disrepair, or are completely un-irrigated. Have we earmarked enough funds in our budget for building new and repairing old irrigation facilities and water impounding projects as we vowed to do when the crisis was upon us? Without water, there is no point in applying inputs such as fertilizer, high-yielding variety seeds, etc.

3. To be competitive, we need to upgrade not only our infrastructures but our human resources. Bill Gates, when asked what the US should focus on in the aftermath of the financial crisis, answered “education.” He owes the success of Microsoft to the deep pool of talents in the US which he was able to draw on. But his aim is modest, he wants every American to finish High School. In our case, should we not aim for the same for every Filipino youth? Senator Mar Roxas is right -with more than 30% of our children who enter elementary grades not able to reach High School, we have a long way to go. (While there are 13 million students enrolled in Elementary, there are only 6.3 million enrolled in Secondary Schools.) But to achieve this, have we recast the budget to give enough funds for classrooms, teachers, books and training of our mentors in math, science and English, and feeding programs for poor school children? Why not use the P26 billion earlier planned for the mercifully scuttled Cyber-Ed project? Without a high school education, our youth cannot even be trained for vocational skills in industry and agriculture which we sorely need, along with Science and Technology graduates, to be competitive.

4. Should we not learn from India and Taiwan which succeeded in converting a brain drain into brain circulation? Indian and Taiwanese engineers and scientists both contributed to and benefited from Silicon Valley. They go back and forth to their native countries and help develop Bangalore as the software capital of India and Hsin Chu Park as the hardware manufacturing and technology center of Taiwan. We should draw up a blueprint for providing work opportunities at home; we should not just educate our youth so they might migrate.

5. While we promote industries in our Ecozones, there’s a lot that can be done in the countryside in agriculture. There is the dairy industry, to cite one neglected opportunity. We import $600 million worth of milk and dairy products for 97 % of our consumption annually, and yet we see our hills and meadows green with cogon grass. All that we have to do is propagate the right kind of grass and legumes for improved pasture. To say that we are in the tropics is no excuse; Thailand is on the equator and yet the Thais have succeeded to produce 50% for their dairy consumption.

6. And finally, equally important as hard infrastructure is the soft infrastructure needed to facilitate doing business. I refer specifically to our regulatory and judicial system. Former Secretary Romy Neri was being truthful when he talked of “regulatory capture.” If one Commissioner of a regulatory body can sign a Cease and Desist Order for the entire collegial body, or a Justice can write the transcript of a proceeding from memory, it is no brainer to conclude that “ something is rotten in Denmark.”

The root of the problem is in the selection and appointment process of our Justices and officials. It is obvious that the deadly combination of our system and appointing authority does not select the best, the brightest and the most upright. This must change.

And perhaps, it is time to think outside the box. There is no field that is more regulated by rules than the field of sports. Sports seem encumbered by elaborate rules; yet you watch a golf tournament, a tennis match, a basketball game or a boxing bout and see that rules get applied on the spot. Sports has even kept up with the use of technology with slow motion replay of committed infractions and the visual tracking of where the tennis ball lands if a player makes a challenge. Why do rules get applied fairly in sports despite occasional protests from the players? The answer is simple: there is wisdom in the crowd. The crowd or audience that sees what is happening, collectively gives instant feedback to the referees, umpires or judges. The referee makes a questionable call and the booing comes loud and fast. He makes a good call and the clapping reverberates. The punishment or reward comes quickly. True, partisans from both sides cancel out each other, but it is the more sensible and objective among the crowd that render judgment. With due sympathy and commiseration with my La Sallite friends, the crowd knew whether or not Ateneo won the last UAAP Basketball Championship fair and square. There is wisdom in the crowd. But it must be allowed to witness, be it a sports event or a Court or Agency proceedings!

So, the debate is not about more regulations or less regulations. It is not even between Socialism or Capitalism, Big Government or Less Government. What we need is a responsible Government and right regulations. We only have to take a cue from Sports and apply it to the field of Governance. How to make a Judge’s or Commissioner’s decision subject to public scrutiny, and thus, to immediate public opprobrium or praise, is the key. Creative legal minds should be able to devise ways to do it.

Felicito C. Payumo was a three-term Congressman of the 1st District of Bataan and former Chairman of the Subic Bay Metropolitan Authority. He is Chairman of the University of Nueva Caceres. Comments to fcpayumo@gmail.com.