Wilberne Persaud, Columnist

(Left)Former Island Life chief executive Oliver Jones ... could have ended up as mogul of insurance industry with patience. - File

(Middle)Former Finance Minister Dr. Omar Davies... his policies were publicly criticised. - File

(Right)Dr. Paul Chen Young... was a principal of one of the entities that collapsed. - Winston Sill/Freelance Photographer

My reason for debate and discussion of the indigenous financial services meltdown of the mid-1990s is simple: to avoid repetition of similar costly mistakes.

Dr. Paul Chen-Young's latest comment continues to rely on flawed analysis of the issues. Initially, I was heartened. He was responding to "a few matters of substance" that I had addressed.

Sadly, anticipation of debate on substance was short-lived. Indeed, it did not survive even one sentence.

Purporting to respond to matters of substance, he instead begins by personal attack - quite a good strategy, for confusion though not truth - creating and distorting a picture of the messenger.

My first inclination is to step back and across, lifting the bat - classic leave alone. I fear nevertheless, even though I shall not respond in kind, I do have to spend some column inches in rebuttal.

Chen-Young claims I am "a close ally" of now former Minister of Finance Dr. Omar Davies, saying, "Both were lecturers at the University of the West Indies." He also suggests that readers be informed that I was "involved as a policymaker at Finsac." These two 'facts' he implies, constitute bias.

First, readers of my Financial Gleaner columns on the meltdown are aware that I immediately declared interest by indicating my connection to Finsac as a board member.

Far from making me biased, on the contrary, it allows me to combine professional training and experience with an almost unique perspective for understanding the issues.

I set out a view with reasons for the conclusions reached. My views can be contested, they are not opinions plucked from the sky.

The logic, the reasoning has to be demonstrated as faulty in order to refute my conclusions.

Never would I suggest Chen-Young is biased merely because he was a principal of one of the indigenous entities that collapsed. I was, still am, contesting the basis of his views as technically unsustainable.

FIREWALL

Second, I have consistently written columns critical of issues of governance, problems of develop-ment, the scourge of 'cost overruns', inattention to technological change and the like.

Surely, Davies would have found it difficult to maintain 'a close ally' who would publicly highlight issues within his portfolio that needed to be remedied for good governance and development.

I attempt to be analytical rather than political. I can only insist that the 'real environment', the 100C temperature at which water boils at sea level, does not bow to politics.

I now turn to the "few matters of substance". I highlight those that I feel will shed the most light for an interested public.

I spoke of a firewall among banking, insurance and other activities in the financial-services sector and those of the 'real sector' - real-estate development, hotel trade, car rental activities, etc.

Anyone who has ever applied for a loan knows his banker is more familiar with his financial condition than his closest friend, even spouse at times. A commercial bank is not allowed to be in the business of 'real', that is, goods and trade, as opposed to the 'financial' sector.

Imagine this: Small Jamaican entrepreneur seeks credit facilities from French footwear manufacturer. French manufacturer will grant 180-day credit subject to report from client's bank.

The bank is part of a group that also sells/produces footwear. Huge conflict of interest here.

Consider a bank lending to a client to purchase real estate only to repossess the property for its own use when he is unable to pay the loan.

Indeed, during the meltdown at least one borrower accused a lender of coveting his property, charging high interest rates ultimately repossessing it. Chen-Young asserts: "There has never been any legal restriction against the creation of financial conglomerates and Eagle was foremost in this strategy."

Correct. There was, still is, no legal restriction against conglomerates.

The problem with conglomerates when there are inadequate regulations and oversight is that enormous temptation and avenues for bad decisions and impropriety exist.

Chen-Young himself cites the case of Mutual Life Assurance Society borrowing multiples of the bank's capital base from its partially owned commercial bank.

Existence of a 'firewall' was not posited as a part of law.

It was a matter of custom in the previous regime of foreign commercial branch banking. Indigenous financial institutions facing troubles, used their conglomerate structure to practise regulatory arbitrage - the mechanism of hiding improper transactions from financial system regulators.

The regulatory system itself, extant legislation and personnel were inadequate in specific rules, number and equipment, respectively.

For instance, the superintendent of insurance was almost literally one person, a small office and a telephone.

USEFULNESS OF CONGLOMERATES

Our indigenous conglomerates destroyed the firewall that previously existed. Initially, this was a good thing, handled with prudence.

Several entities used intra-group operations to theirs and Jamaica's advantage.

Chen-Young highlights some of these positive developments - purchase and building of hotels as government divested.

They also allowed, importantly, expanded stock-market participation and capital-market development, generally.

Never disputing these facts, I have rather, highlighted and commended them.

My point has been that in periods of rising prices, particularly real estate, euphoria sets in.

Crowne Plaza hotel, Island Life's blue head-office building, Mutual Life's second tower, all became albatrosses around the necks of their respective groups - the equivalent of capital haemorrhage.

What could Government policy have to do with these decisions?

BETTING AGAINST DEATH

Life-insurance companies bet their clients they will not die in a particular time period.

As dealer and banker at the table, they usually win. The game is fixed in their favour by the statistics they analyse and the medical tests they do.

But, apart from this, they must use clients' premium payments to generate investment income to cover necessary expenses settle claims.

For this they hold an asset portfolio of cash, securities, real estate and so on. Prudence dictates a particular kind of mix in these holdings.

Here's a crude numerical example. A company collects from 10,000 clients premiums of $4,000 each - a total of $40,000,000 per month

Let us say each client's life is insured for $1 million, totalling $10 billion - a good deal since they are unlikely to die all at once.

Indeed, it is likely that only a few of them will die in less than 40 years. So, the company has those premium funds to use.

If the company does nothing but buy government paper at 23 per cent interest, in 15 years, one year's invested premium income grows to $10 billion. In 40 years, it grows to $1,540 billion.

This is crude - premium payment is continuous, not just one year - but readers can get my drift. This is good business.

But the company must pay its expenses - rental, electricity, salaries, computers and software licenses, etc. It is not cheap.

So, to do even better, companies spread risk and invest in other types of assets that return more than government paper.

In a time of rising real-estate prices, $480 million, the annual premium of our example can be doubled in much quicker time through real-estate development and speculation as opposed to investment in government paper.

Crowne Plaza began as investment in real-estate development - luxury apartments and penthouses billed as Jamaica's most prestigious address.

Perhaps government policy had an influence in its being converted to a hotel to benefit from tourism incentives. But that was an afterthought.

Conversion proved costly as anyone in the building trade would know. As a business proposition, a hotel in that location made no sense.

It could not be a leisure/pleasure/sea/sand/fun resort and Kingston traffic made a business hotel impossible. It was bound to fail.

Island Life converted interest-earning government paper into its commercial building and head office at a time of literally zero economic growth and astonishingly, without tenant contracts.

In what could only be described as a moment of serendipity, I had discussions with Oliver Jones, then CEO of Island Life, in which I advised against this. Jones' son, attending a Canadian university had difficulty with economics. They came after hours, to the Department of Economics at UWI Mona, for an appointment with a lecturer who did not show.

Being head of department at the time, I was upset and embarrassed. I offered to assist if I could.

Jones, in appreciation I thought, invited me for a breakfast meeting at the Terra Nova. At that session, I suggested if only he should be patient he might end up the true mogul of Jamaican insurance. It was already, however, when we spoke, too late.

PRUDENT INVESTMENT

When investing public funds, public institutions in the United States use the 'Prudent Person' rule: "Investments shall be made with judgement and care, under circumstances then prevailing which persons of prudence, discretion and intelligence exercise in the management of their own affairs, not for speculation, but for investment, considering the probable safety of their capital as well as the probable income to be derived from the investment."

The former rule holds for employees.

For a contracting investment company, the standard intensifies to the 'Prudent Expert' - even tougher. Readers can judge for themselves whether the indigenous financial sector institutions' investment strategies met the criteria above.

IMF MANDATE

Referring to my comment that "the IMF publicly mandated that NCB was to be sold by a certain date", Chen-Young said: "It is astonishing that he could have used that rationale to draw his conclusions about the sale of financial entities since Jamaica has no formal loan agreement with the IMF."

This was never claimed as rationale for sale of financial entities. It was mentioned as a negative influence on sale price.

Neophyte investors know if they want basic facts on Jamaica economy and society, the first ports are websites of the Central Intelligence Agency, International Monetary Fund (IMF) and World Bank, followed by the Planning Institute of Jamaica, Statin and the Ministry of Finance, perhaps in that very order.

If the IMF publishes in one of its quarterly, surveillance or other reports that Jamaica is undertaking to sell its largest domestic commercial bank in the next quarter and also indicates its 'support for such action', those who know, understand the code. It would be a dim-witted negotiator indeed who fails to grasp that critical fact.

The seller is time-constrained and the offer price must fall.

There are several further points of contention with Chen-Young's view of the meltdown being primarily caused by government policy - government's supervisory and regulatory regime had serious flaws which I have discussed elsewhere - its aftermath and ultimate solution.

Space does not permit me to continue.

I hope I have been able to demystify some seemingly esoteric stuff and as well, shared enough to dispel the notion of bias underlying my comments as implied in his response.

Finally, I should indicate that I know Dr. Chen-Young personally, having not seen him in a decade, I do hope I remain a cordial acquaintance if not 'a close ally' after all this.

wilbe65@yahoo.com