Friday, 6 February 2009


6th February 2009

The Malta Independent - Friday Wisdom

The gloom surrounding world economies seems to be affecting everybody’s rational thinking leading to confusion and complications.

On the local front, the question of the utilities tariff seems to be a neverending saga. Unions are insisting that the government immediately revises them downwards to take into account falling oil prices and quite a few of them are insisting that the October 2008 increase in tariff rates be revoked altogether as if it never happened.

The government on the other hand is trying to ease itself out of this situation by promising revisions probably after the first quarter of 2009. To justify its stance, the government says that Enemalta made a huge loss in financial year 2007/2008 (15 months to December 2008) and argues that through forward contracting and hedging the full impact of reduced energy prices will only have the positive effect on Enemalta’s acquisition costs in the course of 2009.

The situation is so simple that there is no use complicating it. In the period October 2007 to June 2008 when energy prices were exploding upwards, the government kept an unrealistically low 50 per cent surcharge in order not to risk voters’ outrage in the run up to and immediate aftermath of the March 2008 elections. I had forewarned about this in an article in this series published on 7 December 2007 titled Surcharge surprise. I had warned that:

“If we continue to tailor such important policies merely to suit election and political convenience, then the electorate should not be amazed if after the election surcharge freeze we could have a post-election surcharge surprise”.

So in the period July 2008 to March 2009 (nine months) we have to pay up, through unrealistically high utility rates in comparison to prevailing international energy prices, what we have enjoyed in the period October 2007 to June 2008 (nine months). It’s as simple as that really and there is no need to beat round the bush. The electorate should learn that there is no such thing as a free lunch and what appears as a free lunch before the election normally is paid by a double bill after the election.

At an international level, the economic crisis caused by the financial turmoil seems to be setting the world on a very dangerous slippery slope where the vast benefits gained by all through globalisation are quickly forgotten, and now that it has gone into reverse mode, many are experiencing an irresistible urge to adopt a protectionist mentality.

Governments who have bailed out their banking system are pushing their banks to give credit priority to domestic customers, penalising innocent international borrowers especially from developing countries. We have seen riots and protest in major European cities with Britons showing displeasure against foreign guest workers for taking British jobs. French workers protest against government being generous with banks without realising that the economy can never return to a growth path before the financial sector is stabilised enough to permit the easy flow of credit. The US government suggests a ‘Buy American’ condition favouring US steel producers in the proposed mega stimulus package that is being considered in an attempt to kick start the economy. This has already attracted protests from the EU and Canada who could retaliate with similar protectionist measures further reversing the growth of international trade.

It is odd that at the recent Davos World Economic Forum it had to be Russian Prime Minister Putin to warn against “the blind belief in the over arching power of the state” as major democracies are forced to take direct control of their banking systems. The Chinese Prime Minister said he is re-reading Adam Smith in search for inspiration. Evidently, Russia and China have much to lose now from reversion to protectionism than was the case in their traditional communist days.

What is also offending my eyes is the pretension by senior economists and key bank executives that while governments should put taxpayer money at risk to save the banking system from further damaging the general economy, sort of saving Wall Street to protect Main Street, governments should not make conditions like those being proposed limiting the executive power of the bank management to pay themselves and their subordinates unrealistic bonuses. Such economists and bankers still don’t get it that their irrational exuberance, over-leverage in search of short term profits at the expense of long-term sustainability, and inability to self-regulate have landed us in the mess we are in and is forcing the taxpayers to mortgage their children’s future in an attempt to regain financial stability and avoid a deep depression.

Truth is that while governments are fire-fighting the crisis, they cannot be too bothered about wetting the furniture. However, once the fire is put out and normality returns, there should arise a philosophical argument about who should own the banking system and how it should be regulated.

The concept that banks are too important to fail gives rise to moral hazard issues. Can democracy tolerate a situation where private shareholders enjoy profits when the going is good while taxpayers have to move in with their dollars to save the banks from their own excesses? Is it fair that profits get privatised while losses get socialised?

The only way permanent nationalisation of the major players in the banking system can be put off the agenda is if bank regulation is revolutionised and rendered so effective that banks are not allowed to incur risks which could get them into trouble. This could involve tough regulation regarding the size of banks that will not be allowed to grow too big to fail and that would have to maintain high capital ratios and low leveraging to ensure that if they mess up they can be allowed to fail without causing systemic risk.

In the meantime we have to learn from experience and forget any hope that banks, financial institutions, or anyone else for that matter, can effectively self-regulate. Human nature is what it is! Thank goodness that our banking system was not infected by international greed leading to over-leverage. But events should certainly send a message that for banks as big as the two main banks on the local scene, the government should not (in case of Bank of Valletta) or should not have (in case of HSBC Malta) given up its right to appoint a chairman. Banks commanding a huge slice of the market need more, not less, regulation.

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