Building Financial Markets and Institutions The Place of

Building Financial Markets and Institutions: The Place of Values, Knowledge, Wisdom and Understanding AG Garba Presentation at IV Plenary of Central Banking, Financial System Stability and Growth Conference May 04, 2009 1

OVERVIEW 1. Background 2. To Build, Reform or Transform? 3. Game Changers 4. Building a Sound Financial System 5. Conclusion? – Food For Thought 2

Background (1): Conceptual Issues 1. Financial Market or System? Financial Market: a. Products? b. Allocative or Rationing device? – efficiency, transaction costs, optimal intermediation c. Discovery or Creative Process? - adverse selections; moral hazards; credit crunch; volatility; etc d. Partial, General or Global View? – volatility; contagion; global games and adaptations; strength of national banking and financial systems; capital controls; reform of global financial architecture; etc Financial System: a. Real-Financial Nexus? b. Safest and Fastest Growing/Sustainable Economic Growth? c. Same issues as c. above. 3

Economy-Finance Nexus 1. 2. 3. 4. 5. 6. Links to national income account Links to external accounts Links to private sector account Links to public sector account Implications for Money Survey Implication for Competitiveness 4

Some Indicators of Real-Financial Relations 5

Background (2): Conceptual Issues 2. What Type of Players and Referees? Players (Borrowers, Lenders, Intermediators) a. b. c. d. Knowledge Problems: Information Asymmetries and Computational Skills (Collaterized Securities and Derivatives) Typologies : (i) wealth seeking; esteem seeking and wisdom and truth seeking (Plato) – extrinsic versus intrinsic motivations and (ii) worldly or righteous Moral Strengths and Deficiencies (susceptibility to being corrupted and willingness to corrupt) Implications for Markets; System and Institutions (Moral Suasion vs. Incentives) Referees (Regulators) a. b. Knowledge Problems; Motivations; Moral Strengths/Deficiencies (susceptibility to corruption) Separation from Players; Guardians or Actors? 6

Liberalization, Bubbles and Bursts • • Western referees (governments and regulatory agencies like the Fed, OCC and FDIC) have a monumental challenge; striking a balance between protecting the system against systemic volatility and allowing the market to penalize speculators (gamblers) and risky investors. [1] No one knows what the right balance is. It is clear however, that the trade-off is brought about and tightened by deregulation, gambling and risky investments the same forces driving global financial integration. Historical evidence indicate that deregulation is known to be behind “just about every banking crisis in recent times. ” Much of banking history from the Dutch Tulip bulbs (1637), South Sea Bubble (1720), Mississippi Bubble (1720) to the bubbles of the 1990 s has been one of successive speculative bubbles. Recent speculative bubble “tend to be fuelled by an explosion of credit, a wave of unwarranted optimism and a subsequent mispricing of risk” and then, the burst (The Economist, October 28 th 2000). In all speculative bubbles, the player-referee relations looms very large. [2] Although, not as direct as was the case in the South Sea Bubble and the Mississippi Bubble, referees have been linked to the unwarranted optimism and mispricing of risks that trigger speculative bubbles. (Garba and Garba, 2001). 7

Players: Asymmetries and Contradictory Behaviors • Firm behavior: selective financial misrepresentation is the only strategy that can ensure that its stock price will outperform the market as a whole and thus provide it with the additional credit that drives financeled growth. • Behavior of Individual investor: knowledge of selective financial misrepresentation heightens risk aversion, provides incentives for investing in portfolios which replicate the market and, as such, denies firms the credit that is used to drive finance-led growth. Watson, Matthew. "Whither Financialisation? The Contradictory Microfoundations of Finance-Led Growth Regimes" 8

Background (3): Conceptual Issues 3. The Financial Products Capital, Bonds, Money, Commodities, Foreign Exchange, Derivatives Essence of Products: a. To Facilitate Investment and Growth; Consumption and Living Standards and; Domestic and International Trade b. To Transfer of Risks; Guarantee Security; etc. c. To offer opportunities for channeling dangerous human proclivities into money making: thereby saving society from “cruelty, the reckless pursuit of personal power and authority, and other forms of aggrandizement” (Keynes: 1937: 374). 9

Background (4): Conceptual Issues 4. Institutions and Policy Regimes Rules plus Enforcement Banking, Capital Market, Pension Market and Insurance Universal Banking Transaction Costs Corruption and Money Laundering: AML/CFT Protection of Depositors and Investors Deregulation and Liberalization 10

Background (5): Conceptual Issues 5. Environment Economic Structure and Balances: national accounts, public, private, external, money survey and savings-investment Global Financial Architecture and Crisis: action-lag, market-state failures and consequences Industry Character and Current Challenges 1. Margin Lending Loses: >$10 Billion? /Effects on Banking System and Inter Bank Lending, Interest Rates, Forex Trading 2. Stock Market Crash: from >14 trillion to <5 trillion; declining asset prices and volatility/AP Case 3. Forex Market: Volatility; Excess Demand; Devaluation 4. Pension Funds: Is it secure? Is it productive? 5. Insurance: How Strong and How Effective? 6. External Imabalnces 11

II. To Build, Reform or Transform? (1 a) 1. To Build: a. On what foundation? FSS 2020? Existing Institutions? b. Who builds, For Whom and to What Purpose (s)? c. How to build and using what resources? d. What is the building Plan? 12

II. To Build, Reform or Transform? (1 b) 13

II. To Build, Reform or Transform? (1 c) 14

Indicators of External Imbalances 15

II. To Build, Reform or Transform? (2) Definitions • To Reform: “To improve by alteration, correction of error, or removal of defects; put into a better form or condition. ” Transform: ““marked change, as in appearance or character, usually • for the better. ” Questions – What is defective in players, regulators, markets/games, institutions, foundation, purposes, vision? 16

III. Game Changers 1. 2. 3. 4. Global Financial Crisis and ongoing Debates About How to Fix it Global Dis-connect Between Production and Finance Responses to Global Financial Crisis Consequences of Global Shocks 1. 2. 3. 4. 5. Capital flows: Capital Market Banking System Exposures Forex Market Volatilities Derivatives and Insurance Pension Fund 5. Deregulation and Consolidation 6. Policy Dilemma and Moral Hazard: trade-off between systemic collapse and bailing out inter -mediators. 17

IV. Towards Sound Financial System (1): Foundation Principles 1. Rethink FSS 2020: after a strategic evaluation of (i) Game Changers; (ii) Ongoing Debates about Global Financial Crisis; (iii) Nigeria’s Experiences and, (iv) aspirations of the Nigerian people. 2. Focus: a. Strengthening links between Finance and Production b. Making B, R and T of the Financial System as Subset of Economy wide B, R and T. c. Separate Players from Referees 18

IV. Towards Sound Financial System (2): Who, For Whom and to What Purpose 1. Who? The President, National Assembly, Ministry of Finance, CBN, NIDC, SEC, other stakeholders 2. For Whom Individuals, Households, SMEs, Organized Private Sectors, Inter-mediators 3. Purpose Growth, Job Creation, Price Stability, External Balance, Balanced Regional Development, Reduction of Poverty and Inequalities, Higher Life Expectancy, etc. 19

IV. Towards Sound Financial System (3): How and What Resources Consistent and Integrated National Strategic Plan Framework 1. Clear Vision, Mission and Understanding of Global and National Games 2. Transparent Process 3. Empowered Participation 4. Rule of Law, Due Process 5. Dependence on National Resources: Human, Intellectual and Non-Human 6. Use of Needed and Useful International Resources 20

IV. Towards Sound Financial System (4): Building A Plan 1. The Short Term Plan a. b. c. d. e. Inter-Bank Market and Margin Lending Crisis Stock Market Crisis FOREX Market Global Financial Crisis Information Asymmetries 2. Medium and Long Term Plan a. Performance driven Economic Management Plans that works for a majority of Nigerians and Nigeria b. Stronger National Banking and Financial systems c. Building mechanisms for reducing contagion d. Minimizing moral hazard situations; Volatility and Speculative Bubbles e. Reforming Global Financial Architecture including the Industry of Development Finance 21

Capital Control Debate 1. Horst Kohler (2001), “New Challenges for Exchange Rate Policy”, Kobe, January 13, 2001 Pre-conditions for capital account liberalization include: (i) sound domestic financial systems; (ii) adequate supervision and prudential regulation; (iii) good risk management capacities in banks and businesses; (iv) greater transparency and (v) market discipline 2. Stanley Fisher, “Lessons from a crisis”, (The Economist, October 3 rd, 2000). “The IMF’s position has long been that capital-account liberalization should proceed in an orderly way: countries should lift controls on outflows only gradually as the balance of payments strengthens; liberalization of inflows should start at the long end and move to the short end only as banking and financial systems are strengthened. ” 22

IV. Towards Sound Financial System (5): Other Matters 23

V. Conclusion (1) ? a. The Players and the Referees are humans, governed by values and, knowledge problems b. Values and knowledge and, wisdom and understanding (or, lack of) shape the choices and the actions of players and referees c. Ultimately therefore, success or failures in building, reforming or transforming Financial Market or System would depend strongly on the (1) motive forces driving players and referees and, (2) on the knowledge, wisdom, understanding and righteousness brought to bear in the B, R or T. 24

Food For Thought (1) • • Luke 6: 49 But he that heareth, and doeth not, is like a man that, without a foundation, built a house on the earth, against which the stream beat vehemently, and immediately it fell, and the ruin of that house was great. Psalm 15: 5 He that putteth not out his money to usury, nor taketh reward against the innocent. He that doeth these things shall never be moved. Psalm 49: 6 -7 They that trust in their wealth, and boast themselves in the multitude of their riches; None of them can by any means redeem his brother, nor give to God a ransom for him: Psalm 49: 10 For he seeth that wise men die, likewise the fool and the brutish person perish, and leave their wealth to others. Luke 16: 13 No servant can serve two masters: for either he will hate the one, and love the other; or else he will hold to the one, and despise the other. Ye cannot serve God and mammon. Mathew 6: 19 Lay not up for yourselves treasures upon earth, where moth and rust doth corrupt, and where thieves break through and steal: Mat 7: 17 Even so every good tree bringeth forth good fruit; but a corrupt tree bringeth forth evil fruit. 25

Food For Thought (2) • • Proverbs 13: 11 Wealth gotten by vanity shall be diminished: but he that gathereth by labor shall increase. Ecclesiastes 5: 10 He that loveth silver shall not be satisfied with silver; nor he that loveth abundance with increase: this is also vanity. Isaiah 9: 20 And he shall snatch on the right hand, and be hungry; and he shall eat on the left hand, and they shall not be satisfied: they shall eat every man the flesh of his own arm: Mathew 13: 22 He also that received seed among the thorns is he that heareth the word; and the care of this world, and the deceitfulness of riches choke the word, and he becometh unfruitful. Mark 10: 23 And Jesus looked around, and saith to his disciples, How hardly shall they that have riches enter into the kingdom of God! 1 Timothy 6: 17 -19 Charge them that are rich in this world, that they be not highminded, nor trust in uncertain riches, but in the living God, who giveth us richly all things to enjoy; That they do good, that they be rich in good works, ready to distribute, willing to communicate; Laying up in store for themselves a good foundation against the time to come, that they may lay hold on eternal life. James 5: 2 Your riches are corrupted, and your garments are moth-eaten. Psalm 55: 22 Cast thy burden upon the LORD, and he will sustain thee: he will never suffer the righteous to be moved. 26