Davies dug graveyard of entrepreneurship: FINSAC failed

As I read the article 'Finsac: the truth' (Sunday Gleaner, May 15, 2011) by Dr Omar Davies, architect of the failed financial and economic policies during the period that led to the collapse of the domestic financial sector, closures of numerous businesses, massive layoffs - 90,000 in agriculture and manufacturing - high inflation averaging 34 per cent from 1991 to 1997, high lending rates averaging 40 per cent over the same period, devaluation of 64 per cent over the six-year period, massive trade deficits, destruction of entrepreneurship, and a fiscal deficit of eight per cent of gross domestic product in 1997 BEFORE the financial crisis after erasing a surplus in the early 1990s, my mind turned to one of my favourite maxims: "The mills of God grind slowly, but they grind exceedingly sure."

Dr Davies has tried to tell the 'truth', but, alas, his article conveys erroneous rationalisation of policies that contributed significantly to the financial crisis in the 1990s and the mismanagement that followed. He alludes to the 'fit and proper person' criterion in his scathing remarks about executive chairmen of certain financial entities. But would it not be a legitimate question to ask whether Dr Davies, in his previous job as minister of finance, would qualify to serve again as a 'fit and proper person'?

Despite whatever bias I might have, I have attempted to be objective in my three publications on the collapse of the domestic financial sector. These are: With All Good Intentions: The Collapse of Jamaica's Domestic Financial Sector (1998); The Entrepreneurial Journey in Jamaica: When Policies Derail (2004) and Submission to the Commission of Enquiry into the Collapse of Financial Institutions in the 1990s (2009).

In these publications I have stated that strategic management errors contributed to the collapse of the domestic financial sector. But I also cite the hostile economic environment that made it difficult to survive. Yes, the foreign-controlled banks survived by following strict conservative policies. And the building societies also survived as their portfolio was limited to relatively safe mortgage loans and they were able to absorb whatever losses that occurred.

Important fact omitted

By citing those examples of survival, Dr Davies has omitted from his analysis the important fact that Government encouraged domestic banks and life insurance companies to invest in and to develop the tourism sector, without which involvement the present tourism infrastructure would not exist in its present form. There would have been no successful hotel divestment, which was a failure until the domestic financial institutions decided to make investments in the industry. In retrospect, the institutions went overboard as they scrambled to finance projects at prolonged high interest rates to compete with rates paid on government paper. In the life insurance industry, the main source of long-term funding collapsed with massive increases in encashment of life insurance policies.

It is disingenuous for Dr Davies to simply assert that the problems of the sector were caused by executive chairmen of the domestic financial institutions. The reality of the situation is that the problem was systemic, and no single major domestic bank and life insurance company escaped the devastating effects of the hostile economic environment, especially the prolonged high interest rates.

For the record, in the case of the Eagle Group, I served as executive Chairman of only one entity - Eagle Merchant Bank - where Daisy Coke served as deputy chairman. I served as chairman on most of the other boards, including the Crown Eagle Life Insurance Co, where Dr Oswald Harding served as deputy chairman. There were about 36 directors who, along with dedicated and competent management and staff, spearheaded the formation and success of entities like Eagle Merchant Bank, Eagle Commercial Bank, Eagle Unit Trust, Eagle General Insurance Company, and Eagle Permanent Building Society.

These were viable financial entities that formed the backbone of the Eagle Premium Growth Fund, which was created to raise capital to pay off some J$6-billion in high-cost funds at Crown Eagle, where there was a serious mismatch of assets and liabilities that characterised the industry. Dr Davies launched the Fund in 1996, but it failed to raise the monies needed, partly because of competition from Government paper around the same time that was paying 50 per cent interest.

Unworthy behaviour

I note the reference made by Dr Davies, about a meeting at which an executive chairman and two deputies met with him to seek financial support for a life insurance company immediately after which the same two deputies sought a meeting with him and told him not to provide any support. Whoever these persons may be, I can only say that such behaviour must be regarded as treacherous and unworthy. Dr Davies owes it to the public to say whether he acted on the backhanded advice given to him by these persons. He should also not hesitate to call their names, since this is a very serious allegation about senior persons who were serving in the financial sector.

On a broader note, in my 'Submission to the Commission of Enquiry', I made the point that directors have a legal and fiduciary responsibility for policy and the affairs of a company. No director can escape responsibility when a company runs into trouble. There is the doctrine of collective responsibility where all directors do have accountability. So the executive director propaganda strategy can have no traction as ALL directors are ultimately responsible, and those who disagree with policy decisions should have had the guts to resign.

The scathing attack by Dr Davies on executive chairmen of some of the financial institutions is a straw man and red herring. It is the new mantra that Dr Davies has now graspingly latched on to in order to blame those enterprising Jamaicans who took risks and provided leadership and commitment to develop financial institutions. Under my leadership at Eagle Merchant Bank, we succeeded in developing a network of viable financial institutions, all of which were created from scratch. Despite the loss of the Eagle entities, I am very proud of what my directors, management and staff accomplished. It is no easy task to start companies from scratch and achieve operational viability.

Eagle's wings clipped  

It was a sad chapter when Government took over the Eagle entities, causing loss of jobs to hundreds of employees and wipe-out of shareholders' investments. But even more heart-wrenching was to see some of the entities that were created from scratch with sacrifice and tremendous hard work suddenly destroyed. Some politicians, like Dr Davies, who have built nothing, find it easy to tear down and destroy, but will find it infinitely more difficult to create anything successfully.

I now turn to the contention by Dr Davies that high interest rates cannot be used to explain the problems experienced by the domestic financial sector and by other businesses. I do not believe that anyone could argue that high interest rates alone caused the crisis. It was a combination of adverse economic factors, including wrong strategic investment decisions for which management must bear responsibility. But it cannot be denied that prolonged high interest rates contributed significantly to the financial crisis. The real question is: What caused the prolonged high interest rates?

The core cause was irresponsible fiscal policy that caused a rapid deterioration in the fiscal accounts from a surplus in the early 1990s, to a deficit of more than eight per cent of GDP in the short period of a few years up to 1996 - before any Government intervention in the financial sector. High inflation accompanied the jump in the deficit, and this led to an overvalued currency and annual devaluations. Added to this fact was Dr Davies' much-quoted "run wid it", questionable government expenditures for electioneering purposes.

With respect to the operations of FINSAC, no one should disagree with Dr Davies that he acted properly to save the thousands of depositors and owners of life insurance products - even if he did so just before a general election. He says that was the prime purpose of FINSAC, and not to "protect the owners/managers of the failed institutions or their bad debtors". But the 1998 FINSAC annual report states: "FINSAC was incorporated with the specific mandate from Government to resolve the problems of solvency and liquidity being experienced by the financial sector" and "FINSAC will assist institutions in developing workout plans, where necessary, to return them to viability".

I lost Eagle, and no arguments can change that fact. In my testimony before the commission, I attempted to make a case that Eagle could have been saved, given the terms of reference of the commission and the mandate of FINSAC. There were viable entities in the Eagle Group that even Dr Davies recognised in his testimony before the commission.

Why there was a crisis

On the basis of its mandate, FINSAC had an obligation to help troubled financial institutions return to viability, if that could be realistically done under a workout plan with financial support. Citing various audits to justify the wholesale takeover and sale of institutions and businesses begs the question, why not? Of course, the findings would show that all the major domestic banks and life insurance companies were insolvent. That's why there was a crisis. What FINSAC failed to do was to carry out its mandate. I can think of no financial institution where it worked with owners/management to return them to viability.

I accept the edict that no owner of any business, including financial institutions, has any right to expect that Government will bail him out when his business fail. Other than my testimony to the commission of enquiry, in none of my writings or public statements have I ever argued that the Eagle Group should have been saved, although I strongly believe it had the management, staff and infrastructure to have achieved viability in a relatively short period had the planned joint venture with Government materialised.

The public must hold institutions accountable, and their success or failure will be on the basis of whether they delivered the service/support for which they were established. FINSAC failed to deliver according to its mandate and, therefore, abrogated its responsibility to the country.

Paul Chen-Young, PhD, is former executive chairman of Eagle Merchant Bank.