NUS Business School CAN – List of Donors

The donors (in alphabetical order) to the NUS-Fujiang Village Elementary project are:

Alan Yong

(BBA 2003)

An Jing

(Shanghai Office Staff)

Bai Jin Min

(APEX-C 2000)

Bai Zhen Cai

(APEX-C 2005)

Cai Qing Zhong

(APEX-C 2009)

Calvin Yan Jun

(Shanghai Office Staff)
Chen Chun Hua

(APEX-C 2000)

Chen Ge

(APEX-C 2008)

Chen Jie

(APEX-C 2002)

Chen Shuang Ming

(APEX-C 2005)

Chen Zhi Lei

(IMBA 2003)

Chen Zhi Yong

(IMBA 2003)

Dong Zhen Yu

(MBA-C 2004)

Du Hai Bo

(APEX-C 2003)
Forrest, Zhang Peng

(Shanghai Office Staff)

Ge Jun Shi

(APEX-C 2005)
Gong Ming Jie

(APEX-C 2005)

Guo Yan Liang

(APEX-C 2005)

Hao Yi Hong

(APEX-C 2003)

Huang Chuan Sheng

(APEX-C 2005)

Huang Guang Wei

(APEX-C 2007)

Huang Ping

(APEX-C 2007)
Huang Xiao Bin

(APEX-C 2005)

Jian Lun

(APEX-C 2005)

Jiang Bao Ling

(APEX-C 2005)
Jiang Rong Xing

(APEX-C 2005)

Lao Xin

(MBA-C 2002)
Li Jing Liang

(APEX-C 2005)

Li Li Jun

(APEX-C 2008)
Lin Yun Zeng

(APEX-C 2005)

Luan Jiang Hong

(APEX-C 2005)
Lv Ren Yuan

(IMBA 2003)

Ma Bao Jun

(APEX-C 2005)
Monica, Zhao Shuang Li

(Shanghai Office Staff)

Ni Hao

(MBA-C 2002)
Niu Hai Ming

(APEX-C 2009)

Niu Hong Wei

(IMBA 2004)
Pan Ke Qun

(APEX-C 2004)

Pan Wen Dong

(IMBA 2002)
Qin Ye Hua

(APEX-C 2005)

Song Wen Qing

(APEX-C 2005)
Su Wei Bin

(APEX-C 2006)

Tao Xue Bin

(APEX-C 2005)
Wan Jue Hui

(APEX-C 2008)

Wang Gang

(APEX-C 2005)
Wang Hong

(MBA-C 2002)

Wang Hong Bin

(APEX-C 2005)
Wang Hong Yuan

(APEX-C 2005)

Wang Jian

(MBA-C 2002)
Wang Jin Bao

(MBA-C 2002)

Wang Qian

(MBA-C 2003)
Wang Ru Hai

(APEX-C 2006)

Wen Wei Jia

(APEX-C 2009)
Wu Hang Jun

(IMBA 2003)

Xiang Xiao Qin

(MBA-C 2002)
Xie Shi Fang

(APEX-C 2008)

Xu Xin

(MBA-C 2002)
Xu Xin Yu

(APEX-C 2006)

Yang Li Xin

(APEX-C 2005)
Yang Wei Dong

(APEX-C 2005)

Ye Wu

(APEX-C 2005)
Yu Guo Dong

(IMBA 2003)

Zeng Yuan Ming

(APEX-C 2006)
Zhang Heng

(MBA-C 2002)

Zhang Jiang Yan

(MBA-C 2000)
Zhang Li Juan

(APEX-C 2005)

Zhang Sheng Rong

(APEX-C 2005)
Zhang Yong Tao

(APEX-C 2002)

Zhao Zhong Dong

(APEX-C 2005)
Zhou Bin

(APEX-C 2000)

Zhou Shu

(MBA-C 2002)
Zhou Xing

(APEX-C 2006)

Zhuang Hong Nan

(APEX-C 2005)

Making Sense of US Dollars


Assoc Prof Takeshi Yamada, an associate professor and financial economist at the NUS Business School, explains how the US plans to fund its budget deficit and what the US can learn from Japan’s experience in stimulating the economy.

The US Congressional Budget Office projects that this fiscal year alone, the US budget deficit will top $1.2 trillion, as a result of, among other things, the bailout of American banks and its automobile industry. Astoundingly, this projection does not include the cost of the budget stimulus. How will they finance this deficit?

The US government will probably finance this by issuing treasury bills and bonds (known collectively as treasury securities). They are hoping that governments and investors in countries like China, Korea and Japan will buy up the US government securities.

Why would China and other investors buy US government securities?

For the governments of China and other countries, the alternative reserves assets to the US dollar are probably the euro and gold. However, the value of euro is also weak now because the economic crisis has taken its toll on European economies. Gold is a possible option but it takes time to extract gold, so there are limits to how much gold the governments can purchase in large amounts without driving up the price. In addition, there is a large demand for gold from the jewelry industry, which might add uncertainty in the demand for gold and increase its price volatility.

The US Congress has just passed a US$787 billion stimulus package in the face of what President Barack Obama has described as “an economic crisis as deep and as dire as any since the Great Depression.” What lessons can the US learn from Japan’s past efforts to stimulate the Japanese economy?

One lesson is that there is a danger of inefficient spending, where you get the famous “bridges to nowhere”, because infrastructure is built in inappropriate places, just so that the money is spent.

The other lesson from Japan is that the Japanese government has been unsuccessful in stimulating consumer spending.

People in Japan are worried about their jobs and as a result, they spend less and save more. Japan also has a high savings rate so the Japanese consumers have less propensity to spend anyway, unlike US consumers.

Consumer sentiment in Japan was also bad because of deflation. Deflation was an issue in Japan because when the price of goods falls, you will hold off on spending as long as possible because things will be cheaper tomorrow. The average nominal wages of Japanese workers have declined since the bursting of the asset market bubble in the early 1990s.

Japan in the 1990s also faced a problem of a strong yen and high labor costs. This drove the Japanese companies out of Japan into low cost manufacturing centers around the world, such as China. Japanese companies were investing in factories abroad, hiring workers in foreign countries rather than at home. Even though the Japanese government attempted to lower interest rates and increase liquidity in the banking system to boost corporate spending, banks were not lending out to companies. Instead, they were buying safe government bonds. As a result, many small and medium sized corporations, which relied heavily on banks, went bankrupt.

Some of these issues are present in the US. Much of goods consumed in the US are made outside the US where labor costs are cheaper. And while the US does not have a culture of saving, it has a culture of debt, from credit cards and mortgages. Money that is used to pay back debt is unlikely to stimulate the economy immediately.

The US is now lowering interest rates to save the financial system and help the economy. However, despite the lower interest rate environment, the economy is not looking to grow at this point. For the US consumer to be confident and to spend money, people will need job security, which relies on the health of the corporate sector. However, financial institutions and financial markets are becoming more risk averse. Unfortunately, those who need financing have become riskier and will become even more so if economy deteriorates. To break this vicious link, the US government plans to help the financial sector in various ways and at the same time inject millions of dollars in government spending. Whether this works depends on many factors.

Also, how fast the new government policies can stop the economy from deteriorating further is a big question. If this is prolonged, bad loans will increase and there is a risk that the US economy might fall into a similar trap that Japanese economy fell into.


Assoc Prof Takeshi Yamada can be contacted at:
Tel: (65) 6516-1912


Oil’s Well that Ends Well: A primer on oil prices


Professor Sam Ouliaris, from the Department of Business Policy at the NUS Business School, gives his take on oil price gyrations.


Less than a year ago, the price of oil surged. It easily broke through the psychological US$100 a barrel on its way to a record high of US$147, raising fears of global inflation along the way. Prices have dropped more than US$100 since then. How do you explain these movements?

In April 2008, when oil was selling at US$100 a barrel, the price could be easily justified on economic fundamentals. Using futures contract prices, you would have expected the average price of oil for 2008 to be around US$100 per barrel. Given the high volatility of the oil price, prices above (or below) US$100 were very likely.

There were also very good reasons to expect an even higher average price. At the beginning of 2008 the International Energy Agency predicted a 2 million barrel a day shortage for all of 2008. Most of the excess demand was from emerging markets, such as China and India, which were still growing rapidly then.

As the oil price rose to US$147 and long-term futures prices remained below US$100, some analysts began to blame speculative activity for the price surge.

However, it is rather difficult to prove that speculators were indeed responsible for the price rise. Both the demand and supply of crude oil are rather insensitive to price, and under these conditions, it doesn’t take much of a demand (or supply) shift to change the market price significantly.

Rather than assigning blame directly, it might be easier nuance the “speculator’s did it” argument by saying there was evidence of a growing transitory component in the crude oil price.

Why? According to one of my colleagues in the U.S., the share price of oil companies tend to follow long-term future contract prices. However, when oil prices spiked last year, this relationship broke down—the share prices of oil companies had actually declined way before the spike. This suggests that share market was seeing something that the crude oil future’s market wasn’t.

Why have oil prices dropped since?

Economic fundamentals. The financial crisis has pushed the global economy into a severe recession, and the consumption of crude has declined significantly, reducing future expectations for consumption as well.

Moreover, the decline in crude oil consumption leaves more excess capacity amongst OPEC members, which drives oil prices down further because the precautionary demand for oil also falls.

On the other hand, the decline in the oil price is likely to boost household consumption, especially in industrialised countries, thereby providing some support to the global economy. Since oil prices dictate gasoline prices, lower oil prices imply more money for household consumption items.

Which way are oil prices heading?

Despite the severity of the current recession, long-term futures continue to predict an average price of around US$70 a barrel. This suggests that oil crude will be in high demand again once the global economy recovers. Growth is likely to come from emerging markets such as China and India, which are not “driving nations” as yet. As their car population increase in tandem with a larger, more prosperous middle class, we should expect global oil consumption to move in line with the growth in global GDP.

On the supply side, most forward looking indicators suggest that the market’s reliance on OPEC output will increase gradually as oil fields in non-OPEC countries mature and off-shore extraction costs from newly discovered fields rise.

The overall message is that demand and supply conditions in the global oil market can be expected to be very tight on average.

Why is the growth in emerging markets so important to the price of oil?

While a large proportion of oil continues to end up in industrialized economies like the US and Europe, these regions have not increased their consumption very much in the last five years. Most of the increase in demand during this period has actually come from emerging markets. When the global economy bounces back, emerging markets will again spark high growth in the demand for crude oil.

Do you think we will ever lose our dependence on oil?

In the next five years or so, car manufacturers are likely offer electric cars that can travel 60 miles (97 km) or so between charges. Depending on its adoption, such a car will obviously help to reduce the growth in the demand for gasoline (and hence crude oil). However, it will take some time for this process to have a significant impact on global oil consumption. In the case of Singapore, for example, it takes at least 10 years for the stock of cars to turn over. And even then, depending on price, the proportion of cars that are electric could remain low. The history of hybrid car adoption, which is slow to date because of their relative high price, provides a good example of what might happen.


Prof Sam Ouliaris can be contacted at:
Tel: (65) 6516-1263


A New Check-and-Balance Order



Professor Lim Chin
Professor, Department of Business Policy
NUS Business School





Professor Sam Ouliaris
Professor, Department of Business Policy
NUS Business School


When the dust eventually settles, the origins of the 2008 financial crisis will probably be linked to two key developments in the global economy since 2003.

The first was its rapid growth. The world economy grew by an average of five percent per annum from 2003 to 2007. Growth was supported by relatively low interest rates and easy access to credit. This was especially true in the United States, where sophisticated financial instruments made it easy to use illiquid housing wealth to support consumption.

Economic growth was even higher in emerging markets. Rising global demand for resources, together with ill-advised petrol subsidies and government sponsored food-to-biofuel programs in industrialized nations, fanned a commodity price boom. Food prices nearly doubled between 2000 and mid-2008, and crude oil prices reached a record high of US$146 in June this year. This inevitable outcome was higher inflation.

The second development was the emergence of significant macroeconomic imbalances between the US, on the one hand, and Asia and oil exporting nations, on the other. The US current account deficit averaged more than 5 percent of its GDP in the 2001-2008 period, against only 3.5 percent during the 1980s.

Excess savings in emerging markets and an insatiable demand for its assets enabled the US to finance its current account deficit without significant upward pressure on interest rates.

The potential for adverse effects of these two developments coming together – high growth and global macroeconomic imbalances – became apparent in early 2006. Cheap credit contributed to US housing prices increasing by 125 percent from 1997 to 2006. Low initial interest rates, together with the irrational expectation of housing prices continuing to rise, encouraged sub-prime borrowers to obtain adjustable rate mortgages that would be difficult to service once interest rates rose.

And rise they did. For the Federal Reserve gradually raised its federal funds rate from a low one percent in May 2004 to 5.25 percent in June 2006. It did so, not so much to prick the housing bubble, as to stem inflationary pressures. Rates remained high till August last year, when the sub-prime mortgage crisis first surfaced. The US housing bubble would have burst anyway, but the Fed’s actions merely hastened the inevitable.

What was so special about this housing boom and bust cycle? Cycles in housing markets are not uncommon events. But what made the recent US housing cycle stand out, however, was the systematic failure of market participants to appreciate the financial risks they faced should house prices fall.

The securitization of mortgages in the US had enabled more investors to purchase shares in shaky housing loans. Credit default swaps (CDSs) – which are essentially insurance derivatives – transferred the risk of default from holders of mortgage-backed securities (MBSs) to CDS providers. But the CDS market itself, being unregulated and undercapitalized, added to the systemic risk.

Investment banks, aided by a 2004 Securities and Exchange Commission ruling that allowed them to almost double their debt-capital ratio to 30:1, also helped multiply the volume of MBS holdings and broaden their sales worldwide. Who would have imagined that securitized products – such as Lehman’s Minibonds and Merrill Lynch’s Jubilee Notes – end up being sold to retirees in Singapore?

Securitization of sound mortgages clearly has desirable effects because they spread the underlying risk of market participants to appreciate the size of the default risk. Moral hazard, imperfect corporate governance and regulatory failures were largely to blame.

By March this year, an estimated 8.8 million homeowners in the US had zero or negative equity in their homes. The growing risk of MBS default sent shudders through the financial system. Even financial institutions without MBS holdings became wary, because they had made loans to institutions with MBS holdings. When several major financial institutions failed last month, perceptions of risk escalated and caused credit markets – the bloodline of the global economy – to seize.

Having a financial crisis with failing banks is bad enough; having one along with rapidly eroding borrower and lender confidence and a credit squeeze is a recipe for a global recession.

Why? Most countries are linked by an elaborate web of international capital flows and trade linkages to the US, the world’s biggest economy and its most important financial centre. Through the financial linkages, a major financial crisis in the US quickly becomes a global crisis. And because of trade linkages, a global economic slowdown reduces world trade, further constricting growth in a vicious downward cycle.

Indeed, the Great Depression of the 1930s, which started in the US, lasted several years after the initial stock market crash, largely because of competitive protectionist or beggar-thy-neighbour trade policies. But that period also left policy makers with many hard-earned lessons on what needs to be done to contain a major financial crisis.

First, central banks must expand rather than contract the money supply. Second, strong national leadership is required to prevent bank runs and to restore confidence in the banking system. And third, strong world leadership is required to dissuade countries from pursuing unilateral “ solutions” that have an adverse impact on others.

All three actions were lacking in the 1930s. Fortunately, they were taken in the current financial crisis. In response to the credit market freeze, central banks pumped liquidity into the system. When this step failed to restore confidence, governments announced plans to use public money to remove toxic assets from financial balance sheets and even to recapitalize banks.

At the international level, there was coordination among the major central banks to slash interest rates, rescue banks that needed capital as well as to guarantee interbank loans, thereby removing counterparty risk. Notwithstanding stock market meltdowns, all these actions appear to have improved confidence in the financial system.

That said, damage has been already inflicted on the real economy by the global stock market meltdown. There are already signs of declining growth and rising unemployment in many countries, and commodity prices are easing. The risk of negative feedback between the real and the financial sectors remains high, though manageable provided confidence in the financial system is restored.

More can be done to minimize the damage to the real economy. It is time for national governments to unleash countercyclical fiscal measures. In this respect, Asian economies have an advantage over the US because of their high savings rates and large accumulated surpluses. Increased domestic spending in Asia would also narrow existing current account imbalances in the global economy.

Last but not least, attention must be directed to rework the regulatory system. The prime objective of the financial sector is to serve the real economy by channelling capital and liquidity to its most productive use. Financial markets need to be better regulated to avoid the build-up of excesses that can damage the real economy. But over-zealous regulation must also be avoided so as not to hamper the efficient workings of the financial system.

It is indeed a challenge to design a regulatory framework that balances these two competing needs.


The Straits Times©, 29 October 2008

Singapore Press Holdings Ltd

Permission required for reproduction

Credit Swaps Play Vital Role Too



Professor Duan Jin-Chuan
Director of NUS Risk Management Institute and Cycle & Carriage Professor of Finance
NUS Business School


Dr Oliver Chen
Program Director, Master of Science in Financial Engineering Program at NUS Risk Management Institute
National University of Singapore


The financial crisis now gripping the world began last year with an increase in the number of defaults of sub-prime mortgages in the United States. But in the most recent iteration of the crisis, the focus has shifted to something called credit default swaps, or CDSs. They were one of the major causes for the near-collapse of the insurance giant AIG.

CDSs have been described as unregulated instruments, arcane and toxic. Yet, like many financial instruments that seem exotic to the layman, they have their uses in the modern financial architecture. Because they will continue to have an important role in finance, CDSs need to be better understood by the public.

Simply put, a CDS is an insurance against the default of a bond. And like all insurance, there are two parties: the insurance buyer and the insurance seller. CDSs play a useful role in allowing investors to reduce the risks of the bonds they hold.

To understand how CDSs work, think of car insurance. With car insurance, the owner of a car makes regular payments to the insurer. In return, the insurer agrees to pay for damages to the car if an accident occurs.

With a CDS, the insurance buyer makes regular payments of a fixed size – the insurance premium – to the insurer. In return, the insurer agrees to pay for “damage” to the bond in the event of default by the bond issuer. The bond issuer in a CDS contract is called the “reference entity”. Default is typically referred to as a “credit event”, which is analogous to a car accident.

To understand how this works, we need to have some understanding of how bonds function. Take, for example, a 10-year bond, issued by a hypothetical Reliable Corporation, with a face value of $100 bearing annual coupons – or interest – of 10 percent. The bondholder receives $10 annually for 10 years, at the end of which the bond matures and Reliable pays back the face value to the bondholder. But if Reliable defaults at some time before the 10 years are up, coupon payments stop, Debt resolution may take months or even years to wrap up, but the market will quickly price the bonds at a fraction of their face value. This is known as the recovery rate.

Suppose that an insurance buyer, Wong, and an insurer, Ali, enter into a five-year CDS contract using Reliable as the reference entity. Suppose also that Wong pays Ali $2 every year for every $100 face value of Reliable bonds that he holds. This is the insurance premium and is called the CDS spread. The CDS spread is usually expressed in terms of basis points, which are hundredths of a percent. In this example, the spread is 200 basis points. In the event of Reliable defaulting, Ali will pay Wong an amount equivalent to 100 percent minus the recovery rate of the bond.

Before we turn to the recovery rate, we need to understand the economics of this CDS arrangement. If Wong owns the Reliable bond he can use the CDS to insure against any loss in the event that Reliable defaults. During the period the CDS is in effect, Wong ends up receiving eight percent interest instead of 10 percent on the Reliable bond. This is the net result from the bond’s 10 percent coupon minus the 200 basis points paid for insurance, or the CDS, to Ali. Though Wong gets less than the full amount on the bond’s coupon, his principal is protected, so long as Ali is able to provide the insurance.

In the event of a default, the damage could be settled in two ways: by physical delivery and by cash settlement. In the case of the former, Wong simply transfers the impaired Reliable bond to Ali in exchange for its full face value. In the case of cash settlement, there is a well-established “credit event auction” mechanism.

Take this example: On Sept 15, Lehman Brothers filed for bankruptcy protection, a credit event. Subsequently, a credit event auction was held on Oct 10 to settle the CDSs that referenced Lehman Brothers. That auction set a recovery rate of 8.625 percent, meaning that holders of the relevant CDSs could receive $91.375 from their insurer for every $100 face value protection that they purchased This is in essence the insurance payout. Accordingly, someone who held $100 of Lehman bond and also the CDS would get $100 – $8.625 as the value of the defaulted bond plus $91.375 from the seller of the CDS for the damage to the bond. By contrast, someone who held $100 of Lehman bond without the CDS would get just $8.625 – the value of the defaulted bond.

What determines the CDS spread? For car insurance, the better the safety record the driver has, the smaller the insurance premium he would pay. For CDS, the less likely the reference entity is to default, the smaller the premium.

However, the analogy between car insurance and CDS can only go so far. The biggest difference is that you can buy insurance only for your own car. In the case of CDS, you can buy insurance on bonds that you do not even own.

Let’s return to Wong, who buys insurance through a CDS. Let’s say Wong does not own Reliable bonds. Thus, Wong, is essentially betting that Reliable will default in the next five years. He pays Ali $2 per $100 face value each year. If Reliable defaults with a recovery rate of 40 percent, Wong will get $60 from Ali. However, if Reliable does not default, he gets nothing.

Regardless of whether Wong owns the bonds or not, if Reliable defaults and Ali cannot pay $60 to Wong, then Ali will need to declare bankruptcy. Selling insurance on Reliable has significantly increased Ali’s risk. This was the situation AIG found itself in when a large number of reference entities it issued CDSs on either went into default or became a high risk to default.

While CDSs, as well as those involved with them, have been much maligned in the media, they do perform a vital function in risk management and should be viewed as a positive financial innovation. They should not be completely prohibited. Instead, better internal oversight within firms that use CDSs, as well as external oversight by regulators, will better serve the market.


The Straits Times©, 28 October 2008

Singapore Press Holdings Ltd

Permission required for reproduction

Making Sure The Right Banks Are Helped



By Assistant Professor Hassan Naqvi
Assistant Professor, Department of Finance and Affiliated Researcher of NUS Risk Management Institute
NUS Business School


There is a long and growing list of financial institutions that have failed across the world recently: Northern Rock, Bear Stearns, Washington Mutual, Kaupthing, IndyMac, Hypo Real Estate Holding, Bradford and Bingley, and many others.

A bank is said to fail when it is unable to service its obligations. But failure does not necessarily mean the bank is insolvent.

We need to understand the difference between a solvent and an insolvent bank. Insolvent banks are those that have made bad investments and, as a result, are unable to generate high enough returns to pay off their liabilities.

Solvent banks are fundamentally sound. But they too can fail if too many of their depositors decide to withdraw their deposits simultaneously. Since fire sales are inefficient, banks might be unable to fully realize the value of their good investments to satisfy their depositors and thus fail because of temporary liquidity problems. Such banks are solvent yet illiquid.

As lender of last resort, central banks can prevent the failure of solvent banks. They can provide liquidity to such institutions. The rescued banks can then pay off the central bank in the future when the returns on their healthy assets are realized. In the absence of central bank intervention, the assets would have been sold off at fire-sale prices. Thus central banks can improve the efficiency of the banking system by providing emergency funding to solvent institutions.

However, there is a catch here: In practice, policy makers can find it hard to distinguish between solvent and insolvent banks. Central banks should ideally bail out only solvent institutions. But owning to imperfect information, they could bail out insolvent institutions as well.

Did the United States government really know for sure that Freddie Mac, Fannie Mae and AIG were solvent and merely illiquid – and thus candidates for rescue; while Lehman Brothers and Washington Mutual were insolvent – and thus candidates for bankruptcy and government seizure, respectively?

In a competitive banking system, such asymmetry information can affect the risk-taking behaviour of banks. If they knew they might be bailed out even if they were insolvent, banks would make risky investments. They might end up holding sub-prime assets, and hence become vulnerable to shocks.

Central bank bailouts can be efficient insofar as they prevent the failure of solvent but temporarily illiquid institutions but they can be inefficient insofar as they induce banks to invest in risky assets. Does that mean we should scrap the bailout policy tool altogether?

The answer is no. Absent the power to rescue illiquid banks, the central bank will lose major ammunition in financial crises. What can be done is to mitigate the moral hazard problem.

This can be accomplished by making banks more transparent and by improving banking supervision. With greater transparency, central banks are less likely to bail out insolvent institutions that have made bad investment decisions.

At times, central banks do knowingly bail out institutions that are insolvent. This is because such institutions might me too big to fail, in the sense that their failure would wreak havoc on the financial system. For instance, AIG was provided with emergency funding of US$85 billion (S$126 billion) because it was so intertwined with the financial system that its failure would have had unprecedented contagion effects.

Another tool that regulators have at their disposal is deposit insurance. If a bank were to fail, the provider of deposit insurance – be it a government or a commercial entity – pays the depositors.

But insurance can also give rise to moral hazard. For example, someone with car insurance might take less care of his car compared to someone without such insurance. Analogously, banks whose deposits are insured might be tempted to hold risky assets.

Nevertheless, by giving depositors the peace of mind that their money is safe, deposit insurance can discourage panic runs. In recent weeks, many governments have raised deposit insurance coverage. The US government increased deposit insurance coverage from US$100,000 to US$250,000. The British increased retail deposit protection from £35,000 (S$89,500) to £50,000. Australia, Hong Kong and, most recently Singapore have decided to fully insure all deposits.

There can be circumstances when deposit insurance can be inadequate. Even with insurance, when a bank fails, depositors may have to go through a process of red tape to get their money. For instance, when the British bank Northern Rock collapsed last year, it took months for depositors to be paid off.

People have bank accounts to get ready access to liquidity. Even in the absence o bureaucratic hassles, depositors may still be tempted to withdraw their cash for peace of mind. For instance, depositors withdrew their money from Ice-save as soon as they heard the bank was in trouble, despite deposit insurance.

Deposit insurance does provide relief. But it can build up problems for the future. For instance, following the failure of Washington Mutual, the reserves of the US Federal Deposit Insurance Corporation (FDIC) were so depleted that it could not afford another rescue. On June 30 this year, Washington Mutual had US$143 billion in insured deposits about three times the size of the deposit insurance fund. Fortunately for FDIC, JP Morgan Chase agreed to acquire the banking operations of Washington Mutual. Cynics say that the FDIC raised the deposit insurance coverage subsequently to avoid another failure.

Deposit insurance and central bank bailouts of solvent but illiquid banks are essential policy tools. But the authorities especially in the US and Europe, need also to identify and deal with the roots of the problem – toxic assets on bank balance sheets and inadequately capitalized banks, among other things – before the financial crisis further undermines the real economy.


The Straits Times©, 22 October 2008

Singapore Press Holdings Ltd

Permission required for reproduction

S’pore An Ideal Place for International Guarantee Body


By Professor Duan Jin-Chuan
Director of NUS Risk Management Institute and Cycle & Carriage Professor of Finance
NUS Business School


A television presenter broadcasting out of New York recently began his programme by saying: “Welcome to the financial capital of the world…I believe…still.”

The message was subtle but clear: The ongoing turmoil in financial markets has exposed weaknesses in the system, and New York is facing a rapid loss of credibility as the nexus of global financial markets. This has led to talk of financial centres elsewhere in the world, including Asia and the Middle East, stepping in and playing a bigger role.

But no, not quite yet – not, at any rate, till a number of structures have been put in place.

An area that needs to be looked at in this regard is risk management, or its lack thereof. In adequate risk management was one reason American and European financial institutions took such big, risky bets that have since exploded in their faces. But they thought they were doing right and their actions were sanctioned by regulators. Why so?

Lending a mortgage worth $800,000 while the collateral has a market value of $1 million, and is fast rising, seems conservative. If you don’t lend in such circumstances, your competitors would. Moreover, you are incentivised to lend because your remunerations are tied to the short-term performance of your loan portfolio. In short, moral hazard fuelled aggressive lending practices, which pushed up the value of the collateral too. This bubble feedback loop made housing prices a bigger systematic risk factor in the United States, while simultaneously inducing financial institutions to lend more.

The current US housing crash would have been like any other bubble-bursting story had financial instruments like collateralized debt obligations (CDOs) and credit default swaps (CDSs) not been invented. Bundling mortgages into securities and selling them freed up funds for financial institutions to make more loans. CDOs and CDSs transformed a “systematic risk” rooted in the housing sector into a “systemic risk” for the entire financial system.

It is indeed mind-boggling that so many financial institutions allowed themselves – and were allowed by regulators – to be exposed so heavily to the housing sector, blithely assuming they were properly hedged. What can be done to prevent a recurrence of such cascading systemic risk?

The modern financial system has two pillars: a payment system via banking networks and a securities clearing mechanism via various organized exchanges and dealers. The current regulatory support system is tilted towards safeguarding the payment system with facilities like deposit insurance and central banks serving as lenders of last resort. These safety nets aren’t perfect, but we have witnessed how they worked in stabilizing markets amid the current panic. Due to the gravity of the situation, governments have expanded deposit insurance to cover more deposits, guaranteed interbank lending, and bought commercial paper directly.

An important part of the second pillar is organized exchanges through which stocks, bonds and some derivatives are traded. In the case of stocks and bonds, the role of exchanges is to facilitate transactions, and they do not take direct positions. For derivatives like futures and options, organized exchanges facilitate anonymous trading; and the exchanges serve as the counterparty to both sides and is thus exposed to credit risk. As a safeguard, trading parties are required to put up collaterals, known as margin accounts, for settling daily gains or losses to avoid accumulating large losses.

An important component of the second pillar is the Over-the Counter (OTC) market for interest rate swaps, currency forwards, CDSs and other exotic derivatives. The intrinsic need of businesses for tailor-made contracts is the driving force behind the OTC market. Market makers often step in as a party to a trade when a suitable counterparty cannot be found. Trades are conducted by relying on the credit ratings of participants. Unlike in organized exchanges, it is hard to set up suitable margin accounts in the OTC market to mitigate credit risks because the derivatives traded are non-standard and infrequently traded.

The systemic risk inherent in the OTC counterparty arrangements became evident in the near collapse of Bear Stearns and American International Group, and Lehman Brothers’ bankruptcy. It has been suggested that some of the OTC trading can be moved to an organized exchange. But it would be naïve to think that organized exchanges can completely replace the OTC market. The current financial crisis forces us to recognize the vulnerability of this important pillar of the modern financial system.

The time has come to establish an international agency to guarantee the OTC market makers for their counterparty exposures, much like deposit insurance. But unlike domestic deposits in banks, counterparty transactions here can’t be confined to one jurisdiction. This guarantor should be global in nature and be funded by member states whose voting rights in the agency would be determined by the size of their contributions.

In exchange for the guarantee, OTC market makers would pay risk-based premiums to the guarantor. These premiums can be determined by a combination of quantitative and qualitative measures, in a manner similar to the deposit insurance schemes that exist in many economies. Asian governments should seize this opportunity to take leadership in this endeavour. I am of the opinion that Singapore is an ideal location for this international guarantee agency.

Complacency tends to set in after any crisis is over. It is probably impossible to avoid future crises like the current. But at least we can try to reduce their frequency and contain the damage they cause once they occur. We need to implement better safeguards. This applies to Asian regulators, and the institutions under their supervision, as well as to European and American ones. Indeed, even more so because corporate governance in Asia is still weaker than in Europe or the US.

Wall Street will change as a result of this crisis. The broader trends indicate Asian economies are becoming stronger relative to the developed world. New and better ideas will emerge from Asian centres of finance.

I look forward to the day when that TV presenter in New York says: “Welcome to one of the world’s financial capitals.”


The Straits Times©, 21 October 2008

Singapore Press Holdings Ltd

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The Psychology Behind the Mess


Professor Micheal Frese
Chair for Work and Organisational Psychology
University of Giessen, Germany
Visiting Professor of Organisational Behaviour
London Business School


Professor Richard Arvey
Professor and Head, Department of Management and Organization
NUS Business School


The root cause of the current global financial crisis is that American lending institutions gave out mortgage loans to millions of homeowners who could not afford them. When interest rates rose, these owners were forced to foreclose on their loans, leaving banks, investors and other purchasers of the loans saddled with huge losses.

How could such well-known and reputable firms engage in such unwise lending practices? As Fortune magazine asked last year: “What were they smoking?”

We propose to answer this question through the lens of organizational psychology. What they were smoking wasn’t the problem; what they were thinking was.

To begin with, there is what organizational psychologists have identified as the problem of common mode errors. An example of a common mode error is the over-optimism and overconfidence that executives in the financial industry all came to share. As a result, they overestimated their ability to cope with the potential negative consequences of the risks they were assuming. Managers saw other firms enjoying high success rates despite the risks they undertook, and tended to assume they could take the same risks themselves. Once individuals adjusted to a certain risk level – and got away with it unscathed – they adopted even more risky practices.

The tendency to extrapolate from the past to the future accentuates such risky behaviour. First, financial executives assumed past profit rates could be sustained into the future. Second, this orientation was reinforced by the high bonuses that executives enjoyed for short-term “good performance”. The result was that short-term profits began to drive their investment decisions, and they ceased to look at long-range risks.

Risk assessment involves estimating the probability of particular outcomes and their consequences. Financial executives made a number of errors when assessing the risk they were taking on. They underestimated or even ignored the probabilities of certain outcomes. They did not have an accurate picture of the likelihood that things could go wrong. They formed judgements based on their own personal experiences and perceptions. They used data from their own firms from previous years, indicating high returns, and discounted the possibility of the recent past not being prologue to the indefinite future.

By and large, financial executives, like most people, tend to look for confirming rather than non-confirming evidence when discussing potential scenarios: What confirm happy expectations, no matter how flimsy, are highlighted and what doesn’t, aren’t.

People also have difficulty believing that drastic worst-case scenarios can ever happen. That is why they live in earthquake zones and other dangerous places. Even though financial executives may have understood the risks intellectually, they didn’t quite believe the worst-case scenario – like home prices falling drastically – would actually occur.

In his excellent book, The Black Swan: The Impact Of The Highly Improbable, Nassim Nicolas Taleb describes the ingrained tendency of humans to underestimate the improbable. That is, they fail to realise that incidents that have a low probability of occurring actually do indeed occur.

Similarly, executives may not have believed anything bad would happen to their own firms, although other firms may have come into harm’s way. Psychologists call this tendency ”discounting”, where individuals diminish the risk of extreme events occurring because the probability of their occurring is too low to evaluate intuitively.

Financial executives also seem to have believed that they could pass off risks to other agents – by securitizing mortgages, for example, and selling off the securities to others. And the agents who bought these securities had an inaccurate assessment of their risks, because of what they were told by the rating agencies. It was a case of passing the buck, up and down the line.

On a more sinister and dark note, it is also possible that executives did not care if things went awry because they were so well off financially that they personally would not suffer any consequences if “black swans” – the unexpected – were to turn up. Executives may have assumed too that even if things were to go wrong, other institutions would pick up the losses – governments in this case. This is the problem of moral hazard.

Finally, there were external pressures to conform. The Economist carried a report recently of a risk manager who described his experiences in a bank. Risk managers are paid to identify and assess risks. Some risk managers did actually warn of problems that have since come to light associated with some risky instruments. But there was enormous pressure on them from their peers, as well as senior management, to minimize the risks. For this reason, the risks were not better known, until it was too late.

The point here is that human error in judgement can cause colossal messes. We can’t change human nature, but we can provide checks and balances to ensure that egregious errors happen with great rarity. Understanding the psychology behind decision-making processes would aid in providing greater checks and balances in the financial sector.


The Straits Times©, 16 October 2008

Singapore Press Holdings Ltd

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Review Strategy, Take Crisis as Opportunity



By Professor Kulwant Singh
Deputy Dean and Professor, Department of Business Policy
NUS Business School


The effect of the global financial crisis on Singapore has thus far been limited to the financial sector and to investment losses by individuals and institutional investors. However, it is unlikely that the Singapore economy will escape the effects of the crisis. Tight credit, firms conserving cash to hedge against uncertainty, and consumers deferring spending because of the declining value of their assets, will all reinforce the financial sector’s decline.

The financial crisis will inevitably become a real economic crisis. How should firms react?

Strategies designed for a high-growth environment are unlikely to be equally effective in a slowing economy. Firms should review their strategies. However, many appear to have a different approach: reduce costs, particularly in training and travel; don’t change course unless necessary; and hope that the crisis passes quickly!

A strategic approach will be more effective and would allow corporate leaders to exploit that age-old wisdom: crisis offer opportunities. Businesses should act at two levels – operational and strategic – and at each level, for both the short- and long-term. Crisis management is a priority but an incomplete response, as even actions to deal with the immediate effects of a crisis may have long-term operational and strategic consequences.

Short-term operational actions, commonly termed crisis management, focus on immediate challenges like the preservation of cash and assets. AIA’s efforts to reassure policy holders, and its subsequent reinstatement of cancelled policies without penalty, was an example of crisis management.

Long-term operational management focuses on long-term but not necessarily strategic issues, such as ensuring major assets or inputs are preserved, redeployed or expanded. Barclays Bank’s recent consolidation of operations in Singapore, China and India, though probably planned for some time, had long-term cost and efficiency implications. Share buybacks during a bear market or hiring top talent from failing rivals are other operational actions with long-term impact.

Short-term strategic actions relate to disposing assets or other measures to raise resources for firm-survival, or more positively, bargain hunting for strategic assets. Examples of these would include Goldman Sachs and General Electric obtaining funds from highly valued votes of confidence by selling stakes to Mr Warren Buffett; and Nomura obtaining a rare by taking over Lehman Brothers’ European and Asian operations.

Long-term strategic actions relate to major actions designed to enhance firm-survival and performance over an extended duration. Goldman Sachs converting itself into a commercial bank and Wachovia Bank’s merger with Wells Fargo are examples. Temasek Holdings’ and the Government of Singapore Investment Corporation’s (GIC) recent investments in financial institutions are other examples of long-term strategic actions with substantial potential upsides, even if they might have been undertaken too early.

These examples illustrate that in crises firms must balance dealing with immediate challenges and preparing for future success. Because Singapore firms are well-capitalized, they will be able to overcome the immediate difficulties. The challenge would be to use the crisis as an opportunity to acquire strategic assets to build a base for future growth.

In evaluating strategic and operational changes, corporate leaders should address three main types of restructuring: financial, portfolio and organizational changes.

Financial restructuring aims to modify a firm’s capital structure in response to changes in the availability and cost of finance. Portfolio changes aim to modify the mix of assets a firm owns or the areas in which it operates so as to adapt to changes in markets and asset values. Organizational changes refer to structural leadership and HR adaptations.

How likely are Singapore firms to react appropriately to the crisis? A study I undertook with the National University of Singapore Business School colleagues of how Singapore and South Korea firms reacted during the 1997-98 Asian financial crisis is indicative.

Singapore firms did not undertake substantial restructuring during that crisis; Korean firms did. Singapore firms focused more on organizational changes – particularly on layoffs, retirements, pay cuts and other employment changes while making relatively few changes to senior management. In contrast, Korean firms undertook broader restructuring, though often with less positive impact on performance.

Singapore firms must adopt a more strategic approach to the coming economic slowdown. Failure to do so may result in missed strategic opportunities or in hasty investments that prove to be costly mistakes. DBS Bank’s acquisition of Thai Danu Bank in early 1998 was one example of a strategic investment that could have been managed more effectively.

Unfortunately, Singapore firms now have another opportunity to react to a crisis. A flexible and comprehensive response, guided by an appropriate strategy, will mitigate the effects of the crisis and help firms create the base for future growth.


The Straits Times©, 15 October 2008

Singapore Press Holdings Ltd

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Mark-to-Market: Dangers Abound



By Associate Professor Ho Yew Kee

Vice Dean and Associate Professor, Department of Accounting

NUS Business School


The US Congress has authorized the administration to buy US$700 billion (S$1 trillion) worth of distressed assets. It has also asked the Securities and Exchange Commission (SEC) to consider the possibility of suspending the mark-to-market rule, and report back to the Congress within 90 days.

What is mark-to-market? Why is it controversial? What does it have to do with the current financial crisis?

Mark-to-market requires firms to report the fair value of their assets or liabilities according to the market price available at the measurement date. If financial institutions had bought investment products worth at least US$62 million, they must report their market value. If the market value rises to US$70 million, the financial institution would book a paper profit of US$8 million. If the products are worth only US$50 million, the financial institution would book an unrealized loss of US$12 million. The mark-to-market rule is designed to reflect the true value of assets.

There is a difference between assets held for trading purposes and those held until maturity. Changes in the market price of assets held for trading reflect potential gains or losses. But if the assets are held until maturity, price changes are irrelevant since it is the final price at maturity that matters. The mark-to-market rule allows for different accounting treatment according to the purpose of the investment.

Where investment banks are concerned, there is a presumption that their investments are for trading purposes. Thus they are exposed to the mark-to-market rule. In a financial crisis, that means there can be tremendous downward pressure on their asset values.

The rule is one of the most significant departures in recent years from the cost accounting convention. Its application may result in significant fluctuations in reported earnings. Some argue that such volatilities merely reflect the true underlying value of assets or liabilities. Others argue that the rule introduces a subjective element to the financial reporting process and may cause extreme volatilities. That is the main concern in the current crisis as extreme volatilities can worsen confidence.

Complexities can also arise if the financial assets in question do not have quoted prices or they are not traded. Complex derivatives like collateralised debt obligations (CDOs) and credit default swaps (CDSs) are examples of such assets in the current crisis. Their true values now are anyone’s guess because the market for them is illiquid.

US legislators and some market participants are thus urging the SEC to consider suspending the mark-to-market rule for these assets. The current transaction prices for CDOs and CDSs in the market do not represent fair value, they argue, as sellers are under compulsion to sell. Firms should be allowed instead to use the so-called Level 3 fair value hierarchy. This allows firms to use unobservable inputs to value their assets or liabilities. They can ignore market prices and use whatever valuation technique they deem relevant.

There is clearly a case for financial institutions to abandon the mark-to-market rule if they intend to hold the financial assets to maturity. In such cases, they should be shielded from current fire sale prices and not be forced to book unrealised losses. The rule has drastic consequences for banks in particular in a financial crisis: Their assets appear suddenly to decrease in value, thus making them look less solvent than they really are. The rule can result in a situation where the value of a bank’s liabilities far outweighs the value of its assets, thus causing run on the bank.

The suspension of the mark-to-market rile can halt the downward spiral of asset prices. This would provide a break to the increasing unrealised losses of firms. If left unchecked, such unrealised losses can severely dampen confidence.

That said, the use of Level 3 fair value hierarchy may not help in shoring up market confidence because the assets’ value will be at the discretion of the reporting entity. Liquidity in the financial market may be dampened because market participants refuse to accept such valuations. The rating agencies too may have difficulties accepting the valuations and this too may damage the reputation of the firm. In addition, firms may be subjected to legal wrangles if the market prices continue to be inconsistent with the Level 3 valuation and shareholders or counter-parties suffer losses. And finally there is the issue of moral hazard: How can firms be trusted to value their own assets in a crisis situation?

It is questionable whether suspending the mark-to-market rule will do more good than harm. In the worst-case scenario, the regulator may be accused of helping struggling firms conceal their true financial position by shifting the goalposts.

Desperate times require desperate measures but suspending mark-to-market may be too desperate a measure. Sunlight is the best disinfectant and suspending the rile would obscure the true financial health of financial institutions. And this, in turn, may slow down the recovery process as good money is poured into bad firms.


The Straits Times©, 14 October 2008

Singapore Press Holdings Ltd

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