By Eze Nwagbaraji
The most conclusive lesson of economic theories over the past three centuries is that free markets, when allowed to operate within the norms of fairness to all market participants, lead to enhanced growth in the national economy. Economic growth is the time tested and universally accepted understanding that individual and collective economic well being is necessary to measure the welfare of a nation.
In other words, our economic strength is the sum totality of how our citizens have fared economically. It is this economic strength that unequivocally positions our country as a first, second, or third tiered power within the community of nation states.
Free markets as rational principles are the interplay of private and public interests, participating in the local, national, and international market place, providing services, and reaping the rewards of sound market engagements. For the private participants in the free market, the single most important reason to move private assets into the public arena is to reap the potential profits, inherent in the market, if the managers of such assets are prudent enough.
The state or government on the other hand has an enduring interest in ensuring that there is a level playing ground to enable as many private interests engage in the market. The state through its regulatory role has a further interest to ensure that private market participants do not engage in conducts that are detrimental to the collective interest of the public.
Effective regulatory regimes prod private market participants to become socially responsible, i.e. private businesses, participating in responsive free and competitive markets, using their resources to engage in profit seeking without deception and fraud. Efficient market economies are inherently stable economies. When government fails in its role as a regulator, it creates the market noise that may lead to market failures.
Attempts to deal with these failures in themselves sometimes deepen the problem. Sustained market failure results in economic depressions, which are significant dislocations and depletion in the national well being through losses in individual wealth.
The losses in national well being and public policy attempts to correct the anomaly lead governments into re-examination of such policy intervention instruments as tax regimes, subsidies, bailouts, wage and price controls, regulations, etc.
In the aftermath of the global financial crisis that erupted in 2007 and 2008, several governments across the world adopted emergency economic and financial measures to confront the massive financial implosions that faced their national economies. Some of these measures were put in place without thorough academic, legal, or policy analysis.
These fire brigade approaches to national emergencies seemed necessary to avert national financial calamities, especially where some of the leading economies of the world were prodding others to respond.
The Asset Management Corporation of Nigeria (AMCON)
In Nigeria, rash monetary authority examination of the financial crisis created uncoordinated responses that jig-sawed from indictment of nearly half of the leading financial institutions in the country, forced bail out of some of the institutions through infusion of public funds, removal of financial institutions management teams, to the birth of AMCON.
The speed with which the National Assembly passed the AMCON Act is a classic reminder of the economic emergency mode of the country. Legislators sheathed their armors in response to a Presidential call to give vent to a national economic crisis.
The Federal Ministry of Finance working with the Central Bank of Nigeria (CBN) has since constituted the management team of AMCON. However, some of the fundamentally unanswered questions about AMCON include: What is this institution in the scheme of our national economic system? Is AMCON a permanent financial systemic risk monitoring agency?
Is AMCON a public structured investment vehicle (SIV)? Since AMCON’s mandate seem to be specific to financial institutions, is the Agency a super oversight regulator or monitoring institution that double checks the roles of the CBN, the National Deposit Insurance Corporation (NDIC), and the Federal Ministry of Finance? Or is AMCON a regulator of the free market?
The Federal Ministry of Finance manages and controls government finances within the government’s economic policy; participates in formulation and administration of tax laws and financial regulations; manages the national domestic and foreign debts; advice government on appropriate economic, fiscal, and monetary policies; provide accounting services; supervise and participate in the control of financial institutions and public enterprises, etc.
The CBN on the other hand is our only public monetary authority. It issues the currency, regulates the money supply, controls interest rates, oversees the commercial banking system, and acts as the government’s banker and a lender of last resort in Nigeria.
The CBN is an independent monetary institution not under the control of the Federal Ministry of Finance. While the Federal Ministry of Finance is part of the executive arm of our government, the CBN as a monetary institution enjoys a level of autonomy in its monetary policy activities and its independence from other institutions within the government is one that enjoys a level of protection against executive or legislative interference.
A systemic risk regulation agency is an agency that monitors the entire market and alerts the public and policy makers on market activities, either from the private or public sectors that are inefficient or capable of leading to market failures.
The reach of a market-wide systemic risk agency or regulator is not industry specific. It has broad oversight powers over the market and to be effective, it must have the power to intervene authoritatively.
The case against a systemic regulatory agency is vehemently led by advocates of less government interference in the free market. These advocates point to government failures as the lead causes of general market failures. Less regulation of the free market, they argue, presents better efficiencies.
A structured investment vehicle (SIV) is an operating company that earns a spread between its assets and liabilities like a commercial bank. SIVs borrow money by issuing short and sometimes long term securities (commercial papers and medium term notes and public bonds) at low interest rates and then lend the funds by buying longer term securities at higher interest rates, with the difference in rates going to investors as profits.
For SIVs, long term assets include residential and commercial mortgage backed securities, banks corporate bonds, auto loans, etc. SIVs abilities to securitize these instruments made them unique and popular in such countries as the United States and some of European leading economies in the 1990s.
Invented by Citigroup in the late 1980s, SIVs were permanent fixtures of the American unregulated financial landscape until the market implosion of 2008.
The CBN and the Federal Ministry of Finance seem to have ample instruments in their structure to address our country’s monetary, fiscal, and market issues. However, they failed in their statutory responsibilities to the markets.
The CBN failed the market twice. It failed as a regulator of the financial institutions that were under its regulatory purview and it failed in its conduct of monetary policy. To date, interest rates in Nigeria remain irrational and defy meaningful economic interpretations.
The purpose of parsing out blame is basically to figure out how to prevent a recurrence of past mistakes. AMCON seems to be a loose cannon unleashed on the economy and our market system without objectively directed mission. It seems to be an imposition directed at engaging in duties already within the purview of existing institutions.
In its first major outing AMCON, early December, 2010, moved to issue two trillion, five hundred billion Naira (N2,500,000,000,000) in zero coupon bonds. The Agency argued that such bonds will not hurt the Nigerian economy. As a wholly government owned institution all bonds issued by AMCON are sovereign bonds, guaranteed by the Federal Government of Nigeria.
Zero coupon bonds, also known as deep discount bonds are bonds bought at prices lower than their face value, with the face value repaid at the time of maturity. These bonds do not make periodic interest payments. Investors in these bonds earn the compounded interests at the maturity date, plus the difference between the discounted price of the bond and its par or redemption value.
Bonds pay interests, whether such interests are deferred or not, they are debt instruments. When the federal government, through one of its institutions engages in borrowing, such assumptions of debts have cumulative effects on the national debt. The risks associated with such debts, assumed to service questionable instruments, such as the acquisition of toxic assets from financial institutions, raise doubts about their efficiency.
Worthy of note is also the much publicized profitability of all the banks that are originators of these toxic assets. The banks have since returned to profits. If the profit assertions are correct, why are public funds being used to bail out the toxic loan portfolios of these banks?
The United States for example, infused tremendous amount of funds into its financial institutions and leading corporations, pursuant to the 2008 financial market crisis. The government took equity interests in such institutions as Citigroup and General Motors. Estimates now put the US government profit from its investment into Citigroup at nearly US$10 billion, when the government completes its exit of the bank in early 2011.
At General Motors, the government has successfully helped the corporation relist its shares into the equity markets in what is being described as the largest equity floatation in the country’s history.
When the government uses up financial and other resources that would have been used by private enterprises, the effect is an increase in the cost to the general economy. AMCON’s bond sales will drive up interest rates for the private enterprises and because the bonds have sovereign backing, the demand for such instruments will be high and in the long run, represent an oversupply to the market.
Free Markets and why overbearing market regulations fail
Taxes and regulation are the only reasons why investors care about what kinds of securities firms issue, whether debt, equity, or something else. The structure of a firm’s liabilities should have no bearing on its net worth (absent taxes, etc.). The securities may trade at different prices depending on their composition, but they must ultimately add up to the same value.
Private agents in the market are driven by self interest. Whether regulatory authorities understand this maxim or not is immaterial. The theory is natural in its occurrence. The crises supposedly identified by the CBN within our financial sectors were a tacit admission that the regulatory institution failed in its core duty to regulate those under its purview.
Since these institutions are private corporations, using private funds to pursue profits within the banking sector, financial interventions devoid of interest income to the CBN represent a give away to the banks.
Capital asset pricing models, suggests that investors should fully diversify and their portfolios should be a mixture of the “market” and a risk-free investment. Investors with different risk/return goals can use leverage to increase the ratio of the market return to the risk-free return in their portfolios. This implies there should be demand for instruments that open up new types of investment opportunities (since this gets investors closer to being able to buy the entire market), but not for instruments that merely repackage existing risks (since investors already have as much exposure to those risks in their portfolio).
A close observation of the Nigerian banking sector seem to show that the entire CBN market noise about the banking sector had its optimal impact on lowered or dampened bank stocks or equities. All the banks that witnessed CBN intervention have since returned to profitability, however, the intervention has left sector and market wide reductions in market capitalizations due to lowered equity prices.
AMCON is not going to be any different. Its presence in the market at the end will be a confused symbol of failed ability to understand the complex nature of free markets. The pain at the macro level though is how deep will the injury last and how deep will the distortions in market efficiency variables last?
The Limits of Government Power
Command and control is an instrument of power that works well in military institutions. They hardly succeed in free markets. This is because free agents are free to flee from actions or conducts that inhibit their profit motives. Even in command economies (a relic of past centuries), governments may command or empanelled manufacturing teams and institutions, however, they lack the ability and or power to mandate consumptions.
The Nigerian system of governance is designed with the aim of fragmenting authority and our economic system is rooted in the free markets with its complicated system of confounding efforts to coordinate or centralize production. Our system was intended to be a constrained government system, built to promote the virtues of economic and political liberalism, rather than micro or feudal management of instruments of production or mechanisms of the market.
It is very difficult to correct a problem when the cause of the problem is misunderstood or misplaced. Government interventions in free market economies lead to further government interventions. When such interventions are sector specific, such as the current financial sector led intervention, policy makers in the confusion to address ill conceived quick sand solutions easily prescribe such sector specific solutions as cure all for other sectors of the economy. The ingenuity of those in the financial markets is impressive.
Eventually, they figure out how to circumvent whatever regulatory regimes that are put in place, hence policy makers are left with chasing the tail, and racing to make the next crisis less severe than the previous.
The market truth is that governments are powerless when it comes to the ability of private agents to innovate. The licensing of telecom companies in Nigeria in 1999 without adequate plans for regulation, resulted in the inflow of massive local and foreign capital into that sector of the economy.
To date, regulators are still battling on how to properly regulate the industry, including control of the sales of phone lines not tied to specific individuals. Sky high interest rates in North America and Europe in the early 1980s, gave birth to interest rate swaps.
Following the 2001 recession in the United States, credit default swaps emerged and by 2002 and 2003, the United States experienced the highest corporate bond default rate in its history.
AMCON is a ten ton gorilla in the Nigerian financial market. How it sways through the free market will define those who gave birth to the institution. In the meantime, other sectors of the Nigerian economy need proper regulatory oversight. Telecommunications, for example is another sector that is increasingly becoming a problem. Poor regulation of the sector, though not yet manifest, will eventually create another market bubble down the line.