Ideology of deregulation sowed the seeds of crisis

PUBLISHED : Thursday, 18 September, 2008, 12:00am
UPDATED : Thursday, 18 September, 2008, 12:00am

American International Group has become the latest US financial behemoth to fall victim to the global credit crisis. After frantic efforts to secure a private bridge loan to shore up its rapidly deteriorating financial position failed, US federal regulators had little choice but to step in with a government rescue. The company, until recently the world's largest insurer by market value, is the proverbial corporate giant that is too big to be allowed to fail. Its collapse would have sent shock waves throughout the world's financial markets. A default by AIG on its massive insurance contracts would have exposed many of their holders, including some of the world's leading institutions, to greater financial peril. This would have had dire consequences.

The US Federal Reserve is therefore right to offer an emergency US$85 billion loan in return for control of the company. This is no ordinary bailout, though. Punishing terms have been imposed on AIG, which will pay interest for the two-year loan at far above market rates. All its assets will be pledged as collateral and the government will have warrants entitling it to convert them into about 80 per cent of company shares. Very little value remains for existing shareholders. In engineering the rescue, Fed chairman Ben Bernanke and Treasury chief Henry Paulson had to balance the need to stabilise markets with that of avoiding the creation of more moral hazard. Coming as it did after Mr Paulson's refusal to bail out investment house Lehman Brothers, the Fed is sending out a much needed message: do not expect an automatic bailout; and even if one is forthcoming, expect tough terms.

Whether the latest federal action can stem or mitigate the credit crisis remains to be seen. Most likely, more US financial institutions will fail. It is unlikely the credit crunch will end until the US housing market stabilises, and many economists believe there is still a way to go. But when the dust settles, it will be clear the US ideology of deregulation has contributed significantly to the global crisis. In an interconnected world, it is too dangerous to allow financial institutions to deal in complex and highly risky instruments without adequate regulatory oversight. Many Wall Street chieftains have been able to reap staggering rewards by taking on high risks, yet leaving their staff and shareholders to take the punishment when the music stops. This way of compensating irresponsibility and recklessness must be overhauled.

AIG's rescue no doubt has allowed many policyholders of its Hong Kong subsidiary AIA to breathe a sigh of relief. But they would have been offered a measure of protection anyway because of tight regulations here. Many government officials in Hong Kong openly admire Wall Street financial innovations. But in financial matters, prudence often trumps innovation, especially when it's unchecked.