Joseph Yam Chi-kwong thinks financial innovations are the cause of market turmoil. He is wrong, at least when it comes to the current subprime crisis.
Sure, the development of new and complex financial instruments such as collateralised mortgage obligations and asset-backed commercial papers exacerbated the size of subprime related losses. And the proliferation of structured products certainly helped spread those losses to distant and unexpected parts of the world. But these instruments did not cause the crisis. The blame for that must lie with Mr Yam's peer group: the world's central bankers.
At a forum yesterday held by Europlace, the body set up to promote Paris as the centre of the financial world, the Hong Kong Monetary Authority chief executive concentrated on the role of financial innovation in triggering market meltdowns. In particular he pointed the finger at derivatives, blaming them among other things for the 1998 speculative assault on Hong Kong.
A more reasoned analysis might argue that the underlying cause of the 1998 attack was the relative over-valuation of the Hong Kong dollar's fixed exchange rate. Derivatives were merely the speculators' weapon of choice.
Similarly, while credit derivatives must be implemented as vectors in the spread of subprime losses, the ultimate cause of the crisis was the long period of excessively low interest rates which preceded the blow-up. For that we can blame central banks, especially the United States Federal Reserve.
Concerned about possible deflation, the Fed in mid-2003 cut its benchmark short-term interest rate to just 1 per cent, the lowest level in more than 40 years, and held it there for a year. Long-term rates followed, with the yield on 10-year US Treasury notes falling to a whisker over 3 per cent.
With interest rates so low, investors demanded higher returns. The result was an explosion of lending to poor credits such as subprime mortgage borrowers, with the risk parcelled out to investors around the world via high-yielding structured products.
