Using public money to restore confidence in the financial system, although controversial, is sometimes necessary.
As the financial crisis originating in the US continues to rage, the authorities there are trying hard to contain the damage and hopefully put a stop to it. The measures taken by the authorities so far, and the proposals currently being debated, involve market intervention in one form or another, and the use of large amounts of public money. A recent editorial in a financial newspaper put it like this: "the follies of a generation of irresponsible financiers will fall on future generations of taxpayers." Whether the American people and their government like it or not, they really have no choice. The alternative of letting the markets take care of the problems might lead to a financial meltdown that would throw the economy into a tailspin, which would be a lot more costly to the community as a whole. But it takes time, and possibly severe pain, for stakeholders in a free-market economy to realise and accept the inevitability of market intervention in special circumstances and the use of public money to rescue the financial system.
There are different types of institutions performing the basic function of financial intermediation. In the process of matching the risk appetites of investors and the risk profiles of fund raisers, these financial intermediaries typically leverage themselves and take a variety of risks, including credit risk. To function properly and to command the confidence of investors and fund raisers, they need to have adequate capital and liquidity. When financial crises come financial institutions often find themselves short of both. At the risk of over-simplifying things, to contain or end a financial crisis, there is a need for the authorities to provide liquidity to the financial system and facilitate the re-capitalisation of financial institutions.
The provision of liquidity is obviously the role of the central banks, since they are lenders of last resort. They have been doing as good a job as circumstances allow. In the US, for example, funds are now provided against collateral of a much wider spectrum of financial assets (such as equity) than in normal times; and for much longer repayment periods. Readers may also have noticed large liquidity injections by central banks in many other jurisdictions recently, including Hong Kong where, because we are an open international financial centre, market sentiment is determined to a great extent by developments in international finance. It should be noted that the money market in Hong Kong has been orderly, although there have been heightened concerns about credit risk in the interbank market. The HKMA stands ready to provide liquidity to the banking system as needed, and there is a well-established and transparent framework, built up over the years, for doing so. On Tuesday, 30 September 2008, we announced, as a precaution, five temporary measures to make the framework for providing liquidity to the banking sector more flexible and we may consider, if necessary, further measures to enhance our ability to cope with further stresses in liquidity conditions.
Provision of capital for the financial system of a jurisdiction is a more delicate issue. In the US, raising capital under current circumstances is obviously difficult and the authorities need to determine whether there is a need for the public sector to be involved in the re-capitalisation of the financial system. When asset prices (especially property prices) are falling and the asset quality of financial institutions is deteriorating, prompt and adequate re-capitalisation is crucial to prevent confidence in the financial system and the viability of financial institutions from sliding away. I have said before that the situation in the US is far too serious to let worries about moral hazard be a pretext for inaction. I am therefore glad to see the comprehensive measures proposed by the US Government to repair the balance sheet of the financial system. I hope the US Congress can reach a consensus on these measures soon, while understanding Congress’s views on the need for arrangements to protect the public purse and the interests of "future generations of taxpayers" and to strengthen the regulatory system to reduce the likelihood of a repeat of the problems that led to the current crisis.
Joseph Yam
2 October 2008
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