Published September 16, 2008

The need for buyer of last resort?

By TEH HOOI LING
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IN August 1998, in the throes of the Asian financial crisis, the Hong Kong Monetary Authority (HKMA) spent over US$15 billion scooping up the territory's blue-chip stocks and stocks futures.

The authorities were waging a battle against the speculators who were shorting the Hong Kong stocks, futures and currencies. Then Hong Kong Financial Secretary Donald Tsang defended the stockmarket intervention on the grounds that it was to 'deter market manipulation' and to protect 'national interests'.

Hong Kong's move drew flak. Alan Greenspan, then the US Federal Reserve chairman, said he did not agree with what the Hong Kong government had done. 'One, I don't think it can succeed. And two, I think that the consequences of doing that erode some of the extraordinary credibility that the Hong Kong monetary authorities have achieved over the years,' he said.

As events would unfold, Hong Kong's move proved astute and highly profitable and its taxpayers ended up billions of dollars richer.

Fast-forward to today. The US is desperately fighting its ever-deepening financial crisis. In the process it, too, has resorted to numerous desperate measures.

Instead of being a lender of last resort only to banks, the Fed expanded that role to other financial institutions recently. And in July, the US Securities and Exchange Commission (SEC) banned 'naked' short-selling of 19 large financial stocks traded on the New York Stock Exchange (NYSE), including the beleaguered Fannie Mae and Freddie Mac. The SEC - the bastion of free market - described naked short-selling as 'unlawful manipulation' and claimed that its ban was consistent with its mission of 'protecting investors, maintaining orderly markets and the promotion of capital formation'.

And while the US is trying to stop its financial institutions from collapsing it is the Asian stock markets that have borne the brunt of selling.

Year to date, the US stock market has only shrunk by 15.7 per cent. In Asia, China's market has shrunk by 55.7 per cent, India 45.3 per cent, Hong Kong 33.7 per cent and Singapore 27.9 per cent. And among Singapore stocks, it was the Chinese companies or the S-chips that were pummelled the most. Many decent Chinese companies are now trading at less then four times next year's earnings.

Do prices today reflect the fair value of these companies? How much of the selling was due to the drying up of liquidity as funds were withdrawn from the Asian markets? How much was due to 'market manipulations' of short-sellers?

It would not be wrong to say that markets are somewhat disorderly and illiquid now. In times like this, it is not uncommon for prices of even good assets to fall below their fundamental values.

The same holds for the prices of bad, impaired and sub-prime assets. Impaired assets too will have a fair or fundamental value. That fundamental value may well be far below the face value of the security, but it may also be well above the price the impaired asset would fetch in a fire-sale in an illiquid market.

In times of crisis, banks have lender of last resort to go to. In times of stock market turmoil, perhaps there is valid argument for 'buyer of last resort'.

At the very least, it would serve to build confidence.

And as Willem Buiter, professor of European political economy, London School of Economics and Political Science and former chief economist of European Bank for Reconstruction and Development, said: 'If the central bank, or some other government agency, were to act as Market Maker of Last Resort and buy up assets at a price lower than its fair value, but higher than what it would fetch in the free but unfair illiquid market, such a purchase would be welfare-increasing.'

The central bank or the government agencies will be properly rewarded for taking on this risk - as has been shown by the HKMA example.

And when it comes to S-chips, the 'national interest' argument can also be applied. Singapore has been trying to build itself up as the Asian gateway to the world's capital market for regional companies. It won't succeed if companies come here and are valued at only three to five times earnings.

An investor relations practitioner puts it this way. 'In this market condition, we are in need of leaders - people who dare to make the first step.

Value investments

'Singapore Exchange has done a great job attracting Chinese companies to list here. It is now up to our government-linked funds to be the leaders to ensure fairer pricing for these decent S-shares.

'Government-linked funds should stop just looking outside of Singapore for value investments. It is not necessarily that the grass is always greener on the other side of the fence!'

Ultimately, the point is even the US has resorted to desperate measures in these desperate times. It shouldn't be beyond Singapore to do so as well when it comes to the crunch, especially when national interests are at stake.