Singapore Economy: The Moral Hazard of Bailouts and the Dilemma the Government is in

Singapore, 10 Nov. The Singapore government has been put in a tough spot in on whether or not it should intervene in saving citizens’ losses.

Singapore, 10 Nov. The Singapore government has been put in a tough spot in on whether or not it should intervene in saving citizens’ losses.

Moral hazard is an economic term which describes the repeated bad behavior of companies (or individuals) because they can be bailed out or somehow saved after committing mistakes. A recent example are the banks JP Morgan, Bank of American and Citibank which were deemed “too large to fail”, and as an example of the moral hazard it created, the banks used the money to gobble up smaller regional banks.

A storm has been brewing since early October in Singapore and Hong Kong where investors of the structured products, aka mini-bonds were told that because of the Lehman Bros failure, their investment would be wiped out. What is interesting about this case is that it appeared that what was sold to the investors as a safe investment for their nest eggs were not asset backed bonds but toxic derivatives in the form of credit default swaps, the investors were providing a collective insurance against companies defaulting.

Their upsides were limited, around 5% a year, while the downside was a total wipe-out if any of the six banks listed went into default. The majority of the investors were retirees who were sold these products by aggressive relationship managers or and bank tellers who were privy to their account information whenever these retirees went to update their passbooks at the branches.

What is interesting is that the relationship managers probably did not understand the products they were selling, and many investors thought that they had diversification in the mini-bond as the product brochures listed six-banks whom the Mini-bond was insuring against a default.

I mentioned moral hazard here because the Hong Kong and the Singapore governments are under a lot of pressure to bail the investors out. Hong Kong seems to be doing better because the governments made the banks settle with the investors.

In Singapore, the process is very conflicted because the investors had to endure a long process with the banks who are obviously trying to disprove misrepresentation by their relationship managers.

To complicate things further, only investors aged 62 and above with a primary school education (age 12) were eligible for a full refund. This resulted in pretty ugly scenes (see http://tankinlian.blogspot.com/ and http://theonlinecitizen.com/ ).

I think the government is in a bind if it plays too heavy a hand in settling this issue, it creates a moral hazard with future crisis. However, if it doesn’t appear to intervene, this creates a backlash, especially in a Confucius-oriented society like Singapore.

While the Asian savings rate is the highest in the world (between about 20 – 40% of disposable income goes to savings), Asians (me included) aren’t very good at figuring out where to park the money. Some say the interest rates here too low (eg. The fixed deposit rate is <2% while CPI is 7.7%), resulting in higher risk taking.

In my opinion, our parents do not teach us how to invest, and talking about money is taboo at the dining table, as a result, the risk-reward ratio isn’t calculated properly (me included). Asian investors are starting to learn that financial planners do not necessary have the investors’ interest at heart.

Felix Eng, Independent contributor

Previous article by Felix Eng, “Market Troubles are Opportunities”