âAt his best, man is the noblest of all animals; separated from law and justice he is the worst.â Aristotle. ⢠âOne of the penalties for refusing to participate in.
CLICO Meltdown: Reckless Governance or Too Big To Fail* ©Wilberne Persaud & Wayne Soverall *Presentation to the SALISES 12th Annual Conference: “Challenges of the Independence Experience in Small Developing Countries”, March 23 – 25, 2011, Jamaica Pegasus Hotel, Kingston, Jamaica. 1
• “At his best, man is the noblest of all animals; separated from law and justice he is the worst.” Aristotle • “One of the penalties for refusing to participate in politics is that you end up being governed by your inferiors”. Plato • “Capitalism requires for stability and growth, a continuously adequate, if not optimal flow of financial resources through its arterial system. This necessitates prudential regulation of all functionaries in the financial system. Its absence or imprudent practice allows and in part, causes crises and crashes. I find no historic evidence to counter this proposition.” 2
• If each participant in the banking system has a ‘small’ footprint “… failure of any one company, an accident which, in the course of things, must sometimes happen, becomes of less consequence to the public”! Adam Smith. So, knowledge of the catastrophe surrounding ‘too-big-to-fail’ is neither a recent discovery, nor an ancient hidden mystery.
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Until January 2009, Colonial Life Insurance Company (Trinidad) Limited—CLICO—was the largest private sector conglomerate in the Commonwealth Caribbean. Its operations spanned its initial primary business— insurance and other financial services—and manufacture, petroleum and energy, real estate development and diverse trading activities. 4
• Its collapse ignited comment and speculation as to the root causes. Speculation and statements by its CEO link its demise to fallout from the global financial and economic crisis stemming from the Wall Street Meltdown of September 2008. Yet the available evidence suggests to us that CLICO’s failure stemmed primarily from its peculiar business model
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• An underdeveloped legal, regulatory and institutional framework, coupled with laxity in such regulatory oversight as did exist, permitted the risky business model to exist and continue for years. Inexperienced, insufficiently qualified personnel managing what had become an unwieldy expanding behemoth, metastasizing through an inexorable and enthusiastic acquisitions strategy could not cope with such explosive growth. Prudential and fiduciary responsibility were indeed first line casualties. 6
CLICO operated within its holdings more than 65 companies in 32 countries spanning the Caribbean, Europe, the Middle East and Asia. It employed in its heyday more than 20,000 persons and controlled assets in excess of TT$100 billion. The company and its leadership became the flagship not merely of Trinidad and Tobago but also the entire Southern Caribbean. 7
As a result, a slump in the fortunes of CLICO would cause shockwaves to ripple throughout the national economy and those of the wider Caribbean. Citing CLICO’s financial problems Standard and Poor’s (2009) gave Trinidad and Tobago’s iconic conglomerate an A-minus rating on its watch list.
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On January 30, 2009, the day the meltdown was publicly and officially recognised, Trinidad and Tobago’s Central Bank intervened in the operations of the CL Financial Group. The entities included specifically CLICO, CLICO Investment Bank (CIB) and British American Insurance Company (BAICO). These were the financial services operations of the Group. Government was approached with a claim by CL Financial’s CEO Lawrence Dupres, of significant liquidity problems derived from unusually high levels of withdrawal requests and acute shortfalls in the liquid assets of its banking and insurance 9 operations.
Subsequent review would however, quickly reveal a problem of solvency rather than liquidity—the financial services operations of the group had been soliciting deposit funds, undertaking interest payments significantly higher than its competitors throughout the region. Effectively CLICO entities in the CLF Stables mobilized funds to purchase assets which themselves were pledged as CLF became guarantor for many of the Group’s heavily pledged assets—a severe limiting factor to the potential for asset sales to improve the group’s liquidity condition. 10
CLICO’s model was unsound precisely because it created an irredeemable mismatch between high interest bearing shortterm deposits and long-term investments that would ultimately result in cash flow problems and the liquidity crunch that in the end did materialize. Additionally, as was the case with Jamaica’s indigenous financial services sector meltdown in mid-1996, CLICO’s problems had at least partial roots, in its departure from its core business. (Persaud, W. H., 2006) Failure of this business model—the Group Structure bearing no arms-length financing and investment transactions internally—should, particularly with experience in recent memory of similar malaise in Jamaica, act as a wakeup call for Caribbean governments and regulatory institutions responsible for oversight of financial services firms particularly insurance companies, in relation to the way they conduct business. 11
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Preliminary Fix from analysis of failure • In all fields of human endeavour, analysis of failure gives rise to new designs, systems, protocols etc. • CLICO owned either wholly or in significant part, business and productive operations in six sectors of economic activity: Insurance, Finance and Banking; Real Estate; Energy; Manufacturing; Agriculture and Forestry; Services and Communications. 15
•CLF sourced client funds which it then deployed to generate income through acquisitions and active real sector production such as real estate development and heavy duty equipment rental, in a period of rising real estate prices. •The model of offering higher rates for deposits and flexible annuities then served the group for a number of years. •As in all such schemes risky and imprudent mismatch in the term structure of assets and liabilities precipitate liquidity shortage as clients seek encashment. Enforced sale of real assets in a declining market and, as is most likely without bailout, precipitous descent into insolvency follow. The fact is, both principals and managers in these situations rarely appear able to foresee, or admit their16 company’s impending demise and bankruptcy.
A 1994 National Bureau of Economic Research [NBER] working paper: “Looting: The Economic Underworld of Bankruptcy for Profit”, Economists George Akerlof and Paul Romer considered why financial services firms seemed so willing to take on overly risky decisions. [Moral hazard] They concluded, “an economic underground can come to life if firms have an incentive to go broke for profit at society's expense (to loot) instead of to go for broke (to gamble on success). Bankruptcy for profit will occur if poor accounting, lax regulation, or low penalties for abuse give owners an incentive to pay themselves more than their firms are worth and 17 then default on their debt obligations.”
Required: increased regulation and supervision. But NB: balanced approach in order not to stifle entrepreneurship and innovation in the process. CL Financial Group’s expansion into 32 countries was the crux of an innovative risk-alleviation strategy. In fact, a classic example of a corporation using an expansion/diversification strategy to position itself relative to market and cross countryrelated investment risks. In this approach, diversification into multiple industries in any one market as well as investing in diverse markets might protect against single market and foreign currency risks. King, 2009, suggests subsidy – Bad Idea. 18
The aspects of failure we identify, suggest a pressing need for legislation delivering more appropriate regulatory arrangements, adequate numbers of qualified personnel for monitoring the latter, greater skills in the management of risk and board directors seized of their fiduciary and prudential responsibilities. 19
Urgent Corrective Action • OECS population & economies require urgent attention – CARICOM Dealbreaker • Bailout clients where possible • Conflict of Interest Foxes in Henhouse - Politics, Business, Economics • Urgent need for Regulatory and Corporate Governance Reform; achieve compliance – OECD regulatory concerns – actually decimate Caribbean ‘Offshore Banking’ centres – Tax, terror, M-Laundering. This is in our interest – obviously both domestic and international. 20
