Saturday, March 26, 2011

What Singapore can learn from the US financial crisis of 2008

Wall Street has always been able to attract the best minds from all over the world because Wall Street pays the highest salaries in the world. Wall Street drives its people very hard. They work very long hours. Wall Street people are by nature highly ambitious, driven and self-motivated. With unparalleled intelligence, diligence and energy, you would expect such an organization to be unparalleled in performance. Yet in 2008, instead of scoring an unparalleled success, Wall Street screwed up big-time and its failure was unparalleled in history. Wall Street failed so spectacularly that it almost brought down the whole world.

Many people have attributed the cause to evil Wall Street bankers full of greed who do not hesitate to cheat the financially illiterate public of their hard-earned savings in pursuit of big bonuses. I do not think that Wall Street people are evil by nature and this is not because I am one of them. If you were rewarded to be evil, would you become evil over time? To cut a long story short, Wall Street folks were rewarded to take excessive risks because when things turn out well, they scoop up the gains but when things turn out badly, other people pay for their mistakes. If you work in Wall Street, wouldn't you behave the same? This system of perverse incentives reward bad behavior. Over time, even good people become bad, not to mention the people who are already rotten. How do you expect highly driven, ambitious individuals who are used to winning in school since childhood to behave otherwise? Do you think they are willing to perform poorly?

At the risk of oversimplification, Wall Street collapse was caused by a combination of high intelligence/energy and perverse incentives that drove the system to self-destruction at the hands of its own people. All other problems stem from this fundamental flaw. The world would have been a safer place if Wall Street had hired stupider people. At least, they would not have been so intelligent bringing about destruction to their employer, transferring the cost to taxpayers and becoming fabulously rich in the process.

The Singapore civil service is able to attract the best minds in the country because it pays very well with very good job security. There is nothing wrong in paying well to attract smart people in the government. Indeed, one of the causes for the 2008 US financial crisis was that the US government was not able to attract regulators who were smart enough to deal with much higher-paid, smarter Wall Street folks who ran circles round the lower-paid, mediocre regulators. Paying high salaries to government workers is a good policy to be continued. However, one has to acknowledge that there is a limit beyond which people start losing respect for the government. Effective but painful policies that are hard for the people to swallow become much harder to implement because the message will get lost if delivered by a messenger who is not trusted by the people.

Having smart people(civil servants) working for you (me and my fellow citizens) can be a double-edged sword. If you drive them with the wrong incentives, they will drive you faster down the road to destruction. This is where my worry comes in. In terms of brainpower and paypower, our Civil Service holds similarities with Wall Street. If you mix that with perverse incentives, the combination will be lethal to our country. I hope our government pays particular attention to this risk when they set KPIs (Key Performance Indicators) that determine the bonuses and promotion of their civil servants .

What concerns me is when government puts in place incentives for their people that are at conflict with the interests of the Singaporean people at large. For example, the Government collects more tax revenue when more people go to the casinos. By pegging their own salaries to GDP growth, there is a tendency for policies to overheat the economy leading to a rising cost of living for ordinary folks. To carry this point to the extreme, an unscrupulous government can simply print money to grow GDP while the ordinary people suffers under inflationary conditions. Of course, this is not happening in Singapore based on the strength of the Singapore dollar. (I am losing big money in my US investments just by sitting on cash alone. ) However, there is a risk that policy-makers are taking the easy way out to hit their KPI to grow GDP by opening the floodgates to foreign labour. While foreign immigration is necessary given the low birth-rate in Singapore, it should not be done in a manner which creates another problem - raising the emigration rate and killing the loyalty of local Singaporeans. In a crisis, Singapore requires a core group of rooted Singaporeans to stay behind to fight for its survival.

The risk of self-destruction caused by perverse incentives is very real. Let us learn something from the US debacle and prevent it from happening to us.

8 comments:

  1. Highly insightful article. Why don't you give some examples closer to home instead of Wall Street?

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  2. http://en.wikipedia.org/wiki/Moral_hazard

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  3. Why don't you give some examples closer to home instead of Wall Street?

    Do you mean local examples of perverse incentives that cause harm to the system?

    The financial services industry is rife with such conflicts of interests, from the relationship managers who had aggressive sales quota for the toxic Lehman Brothers minibonds that they sold to retirees to the fund managers who do not have suffer the loss of their clients' money when they take excessive investment risks.

    Much harm has been done to consumers by financial advisers who are paid by commission. Take example, the insurance agents.

    On the surface, insurance agents will say they sell insurance plans based on the needs of their clients. In reality, they sell based on which plan pay them the most commission. This has worked against the interests of consumers because a good deal for the issuer of a financial product is usually a bad deal for the buyer. A good deal usually means high commission for the salesmen of the financial products. Hence, today we have Singaporeans paying large sums of money for whole-life plans and yet not getting adequate healthcare protection.

    As long as financial advisers are paid by commission, we should not expect them to act according to our best interests.

    I would like to make clear that while these people may have done harm to financially illiterate consumers, they are not inherently evil. They simply happen to work in an industry with perverse incentives that turn good people bad. I will be no better if I had worked in the same industry.

    Thankfully, I am lucky that I do not face no such internal conflicts in my line of work as an engineer. I get rewarded when my product work to the satisfaction of my customer. I do not make money from their losses.

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  4. If you think there are problems with the incentive system for our Civil Service, why don't you make some constructive recommendation?

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  5. If you think there are problems with the incentive system for our Civil Service, why don't you make some constructive recommendation?

    This is a good topic for a new blog post.

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  6. im reading your posting but not bored with lot of text,.,.good job

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  7. This article is very insightful, money corrupts, too little, the good people works for someone else and became another country's foreign talent, too much, the good people became greedy and do anything to grab hold of more.

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  8. There's a saying "Money is the root to all evil," I don't usually agree with that statement but for whatever reason, after I read thru this post, I begin to agree.

    I was asking myself the same question, if I were to receive huge bonuses for making a hit and nothing to lose if it's go wrong (cause it's the investors money) wouldn't I'd do the same? Well, guess what, sadly enough, I think I'd might do the same:( Pray for forgiveness.

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