Andrew Sheng article on global financial crisis

Andrew Sheng articles have always been good read – not too technical and basically jargon free. He is adroit in providing incisive views and critiques on the problems and issues of the current  global financial world.  This article  proves  no exception, and in fact is one of the best that  I have read. It is written as foreword for a book by  Professor Reddy from India. 

How do financial engineers make five to ten times more salary than physical engineers year after year? Is there magic in the financial institutions’ ability to create return on equity that is significantly higher than real-sector companies like automobiles or energy? The answer is that they create risks through leverage and interconnectivity which, every ten years or so, become realised losses that are fully underwritten by the public sector through tax bailouts. The financial sector is being subsidised by all the holders of financial paper through zero interest rate policies. Their liabilities are still guaranteed by central banks.

Finance has become the biggest free rider of all time.


Former New York Fed President and current investment banker Jerry Corrigan used to say that central bankers may leave their jobs, but their hearts never leave central banking. The calling of central banking is perhaps one of the most exalted public appointments, as one is entrusted with the stewardship of a nation’s money and finance.

Great central bankers understand that on their shoulders are thrust the fiduciary duty that requires the highest order of professionalism, judgement and integrity, which are routinely put to test. In order to do their job effectively, they have to act on matters of monetary discipline and financial stability, often in situations of grave uncertainty. Occasionally, as Federal Reserve System Chairman, William McChesney Martin Jr put it, they have to ‘take away the punch bowl just when the party gets interesting’. It takes individuals of strong intellectual and moral fibre, who are humble enough to realise that they are mere mortals, and therefore have to shoulder their duties with the help of strong institutions.

All leaders have blind spots. However, central bankers tend to be different from other breeds of public servants because they are incharge of money, which is the lifeblood of all economic activity. Not only do they formulate and implement monetary policies, they must also have a finger on the pulse of financial markets in order to intervene in money and foreign exchange markets and manage public debt. Since they have an overview of financial stability, central bankers must understand the psychology of markets and therefore immerse themselves in the animal spirits of not just dealing rooms, but also the complex minutiae of back-office settlement and clearing. To be truly effective, they must also appreciate the power of politics and public opinion. And that is a tall order.

 Despite this, central bankers generally have the best understanding amongst public servants of how markets function. This is typically true in emerging markets, where the general understanding of financial markets is usually shallow, and strong institutions are still under formation and learning about the complexity of modern finance. 

In addition, because of the global nature of money and finance, central bankers have to master not only domestic issues, but also their international ramifications. As the famous Chinese Qing Dynasty warrior/intellectual Zeng Guofan used to say, to achieve anything, you begin with the big picture, but act on the small details. That requires leadership of a high order, attainable only by a rare few. There are many who can command both macro and micro aspects of finance, but often times, exaggerated belief in their own brilliance and exalted egos blind them to the fact that all human institutions are ultimately flawed.

Each country can count itself lucky to have strong central bankers who put institution-building and national interests ahead of their own egos. 

India is a land of many talents, but it was in the stars to have central bank governors of the calibre of Professor Y. V. Reddy, who was confident enough in his own judgement (stubborn and obsolete, according to his detractors) not to succumb to the temptations of opening Indian financial markets before they were ready for global volatility. Asians instinctively understand that in times of profound change, just as important as knowing what to do is to know what not to do.

Professor Reddy has given me the high honour, and immense pleasure, to write a Foreword to his monumental study of Global Crisis, Recession and Uneven Recovery. He asked me because he wanted an Asian and a developing country perspective on the current crisis.

Having grown up in the East, studied in the West, worked in the Bank Negara, Malaysia and the World Bank during the banking crises in the 1980s, having survived the Asian crisis of 1997–99, and being an ardent believer in free markets after working in Hong Kong, I must confess that I was shaken to the core by this crisis. The current crisis represents not just a seismic shift in global economic power from the West to the East, but has exposed fundamental weaknesses in the intellectual underpinnings of Western economic dominance. As Chinese Vice Premier Wang Qishan famously asked, ‘what do we as students do, when our teachers go wrong?’

The crisis was also as much a shock to the financial system of the West as it was to the confidence of Asians in the probity of Wall Street, long admired and imitated by Asians as the icons of financial excellence, dynamic innovators and paragons of integrity. To the credit of the West, the disclosures of the Financial Crisis Inquiry Commission ( have transparently exposed many of these myths. Laid bare for all to see are the shameless greed and moral decadence of Wall Street bankers, some of whom claimed that they were doing God’s work whilst collecting mammoth bonuses even as pension funds and retirement savings disappeared in billions. My personal belief in Wall Street was completely shattered when the Chief Financial Officer of the leading investment bank in the world confessed before the whole world that effectively, as market makers, their job was not necessarily to look after the interests of their clients.

It then dawned on me that what he was saying was that finance is no longer an agent of the real sector, as intermediary, trustee and fiduciary guardian of public savings. Finance is supposed to serve the real economy. Instead, it has become the master. In a classic reversal of the Principal-Agent Problem of finance, the agent has become the principal. After all, since finance has grown five times larger than the global GDP,1 finance is not just ‘too big to fail’, it had become ‘too powerful to fail’. 

The problem is also concentration of power. Roughly fifteen to twenty-five large complex financial institutions not only control or dominate global financial assets (roughly half), but also half or more of trading in financial derivatives. Their individual sizes are now larger than nations, best illustrated by the Icelandic banks that were seven times larger than the GDP of Iceland.

How do financial engineers make five to ten times more salary than physical engineers year after year? Is there magic in the financial institutions’ ability to create return on equity that is significantly higher than real-sector companies like automobiles or energy? The answer is that they create risks through leverage and interconnectivity which, every ten years or so, become realised losses that are fully underwritten by the public sector through tax bailouts. The financial sector is being subsidised by all the holders of financial paper through zero interest rate policies. Their liabilities are still guaranteed by central banks.

Finance has become the biggest free rider of all time.

 Bank losses are ultimately quasi-fiscal deficits. By underwriting these losses during this crisis, the central bankers of the advanced countries have, through their guarantees and bailouts, transferred the losses to the public purse, morphing (but not creating) a banking crisis into a fiscal crisis. By one Financial Services Authority (FSA) estimate, the amount of bailout was US$13 trillion, equivalent to nearly one-quarter of the global GDP of US$61 trillion.2 According to Bank of England (BoE) Executive Director Andrew Haldane’s estimates, the losses may be more than US$100 billion, 1.6 times the annual global GDP.3

Never have so many been held hostage by so few. Will this situation be allowed to continue? Based on the current reforms thus far, the answer appears in the positive. Despite G-20, this is an issue that has become ‘too hot to handle’. It needs cooler heads and steelier nerves.

Is Evil Local or Global? 

Some Asians like myself feel somewhat peeved by what is happening. After all, not more than a decade ago, East Asians suffered huge losses during the Asian crisis of 1997–99. During that crisis, we were told that ‘all evil was local’, the victims being responsible for domestic mistakes in macroeconomic policy that allowed asset bubbles, bad financial regulation, poor corporate governance and crony capitalism. 

During the current crisis, we are told that ‘all evil was global’, and to our horror of horrors, Asians are to blamed for excess savings that gave rise to low interest rates that caused the bubbles in the West.5 It is as if the depositors are being blamed for the mistakes of a bank’s management, and then have to give the bank management higher bonuses because their deposit rates are now cut to zero.

Is there an Asian View of this Crisis?

I am wary of offering any Asian view of this crisis because Asia is a continent, and not a unity. Asia is so large and diverse that there can be no one view that can be representative of a continent that is home to 55 per cent of mankind with probably more than 80 per cent of distinct human dialects. Furthermore, it is on record that I am against the notion that Asian values are superior to Western values, because my personal belief is that values, both good and evil, are universal and not the monopoly of any geographical region or culture.6 

Let me also put on record that although some Asians may engage in ‘Schadenfreude’ (pleasure in other’s pain), as Financial Times columnist Martin Wolf suggests,7 my view is that East Asian surplus nations stand to lose more than 5 per cent of their GDP in net foreign asset exposure for every 10 per cent revaluation of their currencies. Asians and the rest of the world are all in the same boat, so no one should be laughing except bankers with larger bonuses.

Nevertheless, if you carefully read through Professor Reddy’s book, you can discern several common Asian perspectives, in contrast to the mainstream Western (Anglo-Saxon and European) perspectives.8 What is so different about Asian perspectives? 

For what it is worth, I offer my personal perspective of six stylised and perhaps over-simplified differences, fully recognising that for every case I offer, counterfactual arguments about Asian mistakes can be given. These are offered as a comparative and tentative critique, so that we all learn something from this complex crisis. 

• First, with Asians being less theoretical and more practical in their approach, there is an awareness (conscious or implicit) that policymaking, particularly central banking and financial regulation, remains an art, not a science.

• Second and related to the first, Asians tend to take a holistic and human view of markets, not a partial view.

• Third, because of a longer historical legacy, Asians are inclined towards a long-term view of policy, rather than short-term expediency.

• Fourth, being more rooted in the primary and secondary stages of development, Asians pay more attention to real-sector issues than financial or virtual developments. This is both a strength and also a weakness.

• Fifth, given huge social and cultural diversities, Asians are sceptical of one-size fit all solutions, especially with respect to human behaviour. 

• Finally, there is greater self-awareness, best epitomised by the sixth century bc Chinese military strategist Sunzi’s dictum that before you know your enemy, you should know yourself, because it is that failure where the mistakes are often made.

Policymaking as Science or Art?

The older generation of Asian policymakers, myself included, tend to be less well-trained in quantitative economics than theirWestern counterparties. This, of course, is less true of younger Asian technocrats who gobble up Basle models like ducks take to water. For example, the current Chinese Political Bureau, the highest policy decision making body in China, comprises all engineers and no economists. Being practical and having risen mostly through administrative ranks, their hands-on experience makes them much more sceptical of economics as a science.

Post-crisis, the misgivings about economics as a science prompted a defence by Professor Ben Bernanke, Federal Reserve Bank Chairman and former Professor of Princeton University, in his September 2010 speech at the Princeton University.9 He distinguished between the scientific, engineering and management aspects of economics. For the most part, he felt ‘the financial crisis reflected problems in … economic engineering and economic management’, rather than in the science. In our email correspondences on the subject, Professor Reddy rightly pointed out that ‘when individual machines fail the fault may be with engineering or management, but if all machines based on that theory failed, it is more likely that theory also failed’.

On virtually the same day, Professor Paul Volcker, former Federal Reserve Chairman, speaking at the Federal Reserve Bank of Chicago Conference, lamented the fact that the financial system is broken and that central bankers in charge of financial stability must make some very difficult judgements. I commend his speech because here is someone who is not dazzled by brilliance, but who is wise. He understands that markets are human institutions, because ‘market developments are the creatures of very clever people trained in the physical sciences, applying techniques of physical sciences to financial markets, which are not physical things, but human institutions which are prone to excesses … and simply not well managed under the assumption that everybody follows the normal distribution curve which does not exist’.10 

Even Professor Bernanke has urged economists to study more about human behaviour in a situation of ‘unknown unknowns’ or Knightian uncertainty. Perhaps through their long experience with uncertainty, Asians instinctively react to a crisis situation by not moving, which partially explains the Chinese decision to halt the flexibility of the RMB when the crisis broke out.

Silos Versus System-wide Views

The second difference is the failure of Western intellectuals to recognise that economics and other disciplines had become so specialised and government agencies so fragmented that the world has become one market, but is being viewed and governed in silos. Mea culpa. As a Western-trained technocrat, I made the same analytical mistake. But the Asian dialectic side of me forced me to look for interconnectivity and take a network or system-wide view of the crisis, which surely has causes outside the financial sector, including climate change and real-sector imbalances.11

Indeed, any analysis of the crisis must take a system-wide view, covering not just the macro, but also the micro aspects of human and institutional behaviour. Asians understand that silo-based fallacies of composition do not add up, as Mahatma Gandhi rightly said, ‘we have enough for our needs, but not for our greed’. Chinese Taoism would recognise that short-term benefits do not necessarily mean long-term benefits, and that the world is constantly changing through interaction between dualistic forces. Human behaviour is simply not linear, and is in fact highly interactive. The world is constantly in the process of interactive change, so that any static or partial analysis is fundamentally flawed.

This point is best illustrated by a definitional translation. Neo-classical economic models are based on key assumptions, including some which are not articulated or specified well in the theory or model. The danger, as we have found, is that assumptions may often be wrong and lead to wrong conclusions that become disastrous policy recommendations. The Chinese definition of ‘assumption’ comprises two contradictory words—‘false certainty’—illustrating the dialectics of Chinese thinking.

The Long View

The third difference arises from the historical fact that Asians have experienced centuries of cycles of famine and disaster, over-population and natural resource stress. Asian policymakers understand that human development is a marathon, not a sprint. The willingness to take a historical perspective is epitomised in Henry Kissinger’s question to Chinese Premier Zhou Enlai in the 1970s on what were the implications of the French Revolution. Premier Zhou Enlai answered, ‘it was too early to tell’.

This requires development to begin with the fundamentals, such as education and infrastructure, before moving on to more complex steps. Patience is seen as a virtue, rather than an obstacle to development. 

Stick with the Real Sector

The fourth perspective is that Asian policymakers tend to pay more attention to the real sector than finance. In terms of a choice between real-sector policy reform versus financial-sector policy reforms, Asian policymakers are more likely to choose the former. In contrast to advanced country regulators, who are more sanguine about financial engineering, Asian regulators learnt bitter lessons from the power of financial derivatives in speculating against Asian currencies, plus speculative losses from the Sumitomo copper futures (1995) and China Aviation Oil from speculation in oil futures in 2004. This is perhaps why Asians are more likely to shun what they do not understand.

 Although recent Asian growth was initially funded from high leverage (notably Japanese and Korean companies), Asian policymakers have generally been bold on the real-sector investments and cautious or prudent on the financial front. For example, domestic fiscal investments have generally been funded from domestic savings. The Asian crisis of 1997–98 put paid to any doubts about the dangers of the double mismatch, namely borrowing short to invest long and borrowing foreign currency to invest in domestic assets.

The lack of attention to finance has resulted in an imbalanced development in Asia, since it is precisely the cautious approach to financial risk that has impeded the growth of Asian capital markets. This is a contradiction in policy that Asia must solve sooner or later.

Monoculture is Dangerous

Chinese Taoism which influences certainly North Asian bureaucratic behaviour, compares and contrasts action (wei) with inaction (wu wei). The dialectical analysis explains that too much of a good thing is bad, exactly what Minsky called ‘stability breeds instability’. The dominance of one type of risk management model or one source of market information that seems to suggest that risks or market trends are unidirectional clearly generate their own momentum, and hence add to volatility or risks.

Surely, when everyone believed that the market is always right and even accounting standards are premised on that assumption, accounting standards themselves became procyclical in application and therefore one of the factors in the instability of the system.

As Professor Amartya Sen has convincingly argued, the history of heterodoxy and argumentative debate in India has contributed not only to the development and survival of democracy in India, but also to its social stability.12

The conclusion is that there can be no ‘one-size-fits-all’ solution for global problems, because the world is too diverse and heterogenic. This also implies that we can only at best agree on major principles at the global level, with implementation differences for different countries.


There is a distinctive trait in the analysis of the role of incentives in the current financial reforms. Regulators and policymakers have offered the combination of excessive management compensation schemes and moral hazard as the two most important incentives that led to excess risk building up in the system. As far as this author is aware, other than lone voices such as Professor Richard Posner and Paul Volcker, few Western opinion-makers are willing to discuss why there is no reform of incentives for policymakers or regulators to take unpopular action against the madness of crowds. The matter is conveniently put under the menu for action by the creation of financial systemic risk councils. But those who are wise need incentives to act or to persuade society to act against disaster myopia in the face of growing evidence of rising risks. Society must recognise that timely ruthless truth-telling,13 despite it being highly unpopular, is vital in moments of impending disaster.

Furthermore, there is an unspoken assumption, stemming mostly from Newtonian physics, that the observer can be independent from the observed. This is not true. Ancient Asian wisdom suggests that it always pays to be self-reflective and understand not just others, but how our personal behaviour affects those around us. Interpersonal behaviour is always interactive, so the outcome is not always predictable. Sunzi famously called this ‘know your enemy, and know yourself, and a hundred battles will not be at peril’. We must have the humility to understand that it is our own weaknesses and failure to act or discipline ourselves which may be at the root of many of the problems we confront. 

Finally, there is a trait in Professor Reddy’s book that is different even from other Asian policymakers. South Asian leaders tend to pay more attention to the small man or the poor in their reflections on policy. I commend this thoughtfulness on financial inclusiveness as in the run-up to the current bubbles, there was too much attention paid to how to become rich, with an inclination to forget the under-privileged in our midst.

Tentative Conclusions

Professor Reddy has asked me to venture forth in deep inter-cultural areas that are quagmires of controversial debate. I have responded because we need to have alternative explanations of the current global crisis, which has not been satisfactorily answered in the on-going enquiries.

The current crisis is both a crisis of human governance and a crisis of human thought, including how man interacts with nature. We need the humility to appreciate that East Asia made basically similar mistakes as the West only twelve years ago under less sophisticated circumstances. It is arguable that the fundamental roots of the Asian crisis were never fully resolved, since the Fed took rapid action to increase United States’ consumption, which pulled Asia out of recession. For that, credit must be given where credit is due. The tragedy was to assume that ‘this time it’s different’, or ‘we have little to learn from the Asian crisis’. 

However, the relative decline of the West, even if that is true, does not necessarily mean the rise of the East. The East is still far too backward in areas of science and technology, development, military might, and even social institutions to contemplate true competition. But debate and discourse improves knowledge and understanding for all of us. Both Mahatma Gandhi and the Confucian Analects acknowledge that all men are brothers and that through debate and discourse, our world is improved in harmony rather than in conflict. 

For these reasons, I thoroughly commend Professor Reddy’s book on Global Crisis, Recession and Uneven Recovery as an important contribution to the debate on how we should deal with the great financial crisis of our time.

24 September 2010 Andrew Sheng

Former Chairman of Hong Kong Securities and Futures Commission,

Adjunct Professor, Tsinghua University and University of Malaya


About kchew

an occasional culturalist
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One Response to Andrew Sheng article on global financial crisis

  1. robert says:

    I think the average house wife is a better economist & planner than most Prime Ministers/Finance Ministers who may have selfish agenda or they build something so that posterity remembers him/her.
    The housewife usually spends within the budget given by her husband. If she overspends she will get a big scolding. She does things for people she loves – her children and husband.
    She does not overspend. In fact she tries to spend less than what was given and saved some for raining days.
    You cannot trust most politicians. Even British MPs were caught making fictitious claims.
    The amount of money spent on a leader (Prime Minister or President) is enormous.
    You only get into financial & economic trouble if you spend MORE than what you earn.
    Leaders also lie or manipulate figures as they control the media.

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