By CHRIS GRAEME chris.graeme@theresidentgroup.com
Portuguese companies have to change their economic and business models by investing in training, innovation, research and development to escape the crisis, says Carlos Costa, the new Governor of the Bank of Portugal.
In a talk described as one of “optimism” rather than “crisis” before he took office on Monday, Carlos Costa, then Vice President of the European Investment Bank (EIB), said that the Portuguese economy also needed to be “less dependent on external financing”.
Addressing business movers and shakers from various chambers of commerce, Carlos Costa praised the Portuguese for their ability “to organise and form associations and partnerships compared to other countries” but had not always been so “adaptable when bad weather set in”.
Carlos Costa said Portugal, and Europe, was living through a crisis but shouldn’t forget the crisis that lay behind it.
The “extremely serious” crisis was an international, financial one, both with a differentiated impact on EU member states and on a world level.
For example, Brazil and China were enjoying significant growth rates and the question was why some countries were affected by the crisis and some weren’t.
The immediate causes of the crisis were subprime and the real estate crisis which was the result of a speculation bubble which burst from one moment to the next.
To understand why, he said, it was necessary to realise three things – there was abundant liquidity in the market, interest rates were very low for a long time and there was lack of adequate supervision which created all the conditions for investors to seek alternative products and applications.
The crisis had similar components to the crisis in 1929 yet was different. The banks had an important role to transform short term savings deposits into medium and long term loans that had an economic shelf life of up to six years.
This meant that it was a risk activity in that depositors had to be assured their money was safe, while banks had to hope the money they lent was a profitable investment.
This implied three things: a large degree of confidence and trust between the depositor and the bank, good risk evaluation by the bank on the borrower, and thirdly a good supervisory entity to “protect the system against wide boys”.
What happened before the crisis was that the “wide boys” got the upper hand and the regulators turned a blind eye.
This was able to happen because the financial entities were allowed to self-regulate and confidence was placed in these entities until the day came when they themselves encountered liquidity problems and couldn’t give that liquidity back to the client.
Lesson learnt
The credit rating agencies also played an important role in the crisis as they understated the risk involved with new, complex “subprime” securities that fuelled the US housing bubble.
“Conflicts of perverse interest were created as ratings agencies were paid by firms, such as investment banks, that organised and sold high risk debt to investors, to give AAA ratings. Therefore, third parties didn’t know what they were really buying,” he said.
“You cannot lay all the blame at the door of the banks for wanting to play to the max when the supervisors weren’t doing their job,” he said, adding that it was the referee’s job to keep the football players in check.
The lesson learnt was that there cannot be self-regulation in the financial sector and the new Bank of Portugal Governor is likely to tighten up supervision and regulation of Portuguese banks and force them to increase their liquidity margins to at least eight per cent.
Although Portuguese financial institutions did not largely invest in high-risk financial products like the UK and US markets, Portugal had few savings to export and relied on borrowing capital on those international money markets, so it too was clobbered by the crisis.
The future solution is therefore to reduce Portugal’s dependence on outside credit by increasing savings and promoting innovation and development in Portuguese companies to make their goods and services competitive abroad.
