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Transcript Of Remarks By Minister Tharman Shanmugaratnam At The Launch Of The Harvard Ezra F Vogel Malaysia/Singapore Initiative On 26 March 2009 Nanyang Technological University

26 Mar 2009

Good Evening,
Professor Su Guaning, President of the NTU
Professor Euston Quah, Dean of the School of Social Science and Humanities
Dr Lam Kin-chung, Founder of the Sun Charity Foundation
Professor Arthur Kleinman,

1. I think this is a wonderful initiative. I was very keen to come and support it because it involves three good universities, creating a new set of intellectual bridges. It is not the first of its kind but I think it is unique in some features. It is the first time that we have a leading American university tying up simultaneously with universities from Malaysia and Singapore.

2. Some things will come out of it which are predictable - exchange of scholars, insights and some learning opportunities. But in the nature of these things, some things will also come out of it that are not predictable. And we hope that over time, we will see surprises of one form or another. It always happens when we have these intellectual bridges being created. Some things happen after a while that is unexpected.

3. I was looking forward to listening to Professor Kleinman's lecture today. He chose an interesting theme. There is an industry in it own right that is now emerging which has to do with an analysis of what went wrong in the current financial crisis. And increasingly now..?focused on what should be done to put it right. In fact, just this evening I am flying to London for a conference tomorrow on the same topic. So it is a whole set of discussions taking place all around the world. (But) I think it is useful not to lose sight of the fact that the issues at hand are not just about the architecture of the financial regulation...they are ultimately about the culture of finance, both within our own national systems as well as in global finance.

4. The problems that we have seen in the last year and a half.?are not the same problems that we saw in previous financial crises. And I am sure that in future crises we will see problems that we have not seen before, or at least not in exactly the same form.

5. The recurrence of financial crises is almost a given. The type of crisis, the specific causes, the specific actions will be new and different. They sometimes repeat themselves but they often don't. But there are certain recurrent behavioural traits which underpin most financial crises and it is worthwhile therefore for us to?stand back, reflect on what has been happening, and ask ourselves why were decisions made the way they were made, why were behaviours skewed the way they were skewed and why was nothing done about the problem until it was too late?

6. Culture matters. I think if I had to summarise some of the key behavioural features of this crisis which are not new but which require attention. We have seen an excess of "short-termism" in behaviour in financial markets, both on the part of banks as well as what people call the "shadow banking" system. We will never be able to escape "short-termism" in financial markets. It goes all the way back to the 1800s...But there was an explosion of "short-termism" in the last seven or eight years, not just in the United States but globally I would say. in a way encouraging because we are not talking about having to reverse 30 or 40 years of behaviour but having to learn from mistakes from the last seven or eight years, correct them, mitigate what is a natural human trait, that is, to look at booms as things that will last forever and to understate or underestimate the long term risks of short term actions.

7. Regulators are partly responsible for this, globally.

(i) The fact that regulators allowed banks, particularly in the United States but also elsewhere, to shift risk off their balance sheets and to treat it as not requiring the usual capital and other prudential protection was a mistake that accentuated short-termism.

(ii) The fact that regulators allowed leverage in investment banks and what bank clears to reach extraordinary levels - 30, 40, 50 times leverage - was a mistake made only in 2004?in fact in the United States. Correctible. We now know how it accentuated the problem.

(iii) The fact that regulators decided not to exercise oversight over the derivatives markets allowed for an explosion of new products that were less than transparent, and led to an excess of leverage in the financial system as a whole. Again the mistake of recent years, and correctible. So "short-termism" is inherent in human behavior and in financial markets, but the excesses need not have happened, and we should learn lessons from what happened and correct them.

8. The second behavioural trait which has been quite pronounced in the last decade or so has been an over-reliance on mathematical models, that has allowed for a suspension of judgment on the part of many economic agents - within banks, within investment banks and even amongst regulators. This is a story that has now been told and I think there are important lessons to be learnt from that as well.

9. And the third and related behavioural feature of what has been happening has been the tendency to outsource responsibility for assessing risk and for thinking about risk. Banks were meant to be organisations that specialise in assessing risks. But what has happened in (recent) years has been the tendency on the part of banks to rely on credit rating agencies to assess risks, although most of the risks on the banks, on the balance sheets or...the off balance sheets will ultimately come back to the banks. This was a remarkable act, this outsourcing of risk assessment, on the part of the agents who were meant to specialise in risk assessment. Hence I think contributed to the problems that we have seen.

10. So avoiding "short-termism", avoiding the pretence that mathematical models can be of sufficient complexity as to capture all the uncertainties of the reality that we live in, and avoiding the tendency to outsource responsibility for thinking hard about risks and making the right provisions for risks - these are do-able things. They are not going to stop the financial crisis from recurring. They are not going to eradicate the almost inherent?tendency to think short term..But they can mitigate crisis, and they can prevent the next crisis from being as severe as today's.

11. I look forward to listening to a far more scholarly and in depth presentation from Professor Kleinman. But I thought it was apt that he chose this theme. We have to keep reminding ourselves that culture matters, not just instruments, models and architecture. Thank you very much.