The global economic crises – Lessons from Zimbabwe

The global financial markets are in turmoil and the world is facing an economic meltdown of an unprecedented magnitude. The governments have stepped in to introduce a raft of measures to stabilise the situation and restore confidence in the markets. The responses have been as varied as they have been controversial – from bailout packages in the US, UK and Europe to guarantees of depositor funds in Ireland, Greece and Australia. These interventions notwithstanding, the outcomes, for the moment at least, have been disappointing. The markets are plummeting and institutions are failing at an alarming rate.

But if the truth should be told, the current events are not new and have been playing out in a small corner of the globe on which attention has been on entirely other matters. In the past few years I have been conducting a doctorate research on corporate governance in Africa with particular focus on Zimbabwe and Kenya. In Zimbabwe I conducted a case study research on the financial sector which collapsed due to corporate governance failures. Reflecting back on this research, the findings reflect astonishingly closely what is now happening in the global economy and I thought I should share some of these findings and conclusions in the hope that this will be useful in understanding what has happened and in shaping a way forward.

While my case study research focused on one particular institution the issues concerned the whole financial sector in Zimbabwe and, by extension, to the national economic performance of the country. Let me start with an obvious and necessary admission. Zimbabwe may not be such a good example given other well known exogenous factors. However the situation was not always like that. Until a few years ago Zimbabwe was a reasonably performing economy with world-class financial institutions and efficient public and private sectors. What led to its slide into its current economic abyss are, in part, events which are very similar to what is now happening on the global arena.

The most telling and decisive slide of the Zimbabwean economy can be traced to 2004 when many financial institutions in the country which had tied up funds in speculative activities began to experience liquidity constraints accelerating runs on the banks by agitated depositors and, in turn, triggering the banking sector crisis. At the height of the crisis in 2004, ten financial institutions including banks and building societies, collapsed due to insolvency and liquidity problems. This mirrors the present situation where global financial institutions are suffering the effects of their exposure to the sub-prime mortgage market amid growing accusations of malfeasance by the so-called corporate fat cats.

In my research I found that prevailing economic environment largely dictates the nature of business practices and transactions. In the case of Zimbabwe, it was the unstable macro-economic environment (soaring inflation and high interest rates) which encouraged financial institutions to engage in high risk investments which provided very high near-term benefits. The long term implications turned out to be quite adverse, as the financial institutions later painfully learnt.

What is important to remember is that financial institutions are cash rich but a greater proportion of that cash is constituted of depositors’ and equity funds. Operating margins (mostly interest and changes) represents a smaller component of their funds. In a business world which avers that “cash is king”, financial institutions find themselves in a unique position of trying to play around with a large amount of funds which they have not really earned. While there are regulations which guide their activities in this regard, there is, nevertheless, a great deal of flexibility and discretion. Today’s top performers are those institutions and individuals which are adept at executing the most unusual and highly profitable financial deals. This has given rise to the widespread use of instruments such as special purpose vehicles to conduct structured financial deals.

The prevailing level of discretion may suggest the need for stronger regulation and supervision of financial institutions. Evidence from my research suggests that regulatory interventions are not always the right answer. In Zimbabwe, for example, the regulatory authority, the Reserve Bank, responded to the banking crisis by issuing a raft of control and supervisory measures many of which failed to address the problems. In the end the central bank was criticised for lacking due consideration of the risk of regulatory failure with the consequence that where failure had occurred, regulatory measures had worse effect or consequences than the failings and potential dangers they sought to address.

There is also a need to strike a balance between regulation and supervision (which are socialistic in nature) and allowing for entrepreneurship and enterprise which form the bedrock of capitalism. An effective regulatory framework should ensure that business organisations are fully aware of what they can or cannot do and the consequences of departing from the straight and narrow path. In this context regulation is not seen as an external influence but more as an enabler, bearing in mind that the existence of regulation does not, on its own, enforce compliance in much the same way as the existence of criminal law does not stop criminals from committing crime. Good regulation therefore functions as a benchmark for accepted behaviour.

In the Zimbabwean banking crisis the issue of poor corporate governance relating, especially, to executive decision making and executive remuneration seems to have played a significant role in the events which unfolded. Another important issue was that the managers of the financial institutions were also significant shareholders. I will argue here that the prevailing practice in global corporations of partly remunerating executives with stock options makes them owner-managers. Evidence from my research suggests that owner-managed institutions tend to engage in higher risk behaviour to achieve higher stock returns from which the managers directly benefit. Owner-management undermines the foundations of the “principal-agent” model which has stronger prudential properties and promotes the high risk “myopic-market” (or “short-termistic”) tendencies in executive behaviour.

It must be conceded however that executive remuneration is largely defined and dictated by prevailing market conditions. The excessive compensation packages offered to financial executives may be a reflection of efforts to attract and retain competent skills within a constricted market. In this regard, it may not be entirely reasonable to fault financial institutions for the generous compensation packages which they offer their executives. Rather, efforts must be made to increase investments in training and human resources development in order to increase supply of skills and reduce demand levels. In parallel, it is necessary to devise and adopt alternative remuneration practices which do not involve stock options. Consideration should also be given to introducing executive remuneration caps in order to reduce or limit the growing remuneration gap between low and top earners.

When the liquidity crisis first hit the market in Zimbabwe in late 2003, the Reserve Bank established a Troubled Bank Fund as a temporary measure to support banking institutions which were experiencing liquidity constraints. The fund was intended to assist the troubled banks to re-align their asset portfolios and strengthen their balance sheets. When these efforts failed to successfully resolve liquidity problems, a further step was taken to acquire the failed banks to help avoid a severe loss of depositors’ and creditors’ funds and more serious destabilisation of the financial markets. If anything is to be learnt from this experience, it is that the governments in the US and Europe which are rushing in to shore up their sinking banking institutions will realise, much sooner rather than later, that they are faced with some real tough choices.

When governments decide to bail out financial institutions they may very well help to save depositors and creditors funds. However this invariably means that investors will loose out because of the dilution of their stocks. This undermines investor confidence and entrepreneurship and has adverse effects on long term economic growth. This appears to be what is happening with the financial stocks on the global markets.

Zimbabwe may now be better known for the notoriety of its political and humanitarian situation, but a deeper analysis of the financial crisis which it experienced four years ago and which accelerated the descent into its current economic abyss may provide useful insights and lessons for how the world should be responding to the current global financial crisis. In the event, that small wretched country may, after all, become a force for good. What a forlorn hope!