With the stock market index around 6,000 points amid fear of a crisis in the financial markets caused by massive sellouts, the National Stabilization Fund
After the short-term uncertainties clear up somewhat, however, the government should extract itself from the stock market as soon as possible and let the market adjust itself. Drawing a lesson from bitter experience, the structural factors that led to instability in the stock market must be thoroughly confronted.
If the four government funds and the Securities and Futures Commission (證期會) had not so forcefully shored up the stock market, the index perhaps would not have plunged to less than 6,000, down from the near-10,000 point peak at the time of the presidential election. While working day and night to salvage the stock market, the government officials would not have thought that all their efforts might become a signal for smart investors to sell on the good news and take their profits.
The securities market brings together the capital and wisdom of tens and thousands of investors. Even though sudden rises and falls are not uncommon in the market, very few people can make a correct decision on the spot. Otherwise, there would have been many more examples of investors getting rich at supersonic speed.
The government has no shortage of talented officials. Many of them know where stock prices should reasonably stand at any given time. Also, the higher their position, the more precisely they know. When the stock price does not fit what they believe to be reasonable, there must be some "irrational factors" interfering in the market. For the good of the country and the people, they must mobilize the four government funds and the National Stabilization Fund to make people regret their hasty sellouts. Also, those institutional investors who do not have a "correct understanding" of the market need to be educated and pursuaded -- with love -- and over a cup of coffee.
When investors are overly pessimistic about market prospects, those who want to sell their shares must pay the price, because when more people want to sell than buy, transaction values will certainly be low. If the prices fall to such an extent that selling no longer pays, those who initially want to sell may not do so any more. Even if they have to sell, they will sell the shares with a broken heart.
However, investors who have confidence in the market and do not hesitate to take risks will be able to buy at lower rates. Given more room for price hikes, they will get the profit they deserve for taking risks. Government intervention provides exactly the opposite incentives. When government funds buy shares with the intention of shoring up prices, they are prevented from falling to a level which investors generally think is reasonable.
Thus, investors with no confidence or foreign investors who want to withdraw their capital can sell out at relatively higher prices and saunter out of the market. Those who want to buy at low rates will also choose to hold out because the prices have not hit rock bottom. Because those who want to get out can dump their shares but no incentive exists for serious investors to buy, the market has nowhere else to go but down -- gradually. As the market's long slide intensifies the atmosphere of pessimism, the government funds once again have to increase the amounts to be thrown into the stock market, setting off another round of the vicious cycle.
In coordination with the stabilization measures, the SFC has spent a substantial amount on phone bills, calling institutional investors and talking them out of going against the government funds. During every struggle to keep the index above a psychological threshold, securities firms and investment trust companies always receive phone calls from SFC officials expressing concern. When official concern prevents an institutional investor from selling his shares according to his professional judgement, he or she will immediately deduce that other institutional investors must be facing similar situations, thereby arriving at the conclusion that the current market rates do not reflect reality.
It is said that when some institutional investors receive a phone call from an SFC official trying to dissuade them from a big sellout, everyone in the office will scramble to tell their friends and relatives to sell their shares. It is lamentable that all the pains taken by the authorities to boost the market actually serve as signals to take the opposite direction. However, individual investors, who make up 80 percent of the transaction volume, often do not understand the short-term nature of the market boost created by government measures.
Misled by government measures and rallying remarks from government officials, those who have no shares on hand valiantly jump into the market believing in the illusory rock bottom. Meanwhile, margin traders holding shares are unwilling to take losses and get out of the market, causing the individual investors to get stranded all the way from 9,000 to 8,000 to 7,000 points. As grief and anger continue to rise among the large number of misled investors, public confidence in the government has slid along with the stock market index.
The stock market level reflects how the investors view business prospects. It has no direct correlation with whether an enterprise can survive. More than 95 percent of businesses are not listed and therefore do not have floating stock prices. If we say that companies can only survive on reasonable stock prices, then most of Taiwan's businesses will go to the dogs.
The continuous lobbying by a few major industrial and commercial organizations -- pushing the government to pump in capital and salvage traditional industry stocks -- are mainly aimed at protecting the interests of major shareholders and their power to control. Through investment companies or their subsidiary companies, many conglomerates have acquired bank loans on stock hypothecation (using their shares as mortgage). Then they buy more shares with the loans and once again use those shares for more loans (rehyhpothecation). Some major shareholders have more than 90 percent of their shares mortgaged at the banks. When stock prices fall to a certain level, the banks must sell the mortgaged stock in order to guarantee credit. After the shares are sold, the shareholders lose their power to manage the company.
In recent years, there have been numerous examples of managers diverting their company's capital to shore up stock prices and, after they have exhausted their resources, collapsing along with the companies they manage. Currently, major shareholders have mortgaged several hundred billion NT dollars worth of stock at the banks. Once they are sold at low prices, a few traditional industry conglomerates will inevitably collapse, which in turn will have a massive impact on the financial market. The financial authorities should find ways to gradually prohibit or reduce stock mortgage percentages and delink stock market fluctuations from the financial risk of the businesses or their management.
Appropriate restrictions, however, should also be imposed on individual investors expanding their financial leverage through margin trading. This will prevent families going bankrupt on a stock market plunge and the resulting social problems. It will also prevent instability factors, whereby the financing institutions take major losses, sell en masse and trigger a stock market plunge.
The financial authorities should also rethink their policies' lopsided and unfair treatment of bulls and bears (eg, higher minimum margin percentages on shortselling than on margin buying, prohibiting short sales when the stock price is going down, etc). They must understand that when there is buying, there has to be selling. Sellers will also have to buy again later. Short-term excessive encouragement of buyers and suppression of sellers sows the seeds for a future plunge.
Attracting foreign capital and expanding the depth and breadth of Taiwan's stock market can help alleviate the impact of market capital being crowded out by new companies going public or the sale of government shares. To attract high-quality foreign investors, the government must respect market functions and minimize intervention. Any experienced fund manager knows better than to invest in companies whose major shareholders love to play with their own shares. Such shareholders are not able to concentrate on running their businesses and they can easily burn themselves by playing with fire.
If we draw a parallel between a country and a company, or between those in power and major shareholders, many foreign institutional investors openly prohibit investments in countries with excessive government intervention. If we want to internationalize, we must abide by the rules of the international game.
Looking at the prospects of the new Cabinet, we can see many uncertainties on the political side. But as long as it makes no major mistakes in financial and economic policies, Taiwan's economic and stock market prospects are not necessarily wholly bad. After all, in their past endeavors, the Taiwanese people and businesses have relied more on themselves than on the government. What the government needs to do is look around the world and see which developed countries have been successful because of smart government. It would have been very difficult for countries like Japan and South Korea -- with their hard-working and outstanding people -- to sink into the economic quagmires they are in today, but for senseless government intervention in their financial systems.
Apart from the stock market, the new Cabinet should also handle the banking system very carefully. It should be wary about postponing problems or adopting short-term solutions. The government should focus its energy on an overall re-evaluation of the financial system and building a solid foundation for industrial development.
The new government must build a solid financial system for Taiwan in the 21st Century, eliminating the source of chaos -- government intervention -- with courage, a sense of shame and an understanding of the malady. Then, who will be able to call a minority government incompetent?
Chiu Shean-bii is a professor at the department of finance of the National Taiwan University.
Translated by Francis Huang
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