♠ Posted by Emmanuel in Credit Crisis,Europe
at 9/14/2011 08:08:00 AM
American author Robert Fulghum catapulted himself into global fame in the Eighties via All I Really Need to Know I Learned in Kindergarten. This book illustrated core principles that he argued held in all walks of life that grown-ups often tried to rationalize away to avoid. Rummaging through the web for course material, I came across an Asian-financial crisis era work from 1998 (I figuratively blow dust off its virtual cover--fffffff) by IIE stalwart Morris Goldstein. As we are now being bombarded by news of crises arrived and impending in Western Europe and North America, let us pause and reflect on how the important lessons from the Asian financial crisis that Goldstein identified are applicable to the present time. In Fulghum-esque terms, All I Really Need to Know About Modern Financial Crises I Learned in 1997-1998.I do not need to rehearse the boilerplate excuses: Us rich countries set the rules and you follow them; we issue reserve currencies; we have an exorbitant privilege; we are leaders and not followers of globalization and so forth. Well, not quite. Reviewing the concluding part of Goldstein's scribblings, you get a distinct sense of deja vu. That is, had the rich countries taken heed of the general antecedents--not merely symptoms--of modern financial crises, perhaps they wouldn't be in such a wretched state. For your convenience, here are Goldstein's concluding top 10 list of lessons learned and some commentary:
1. Leaving reform of the financial sector and of the prudential/supervisory framework too late in the economic development process is a bad idea--even when the country's macroeconomic-policy record and growth performance place it in the first division of emerging economies. When the financial markets finally discover the true (sorry) state of balance sheets in the financial sector, the cost (in terms of both reduced growth and the fiscal costs of recapitalizing the banking system) can be enormous.
So true. By developed country standards, US economic growth post 9/11 was quite healthy by OECD standards--but look at the rottenness it propagated and masked in bank's balance sheets, clogged as they were by assets of dubious quality. And I certainly am not convinced that dumping these assets onto that of the central bank (the Fed) is much of an improvement.
2. The composition of foreign borrowing deserves as much attention as the overall debt burden...The original saving obtained from shortening the maturity and denominating external debt in foreign currency is likely to be swamped by the ultimate price paid if rollover and currency risk ignite a successful speculative attack.
This proviso is an interesting one when it comes to Europe and is perhaps less applicable. Still, is the euro *really* the currency of troubled PIGS countries? The ECB keeps open a facility by which sovereign issues from troubled countries can be exchanged for euros, allowing them breathing room. However, private borrowers who took advantage of, say, French and German banks setting up shop in Eastern/Southern Europe certainly are not untroubled by these financial institutions from abroad being subjected to questions about mounting bad loans. When in doubt, they will tighten screws on international borrowers who originally took out debt on significantly more favourable (pre-crisis) terms.
3. Rapid expansion of bank and nonbank credit (far in excess of the growth of the real economy), cum high concentration of credit to the real estate and equity markets, is almost always a harbinger of trouble, in developing and industrial countries alike. The risk is multiplied when lenders don't do careful analysis of creditworthiness (taking property as collateral instead) and when high loan-to-valuation rations and low bank capital don't provide much of a cushion when the credit cycle turns south.
This part accurately describes rapid financialization unaccompanied by economic growth in the real economy of most of the PIGS countries--Goldstein did point out the LDCs alone weren't a class by themselves here, unfortunately for the West. The basic workings of the "ownership society" subprime fiasco are also accurately described but made worse in the absence of meaningful collateral.
4. Large current-account deficits that are used to finance investment may render economies less vulnerable to speculative attacks than those used almost exclusively to finance a boom in consumption...
Well put. A boom in consumption funded by sizeable current account deficits did occur in both troubled Europe and the US. The latter, of course, has done little to close its external gap. I would naturally argue that failing to do so has led the US to stumbling from crisis (in 2008/09) to crisis (stagnant to declining growth since then likely giving way to another outright recession in the near future). It goes to the crux of the "deficits don't matter"/"exorbitant privilege" arguments debates. If you follow this line of reasoning, they are rather poor excuses that contribute to the continuation of suboptimal economic outcomes. Exhibit A: modern America.
5. Efforts to promote financial and capital account liberalization without first strengthening the prudential framework--such as the ill-fated Bangkok International Banking Facility in Thailand--are a recipe for disaster.
To be fair to troubled European countries, some of the responsibility EU bureaucrats were supposed to take up with their better institutional capacity in this respect simply wasn't. As international banks set up shop, the foibles of excessive credit growth in these economies was not made into an issue until the fortitude of EU integration was put to the test. Distinguishing the creditworthiness of Portugal in itself as opposed to being in the EMU came later in the game, allowing much to be swept under the carpet for the longest time as EU watchdogs fell asleep at the switch.
6. Long-standing weaknesses in the economy that lenders seemingly ignored for long periods of time can take on a different character in the midst of crises elsewhere in the region. Once the process of contagion begins, it takes bold and determined defensive and reform measures to stem the tide in individual countries--especially if a lack of transparency and disclosure make it difficult for investors to differentiate weak from strong firms.
In a nutshell, this phenomenon is happening with French banks now being affected over Greece. What is the true state of their balance sheets now? It is certainly not easy for external observers to ascertain under the fog of crisis, and there is definitely a pronounced feedback effect. Witness the major moves these banks are making to shore up matters.
7. Overshooting of exchange rates and equity prices can be much larger than we though in an atmosphere of political instability, uncertainty about reform, and wide-ranging contagion.
Remember the Dow Jones Industrial Average falling below 7000 in 2009? What's to stop it and other indices making similar swoons soon?
8. It's much tougher to battle your way out of a crisis when the region's largest economy is struggling with its own macroeconomic, financial, and exchange rate problems (Japan) than when (as in Mexico's case) that regional hub (the United States) is in good overall shape.
Fascinating: Japan was well into the doldrums when the Asian financial crisis hit. But now us Asians have a new sheriff in East Asia which is comparatively free from such problems heading into a new global slowdown in China. (It replaced Japan as the world's second largest economy and hence our region's largest in 2010.) Meanwhile in Europe, Germany has come to a virtual standstill and this situation may have significant knock-on effects for the rest. Let's see how this turns out, but I think the logic illustrated here is reasonable.
9. The distinction that was drawn after the Mexican peso crisis between sovereign debt and private debt has turned out to be not nearly so neat and tidy. When much of the banking system becomes insolvent, debt that starts out it the private sector doesn't stay there long...
In the end, the home country has little choice but to intervene when things go awry in its domestic financial system, thus burdening the public with private woes in addition to whatever else existed before. Witness Ireland guaranteeing private lenders when the state did not fully realize the obligations involved in doing so. Or, think again of the US government being saddled with housing-related assets of extremely dubious quality while trying to relieve pressure from troubled banks. (The funny thing is that Uncle Sam is now seeking damages as it were when it deliberately set itself up to be duped.)
10. There's nothing like a major crisis to focus people's minds on why it is important to improve the international financial architecture...
My general intuition is that the international financial architecture is shaped by financial flows. That is, the likes of Basel III are reactive, not proactive measures which do not necessarily get to the heart of the matter: wayward patterns of capital movement have deeper underlying causes than what can be addressed by simply arguing for [more, better] regulation. Why do some people save too much while others spend too much? As G20 talks have demonstrated, we have not even gotten past the process of apportioning blame between surplus and deficit countries, let alone developed a pan-global way of mitigating such imbalances.
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They say that those who don't learn from history are doomed to repeat it. From my standpoint, Asia learned from its crisis, but the West didn't [1, 2] due in no small part to its arrogance. Had the abovementioned warning signs deduced from the Asian crisis been heeded, would the West be in such bad shape? (Dig TIME's somewhat hyperbolic recent cover and all.) While this question is not one I have to directly contend with, it certainly does affect the course of the global political economy.
