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Are Financial Crisis Inevitable? |
| By Bryce Meeker, F’04 (bryce.meeker@tufts.edu) Financial crisis have become a reoccurring epidemic among developing countries throughout the 1980s and 90s. Reoccurring patterns in financial crisis have fueled controversy over their causes and incited speculation over the ability of governments in developing countries to avoid bankruptcy. In a fast moving global economy with few rules governing the financial markets combined with such a variety of macro-economic means to manage an economy, who is truly to blame? Even institutions such as the International Monetary Fund (IMF), which has functioned as a bailout mechanism, may have simply escalated the magnitude of the crisis, causing more harm than good. This was the topic in a recent presentation and lively exchange with students by Dr. Arturo Porzecanski, Managing Director and Head of Emerging Markets Economics & Debt Strategy of ABN AMRO Inc. His September 20th visit to Fletcher was sponsored by the International Business Relations Program Global Speaker Series (http://www.fletcher.tufts.edu/ibr/gss/speakerseries2003.htm). According to Dr. Porzecanski; “Globalization is part of the answer.” Throughout the 20th century, the monetary system shifted from the gold standard, to the Bretton Woods system of pegged currencies of the US dollar, to the hap hazardous transition to a free floating exchange system and has left many economists, as well as governments, in the dark. “Leading currencies floated in the early 1970s and economists should have advised all countries to float as well. Their failure to move rapidly sowed seeds for crisis in the 1980s and 90s. Distortion created by governments is the root cause” argues Dr. Porzecanski. The crisis being a product of the environment following the breakup of the Bretton Woods system does carry weight, especially given the lack of experience even developed countries had with the free floating market in the 1970s. However, the mechanism for bailouts introduced by the G-7 countries and implemented by the IMF has played a distinctive role in defining the rules of the game. “The prescription seemed to be that countries with crisis went to the IMF and had to institute more flexible regimes to receive support” said Dr. Porzecanski. “This support often included the forgiveness of loans in the 1980s.” This practice gave incentives for governments to institute macro-economic reforms prescribed by the IMF, but clearly crisis continued to develop in numerous countries throughout the 1990s and only continued to escalate in magnitude. In the mid 1990s, “a $50 billion package was put together for Mexico. They avoided a debt crisis which was viewed by the IMF as a success, even though the economy still collapsed” said Dr. Porzecanski. This “umbrella” created a moral hazard because it had begun to effect investor behavior in an adverse, non-competitive way. The IMF realized this inherent flaw and vowed to cut back packages. However, their actions proved otherwise and the bailouts became larger. As a proposed solution to this escalating distortion, Dr. Porzecanski suggests; “The IMF should go back to a rule based approach: if you have a problem, you know what you can get.” Returning to a policy where the bailout packages given by IMF are more predictable may reduce the escalation of the crisis, but will it offer a sufficient cure? Answering this question leads back to the initial question; is the environment solely responsible for the cause of such crisis? The thriving economies known as the “East Asian Tigers” have sought out highly controlled currencies throughout the entire 1970s, 1980s and, to a lesser degree, the 1990s. The net effect of having a high degree of control over exchange rates, investments, imports and exports combined with the rapid economic growth of countries like Japan, South Korea, Taiwan and Singapore continues to be a topic debated by development economists. Such examples of developing economies that have thrived despite the controlled nature of their currencies and other macro-economic factors may indicate other factors than the environment play a role in the susceptibility of a country to a financial crisis. Arguably the credibility of governments and companies operating in developing countries to act as credible borrowers and to enforce continuity in exchange rate and investment policies would be ideal, whether the rates are fixed or floating. Likewise, the lending banks ideally should take such inherent risk factors into account and weigh them accordingly to the return. Attempts of some international banks to exploit markets of imperfect information through packaging syndicated loans has damaged many countries’ economies by issuing massive loans that had little likelihood of repayment, backed only by a guarantee from the receiving government. An industry wide policy of continuously re-bundling of the loans escalated to a point where it was perceived that the practice was too big to fail. Knowledge of having an established bailout mechanism such as the IMF acted as a risk subsidy because banks knew they would be bailed out. Though markets are never ideal and “perfect information” has yet to be achieved even in developed markets, improvements in practices on both parties could diminish the need for bailout mechanisms such as the IMF. The ultimate responsibility of lending practices lies with both parties: the lender and the borrower. Unfortunately, the burden is still bore by the developing economies since they are left with the tarnish of having defaulted on their loans and massive debts that continue to drain their economic resources. |
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