Wednesday, 14 January 2009

Someone else's meltdown

As the new year begins and further stories of economic downturn abound it is interesting to take stock of the 1997 Asian Financial Crisis and how the world's reaction has differed to today's problems.

South Korea is an excellent case in point. The stock exchange fell by 11% over two days. This is certainly of a similar magnitude to the falls felt by the FTSE this year. The solution proposed for South Korea and the other affected countries (Indonesia & Thailand being especially hit) was very simple: allow insolvent banks and financial institutions to fail.

This stands in stark contrast to the principles applied in the UK and the US. Insolvent bank after insolvent bank has been propped up by the state. From companies that were unheard of to the average UK household twelve months ago (Lehman Brothers) to firms that were seen as bread and butter British institutions (HBOS, Lloyds TSB) public money was showered on banks. After Northern Rock, which itself was nationalised a little less than a year ago, no bank was to be allowed to fail - the government effectively underwrote all deposits, although the nominal government limit was £50,000.

Interest rates offer another sharp contrast. On January 8th 2008 the Bank of England cut interest rates to a record low. Cho and West provide a fascinating study of the efficacy of this policy, but for those who do not wish to examine page 11 interest rates about 10% were common in South Korea, Philippines and Thailand , and above 20% more frequent than one might hope. This rather contrasts with the 1.5% in the UK. As an International Monetary Fund (IMF) press release notes, "Interest rates will be kept high for some time".

The South East Asian crisis was not the same as the current crisis. Many countries had currencies pegged (that is fixed in value) to the US dollar, but structural weaknesses made it increasingly hard for states to maintain this pegging, and when released the currencies fell sharply. There is some logic in increasing interest rates (and thus making owning the currency more enviable) to counter a currency devaluation.

However, one cannot help but feel that what was prescribed for Johnny Foreigner with some gusto by the IMF is not what is being required of today those who, in 1997, were most vocal in setting the direction for the South East Asian economies. The striking difference in the philosophy of what do do with 'bad' banks amply underlines this point. While it was, supposedly, the prudent course of action to allow them to fail in South East Asia, they are, it is reported, 'Too Big to Fail' when they occur a little closer to home.

Perhaps it will be the South Koreans who, having been treated like naughty children, have the last laugh. South Korea's economy, and remarkably Thailand's given its appalling governmental troubles, have been strong since the crisis. Both have suffered in the current downturn, but it is entirely possible that the western contemporary edict requiring massive debt to be accepted, large bail outs provided to failing industries and the protection of almost any bank will not work as effectively. Countries that set the agenda for the South East Asian crisis may yet wish they had listened a little more carefully to their own advice.

1 comment:

Andrew said...

While it might be hypocritical, perhaps the scale of the banks plays an important part. I don't imagine that even the largest of the banks in Thailand was anywhere near the size of the banks that have been bailed out here. Additionally, the consequences of Lehman's bankruptcy are still unknown. For example funds which used Lehman's as an administrator still have assets tied up which they can do nothing with. The accounting firm who are in charge of sorting the whole mess out can choose to declare that all unsettled trades are void (i.e. you get cash back), that all unsettled trades are settled (you get the assets you tried to buy), or they can even cherry pick the trades to say that any trades that were beneficial to Lehman's stand, and any that weren't are cancelled. A decision still hasn't been made so there are thousands of funds who don't know what's happening to their assets. This could easily bankrupt these funds if they'd been unlucky enough that shares they had tried to sell (and got caught in the settlement cycle) have since fallen in value. Additionally the more banks that are allowed to fail, the jumpier investors will get, if there's even a hint that UBS (say) might be in trouble then clients will be much more likely to switch to a different counterparty increasing the chance of UBS failing. I think these are part of the reasons that these banks are considered more of a systemic risk. A Thai bank failing would have had much smaller consequences for their counterparties.