Document Sample
        OF THE LATE 90S


                 Bank I - VI

   Institut für schweizerisches Bankwesen

             Universität Zürich

              Dr. H.-U. Doerig

       Teodoro Cocca, lic. oec. publ.
            Patrick Lutenauer


                 Igor Kos
             Theresa Supremo

                 Mai 1999

What caused the financial crisis in Asia? How did it come to be that the instability of
the Thai baht in July 1997 led to a series of haywire situations in various countries in
Asia? What happened in Russia? In Brazil?

It is undeniable that the real consequences of the globalization trend, which as
already observed by some economists in the 1980s, has not yet been fully grasped.
We bear now the consequences of this lack of knowledge on the breadth and depth
of the interdependence of financial markets and the mobility of international capital

Identifying the roots of the crisis of the late 1990s is however a difficult task. Various
opinions, complementary or contrary to each other, have been said on the matter. If
such is the case, the proposition of solutions faces equally the same difficulty. In
order to lay down appropriate solutions to prevent the onslaught of another crisis, the
facts have to be looked into and the various symptoms of the financial crisis could be
thereafter given the corresponding dosage of medication.

1.1 Statement of the Problem
Who is right on the different issues behind the international financial crisis? Facts
have to threshed out so as to go into the crux of the matter. Undebatable facts will
help shed light on the appropriateness of the propositions of the International
Monetary Fund (IMF), the Institute of International Finance (IIF), the Group of 7
nations (G7), etc.

Thus, the general characteristics of the crisis and the various analyses on the causes
of the crisis raised by well-known economists and institutions ought to be looked into.
This will serve as a guiding light in the appraisal of the set of solutions that have
been raised in line with the goal of improving the international financial architecture.

1.2 Objectives of the Study

A general picture of the Asian financial crisis will be drawn based on news reports
and analyses of various economists and institutions. After a look at the data, the
main points recognized as the causes of the crisis will be summarized. The next
chapter will make an attempt to summarize the propositions raised to improve the
global financial architecture. This will be followed by an appraisal.

1.3 Methodology

The key results of an existing study on the facts behind the stock price movements in
Japan and Thailand will be presented. This study takes its facts from various reports
of the Financial Times, Wall Street Journal, Neue Zürcher Zeitung, Nikkei Net, and
The Nation Multimedia Group. The comments of Radelet and Sachs, Krugman, the
IMF, etc. on the same facts will thereafter be quoted. What follows is a summary of
the propositions towards improving the international financial architecture taken from
released documents. This will be followed by a diagnosis-based assessment.


2.1 The Observable Facts Behind Stock Price Movements
A number of indicators can be observed in order to weigh the degree of instability in
Asia. One can take a look at movements of equity prices, bond rates and exchange
rates. And a look at the reasons behind the upward and downward swings would
give us a factual basis for hypotheses on the causes of the crisis.

A documentation covering the months of July 1997, the month in which Thailand
freed the baht from its dollar peg, up to March 1998 was made on the reasons
behind equity price fluctuations in Japan and Thailand. The focus was put on the
movements of the Nikkei 225 index and the Stock Exchange of Thailand (SET)

The results show that the major factors behind the up-and-down swings of the Nikkei
Index were macroeconomic concerns (uncertainties, bleak reports, etc.), the
imposition of new government measures, the announcement of bankruptcies, and
stock market events in the neighboring countries and in Wall Street. On the other
hand, the factors behind the volatility of stock prices in Thailand were the baht
movements, the weakness of the financial sector, the events in the stock markets of
the rest of Asia and political chaos within Thailand itself. 1

In Japan, rumors of income tax cuts for example sent the market soaring at one
point, and the disappointment over the actual released measures sent the market
reeling at another point. One of the upward leaps was caused by a Wall Street rally,
but was then followed by a plunge the very next day as Hong Kong crashed. The
see-saw movements could also be witnessed at another point in November 1998:
Whether the government would intend to use or not to use public money to aid the
financial sector was closely watched. As initial rumors about the injection of public
funds into the market was heard, the stock market soared. It however immediately
sunk as the other way around was declared. In fact, on the day that the prime
minister took back his words over the government’s readiness to aid the financial
sector through the injection of public funds, the market suffered the steepest single-
session decline of the year.

In Thailand, the big calendar event was of course the 2nd of July, the unpegging of
the baht. The baht declined 17%, and investors flooded the bourse and lifted the
index up by more than 7%. In the next two days, the stock market continued to climb
and went up by 25% as a whole. The next three weeks however were drives
downhill. A tug-of-war between profit-takers and bargain-hunters took place. Under
this atmosphere, mounting worries over foreign exchange losses loomed. The
downward falls of the SET index were parallel to the baht’s weakening. If ever it went
up, it was because of hopes raised by news of an IMF bail-out or the idea that the
rumors on collapsing banks were unfounded. For the rest of the periods covered by

    Supremo, T. (1998): The Asian Financial Crisis: Facts and Fantasies, pp. 106-110.

the study, persisting worries mainly caused the souring up of the market , whereas
positive local and regional news, as well as the stabilization of the baht, brought
some turn-arounds.

See the appendix for more details on the documentation.

2.2 The Various Analyses on the Causes of the Crisis
After looking into fluctuations in the market and the reported underlying causes, it is
of interest to put them side by side with the varying opinion on the matter. A
validation of the comments can then be made based on the known facts. The
following are some comments of various economists and institutions on the causes
of the crisis:

2.2.1 The IMF: A Combination of Factors

The major factors leading to a marked drop in Japanese equity prices and
government bond yields were: a) the deterioration in economic performance, b)
concerns about the impact of the financial turmoil elsewhere in Asia on Japan, and c)
doubts about the health of Japan’s financial sector, with failures of security firms in
the background. In addition, uncertainties about the use of public funds for financial
sector restructuring led to considerable volatility in the stock market.

In the case of Thailand, the dominant factors were: a) the failure to dampen
overheating pressures in large external deficits and property and stock market
bubbles, b) the maintenance for too long of a pegged exchange rate, and c) lax
prudential rules and financial oversight. All of these led to repeated attacks on the
baht and subsequently, on other currencies in the region. As the crisis unfolded,
political uncertainties and doubts about the authorities’ commitments and the ability
to implement the necessary adjustments and reforms exacerbated pressure on
currencies and stock markets both in Asia and other emerging market countries. 2

A subsequent speech delivered by Shigemitsu Sugisaki, Deputy Managing Director
of the IMF, in May 14, 1999 likewise gave importance on several factors behind the
Asian crisis which are: the interaction of a) macroeconomic imbalances, b)
fundamental structural problems, and c) shortcomings in the international financial
system. The macroeconomic imbalances were reflected in rising and unsustainable
external current account deficits and a build-up of external debt (short-term debt in
particular) which were linked to the maintenance of exchange rate pegs. Structural
problems were mirrored in the weaknesses of financial institutions. Moreover,
insufficient bank supervision, non-transparent relationships among government,
banks and corporations were among the deep-seated problems. Corporate debt also
became a particular problem when exchange rates tumbled because of the enlarged
dollar debt. Several of the countries experienced volatility in prices and sudden
market movements that ultimately precipitated a crisis. And what made the crisis
different from previous ones were the financial speed and size of capital flow

    IMF Staff (1998):, “Financial Crises: Causes and Indicators“, in: World Economic Outlook.

reversals that occurred once the vulnerabilities were revealed, which is indicative of a
deficiency in creditors’ risk assessment.

2.2.2 Krugman (Massachusetts Institute of Technology): A Bubble

Krugman stresses that the currency crises were only a part of a broader financial
crisis, which had very little to do with currencies or even monetary issues per se. The
Asian story for him is really about a bubble of asset values, which subsequently
collapsed. The currency crises were therefore more symptoms rather than causes of
the malady.4

2.2.3 Schwartz (National Bureau of Economic Research): Domestic Problems

Schwartz denies the phenomenon of contagion in the Asian debacle. Stock market
declines have just simply matched the currency declines. It was not contagion from
Thailand that made the countries vulnerable to a financial crisis. They were
vulnerable because of their home-grown economic problems. Capital flight from
countries with similar unsustainable policies is not an evidence of contagion. And
currency crises, according to her, occur when internal economic conditions --
unsound monetary and fiscal policies -- are incompatible with external conditions set
for the currency.5

2.2.4 Rubin (Treasury Secretary, US Government): No single, simple cause

Rubin claims that the crisis did not have a single, simple cause. Weak policies and
institutions in many developing countries and an inadequate focus on risk on the part
of banks and investors in industrial countries combined together to produce
vulnerabilities in these economies. It was this combination that led ultimately to the
abrupt collapse in confidence that spread throughout Asia and other emerging
economies. After confidence was lost, investors who had previously extended
excessive credit to developing countries overreacted in the opposite direction and
began to pull out of developing countries indiscriminately. 6

2.2.5 Radelet and Sachs (Harvard): Financial Panic

Radelet and Sachs of the Harvard Institute of International Development set up
categories of crises and analyzed the Asian financial crisis according to its
symptoms. Among the possibilities included a) a macroeconomic policy-induced
crisis, b) financial panic, c) bubble collapse, d) a moral-hazard crisis, or e) a
disorderly work-out.7

Based on their analysis, at the core of the crisis were inflows of large-scale foreign
capital into financial systems that became vulnerable to panic. While there were

  Sugisaki (1999): The Reform of Global Exchange and Financial Systems Since the Eruption of the Asian
Crisis, p. 1.
  Krugman (1998): What Happened to Asia?
  Schwartz (1998): “International Financial Crises: Myths and Realities”, in: The Cato Journal.
  Rubin (1999): ”Treasury Secretary Robert E. Rubin Remarks on Reform of the International Financial
Architecture to the School of Advanced International Studies”, in: Treasury News, Office of Public Affairs, pp.
  See Appendix for details.

significant underlying problems and weak fundamentals besetting the Asian
economies at both a macroeconomic and microeconomic level, the imbalances were
not severe enough to warrant a financial crisis. A combination of panic on the part of
the international investor community, policy mistakes at the onset of the crisis by
Asian governments and poorly designed international rescue programs turned the
withdrawal of foreign capital into a full-fledged financial panic.8 Net private capital
inflows from private creditors (commercial banks plus non-bank creditors, such as
bondholders) into the five most affected Asian economies (South Korea, Indonesia,
Thailand, Malaysia and the Philippines) dropped from $97.1 billion in 1996 to $12
billion in 1997. Net private capital outflows in the latter half of 1997 totaled $11.9
billion. This turnaround of $109 billion in one year (actually just six months) is
equivalent to about 10% of the pre-crisis Gross Domestic Product of these five

One reason that such a large amount of capital was able to leave so quickly was that
a substantial portion was structured with very short-term maturities. In each of the
severely-hit economies, short-term foreign exchange liabilities grew in excess of
short-term foreign exchange assets, leaving the economy vulnerable to liquidity
problems in the event of a sudden withdrawal of foreign capital. Presumably, foreign
lenders (mainly banks) had made short-term loans under the assumption that they
would routinely roll over such loans in the future. But they pulled these loans abruptly
in the second half of 1997. 9

2.3 What Really Caused the Asian Crisis?
On the basis of the observable facts and the different analyses of the scenario, the
cause of the internationally spread crisis can be summarized to be mainly financial
panic: the rapid reversal of capital inflows, which became subject to contagion. That
can however be not singled out as the only simple cause. There are underlying
elements, which are conditions for the crisis but do not cause the crisis, and
stimulators, which are factors that promote and aggravate a crisis, but in themselves
do not necessarily lead to a global quagmire.

Among the underlying elements is for instance the increased global capital mobility.
The increased number of risky ventures or trade instruments is another. They in
themselves do not cause a crisis, but condition it. Concretely, global capital flows are
beneficial for economic growth considerations. Capital controls that keep capital in
industrial countries from flowing to developing countries inhibit the optimal use of
capital in time.10 Capital hence ought to be mobile and investable in various regions.
However, due to capital mobility, a sudden, sharp reverse in capital flows is possible
once the opinion of the investors as to the investment climate changes. Capital
mobility here in itself is not the cause of the capital flight, but without its prior
existence, capital could not have freely flown at all.

Among the stimulators of the crisis are inappropriate government policies, the lack of
administrative oversight on macroeconomic and microeconomic fundamentals, and

  Radelet and Sachs (1998): The Onset of the East Asian Financial Crisis.
  Radelet and Sachs (1999): What Have We Learned, So Far, From the East Asian Financial Crisis?
   De Long (1999): Preparing for International Capital Flows, and Volcker (1999): Emerging Economies
Navigating in a Sea of Global Finance.

the large number of poorly planned investments not only by the government but by
various financial institutions, which is indicative of poor risk management. Such
factors indeed penalize liquidity and promote and aggravate a crisis. Their existence
however does not necessarily lead to an internationally woven financial plight. The
Philippines for instance could have a steady budget deficit, a low savings rate or
whatever may it be, but such poor economic figures do not necessarily induce a
capital flight out of its neighbor, Indonesia.

The financial crisis was indeed rooted in the sudden shift of international investors’
opinion. Irrational panic ruled the mob and made the markets tumble.


3.1 Improving the International Financial Architecture
The occurrence of the Asian crisis and the subsequent developments in Russia and
Brazil indicates clearly that the international financial architecture needs to be looked
into. The analyses and insights on the causes of the crisis in this case are important,
so that existing problems could be addressed. Table 1 shows a summary of the
proposals raised by the IMF, the Institute of International Finance (IIF) and the Group
of 7 Nations (G7) towards improving the international financial architecture:

TABLE 1. Summary of the Proposals Raised by the IMF, IIF and the Group of 7 Nations

              Supranational Sector             Private Sector                  Public Sector
  Reform         International                   Institute of               Group of 7 Nations
 Proposal:      Monetary Fund              International Finance
IMF           * provision of contingent                                   * an enhanced IMF facility
              lines of credit                                             to provide a precautionary
              (increase quotas, enforce                                   line of credit that could be
tionary       the New Arrangements to                                     drawn if needed by
credit line   Borrow, allow Special                                       countries pursuing strong
              Drawing Rights)                                             IMF-approved policies
IMF           * lend into arrears to       * no lending into arrears to   * changes in lending
              support adjustment           private creditors, except in   policies, terms of lending
              measures during debt         exceptional circumstances, and improved conditionality
policy        negotiations (case-to-case   when there is support from a * lending into arrears on a
              basis), stays on creditor    broad majority of private      case to case basis
              litigation                   creditors
Private       * expand IMF dialogue        * special programs for         * “collective action clause”:
              with the private sector      stronger relations between     private sector bilateral
              * commercial contingent      governments of emerging        financing (with the IMF) on
              lines of credit              market economies with          a case to case basis
              * organize creditor-debtor   private sector investors and * develop market-based
              councils                     lenders: regular and           contingent financing
                                           comprehensive consultation mechanisms to provide
                                           to build familiarity and trust either greater payments
                                           * more active use of           flexibility or the assurance

                                            contingent lines of private     of new financing in the
                                            sector credit                   event of adverse market
World                                                                       * a World Bank emergency
                                                                            facility to support
                                                                            vulnerable groups and to
emer-                                                                       support financial sector
gency                                                                       restructuring and private
facility                                                                    flows catalization
Action in     * develop an early warning    * intensive consultations       * measures to ensure the
              system: empirical models      with investors and creditors    orderly and cooperative
the wake
              to predict balance of         at times of weakening           resolution of future crises,
of a crisis   payments crises               market confidence               in particular mechanisms to
              * encourage countries to                                      involve the private sector
              consider changes in the                                       * new ways to prevent and
              terms of foreign sovereign                                    respond to crises, including
              bond contracts to speed                                       new forms of official
              the negotiation process                                       finance
            Supranational Sector            Private Sector                Public Sector
  Reform         International                Institute of            Group of 7 Nations
 Proposal:      Monetary Fund          International Finance
Surveil-   * integrate the use of     * regular market surveillance * establish a process of
           international standards in of emerging market            surveillance of the
              IMF surveillance, improve     economies that                  international financial
              systems for monitoring        complements the IMF             system by national and
              short-term external debt      surveillance                    international regulatory and
              (comprehensive reporting                                      supervisory experts
              on the capital account)                                       * IMF: to monitor the
              * joint monitoring of the                                     implementation of codes
              IMF and the World Bank                                        and standards as part of its
              * improve financial market                                    regular surveillance.
              supervision, focus on the
              linkages between
              macroeconomic policies
              and banking system
              * improve the quality of
              banking supervision
              internationally (compliance
              with the Basle Core
              Principles for Effective
              Bank Supervision)
Improved      * embed call options in       * private financial             * regulation of financial
              interbank loan agreements     institutions: strengthen risk   institutions in industrial
                                            management processes;           countries to promote safe
manage-                                     more timely and meaningful      and sustainable capital
ment                                        economic data for sound         flows, encouraging sound
                                            risk assessment                 analysis and better risk
                                            * improvement through           assessment. Examination
                                            increased transparency of       of the implications of
                                            both counterparty firms and     operations of highly
                                            governments; improvement        leveraged and offshore
                                            in collateral management        institutions, with a view of
                                            * increase stress testing and   encouraging offshore
                                            scenario analysis in value-     centers to comply with
                                            at-risk analysis, implement     internationally agreed
                                            more advanced credit risk       standards.
                                            assessment systems and
                                            better integrate their credit
                                            and market risk analysis

Insolven-                                                                     * the World Bank, the IMF
                                                                              and other multilateral
cy and
                                                                              development banks should
debtor-                                                                       work to put in place
creditor                                                                      effective insolvency and
regimes                                                                       debtor-creditor regimes

          Supranational Sector           Private Sector               Public Sector
  Reform       International               Institute of           Group of 7 Nations
 Proposal    Monetary Fund          International Finance
Transpa- * private sector:        * public sector: detailed     * public sector: economic
          disclosure requirements reporting on reserves (weekly policy-making and
              (including offshore           data, composition and             economic statistics and
              financial centers, non-       disposition, other foreign        key indicators (IMF Code
              bank financial institutions   currency held, potential          of Good Practices on
              and for transactions          drains), capital movements,       Fiscal Transparency, Code
              involving highly leveraged    bank deposits, holdings of        of Conduct on Monetary
              institutions)                 securities and derivatives        and Financial Policy,
              * More information on         * private sector: better data     foreign exchange liquidity
              IMF surveillance of           from private financial            position, SDDS)
              member countries,             institutions lending and          * private sector: examine
              programs of economic          investing in emerging markets     the question of appropriate
              reform and adjustment,        * greater transparency at the     transparency and
              analyses of policy issues,    IMF (country situations,          disclosure standards for
              IMF finances, IMF policy      repayment schedules on            private sector financial
              evaluation, disclosure of     borrowings, publication of        institutions involved in
              highly leveraged              Article IV)                       international capital flows,
              institutions that they        * timeliness, coverage and        such as investment banks,
              supervise and regulate        relevance of BIS data on          hedge funds and other
              * implement the “Code of      international lending (not only   institutional investors
              Good Practices on Fiscal      commercial banks; include         * Transparency Report of
              Transparency “, create a      investment banks, mutual          IMF surveillance
              code of good practices        funds, pension companies,
              on transparency in            hedge funds and other asset
              monetary and financial        holders
Standards     * strengthen the Special      * implement the “Core             * strengthen financial
              Data Dissemination            Principles” of the Basle          systems and find better
              Standard (SDDS)               Committee on Banking              ways to motivate countries
emerging      * develop standards           Supervision                       to adopt international
markets       relevant for the                                                standards
              functioning of financial                                        * code of principles of
              systems, including on                                           sound corporate
              accounting and auditing,                                        governance and structure
              bankruptcy, corporate                                           (OECD, World Bank and
              governance, insurance                                           other regulatory bodies),
              regulations, payment and                                        internationally agreed
              settlement systems, and                                         acctg. standards (IOSCO,
              securities market                                               IAIS, Basle Committee)
Exchange      * assess measures                                               * a sustainable exchange
              related to exchange rate                                        rate regime in emerging
rate policy
              arrangements                                                    markets backed by
                                                                              macroeconomic policies
                                                                              that promote stability

              Supranational Sector               Private Sector                   Public Sector
 Reform          International                     Institute of                Group of 7 Nations
Proposal:       Monetary Fund                International Finance

Capital           * consider capital         * no capital control (temporary
                  controls, and how to       price-based disincentives to
                  achieve orderly            short-term capital inflows
                  liberalization             allowed, but these don’t
                                             substitute fiscal, monetary and
                                             exchange rate policies)
Govern-           * raise the cost of short- * limit vulnerability to high
                  term cross-border capital short-term external debt;
                  flows                      remove distortions that
policy on                                    discriminate in favor of short-
external                                     term borrowing, including
debt                                         obstacles to long-term
                                             borrowing and to direct foreign
Social            * social safety nets to                                        * general principles of good
                  complement the reform                                          practice to protect
                  of the international                                           vulnerable groups
                  financial system                                               * assess proposals of the
                                                                                 IMF in this regard, and
                                                                                 strengthen the Interim and
                                                                                 Development Committees
                                                                                 of the IMF and World Bank

Note that the reform proposals are basically geared at increasing transparency,
improving surveillance, heightening the involvement of the private sector and
enforcing standards within the financial system. The IMF, IIF and the finance
ministers and central bank governors of the G7 are all amenable to more or less the
same changes or improvements so as to strengthen and stabilize the international
financial system.

Where they differ is on the issue of the IMF’s lending policy. The difference is
however narrow. Both the IMF and G7 opt for lending into arrears; the IIF does not
wish that, although allows it in exceptional circumstances, which in the end comes to
the same thing – a case-to-case basis. The IIF also did not release a statement on
the proposed IMF precautionary credit line, whereas both the IMF and the G7 have
indicated their approval. But credit lines nevertheless find favor in the IIF in that it
recommends the increased use of contingent credit lines from the private sector. As
a matter of fact, the IIF points out that private sector losses in recent emerging
markets crises have been formidable, such that the issue of moral hazard, although
recognized, cannot take general precedence.11

Another point where they vary is on the issue of capital controls. Although the G7
summit yielded no comment on this, the IMF is open to capital controls, whereas the
IIF strictly limits it to temporary price-based disincentives in times of buoyancy.

On risk management, only the IIF and G7 have detailed suggestions. Both see the
importance of improving risk assessment capabilities. The IIF is centered on the
implementation of specific measures, as it belongs to the private sector itself. The
G7, on the other hand, sees its role in the regulatory aspect and is wary of highly
leveraged and offshore institutions, which is indicative of the fact that they believe
that the crisis was stimulated partly by their existence.

     IIF (1999): New Approaches Advocated to Strengthen Global Financial System, P. 2.

3.2 A Critical Look
Transparency, Standards, Risk Management and Surveillance: Transparency and
the establishment of standards could be of good assistance in minimizing the advent
of a crisis. The same applies for improved risk management and surveillance.

One problem is that no one can force all countries to follow international standards
and transparency rules. Each country has for instance its own principles of
controlling the market, and thus an extra IMF surveillance is needed first and
foremost to assess the degree of transparency of the different regions. The IMF and
other institutions fortunately recognize that and recommend the publication of a
“Transparency Report”. The other problem is, even if the IMF publishes such a
report, it still would not have control instruments in the way that national authorities
have. The punishment for non-compliance to standards or transparency rules will
come from the market itself. Transparency also has its drawback in the fact that, in
the event of a crisis, it can no longer do its service as a crisis-mitigator. Once
financial panic reigns, the pains will be felt, and the effort to keep the books open will
not have that much effect.

But it is better than nothing. Sharp swings can nevertheless be substantially reduced.
Transparency fosters better economic performance, aids better risk management,
and fosters confidence and certainty. The lack of reliable basic data on the national
economy could be a tremendous force leading to market disarray. In other words,
markets work well when they have information. The better the information, the better
will the markets function. Poor information adds risk. In South Korea, for instance,
the amount of short-term foreign debt due in the next year was unknown. It took
several weeks before they ended their disputes and came out with a figure. This
uncertainty contributed to a wariness in the market. The Korean won depreciated
and led to further serious problems. 12 The same is true for all other countries.
Uncertainty fed the fire, as manifested by the up-and-down swings of the stock prices
mentioned in Chapter 2.1.

Emergency credit lines: Financial panic catapulted to a crisis, but we cannot deny the
existence of stimulators such as clearly risky investments made by many private
investors, as was also encouraged by governments. Thus, this raises the question
whether it is prudent to grant emergency credit lines from the IMF, the World Bank or
even the private sector itself.

We can go back to the question on the causes of the Asian crisis. Was it caused by
moral hazard? Increased risky investments may be indicative of that but is not
conclusive evidence. Radelet and Sachs have argued that blaming the Asian crisis
on moral hazard denotes the fact that investors in the Asian markets were reassured
by the IMF/United States (US) Treasury’s bail-out of Mexico in 1995. That means,
creditors recognized all the growing problems in Asia and believed that at some point
these economies would collapse, and were thus using short-term lines of credit as a
means of betting on the timing of the end of the Asian bubble. 13 And that was not the
case. The crisis was not anticipated, except probably by selected people like George

     Bennet (1999): Increasing Financial Transparency in a Global Economy, p. 1.
     Radelet and Sachs (1999): What Have We Learned, So Far, From the East Asian Financial Crisis?

Soros and Paul Krugman, who claim to have seen it coming. But Soros himself
admits that the mass of the crisis also caught him by surprise and as a consequence,
had to swallow massive losses. Moral hazard is not at the core of the issue.

A second moral hazard argument is that creditors felt secure that they would be
repaid for lending to specific projects that were controlled by companies with close
connections to the government. But that too is not the case. Radelet and Sachs
expound that it is probably more accurate to say that the creditors expected the
government-supported companies to continue to be profitable (and thus the loans
will be repaid) and not because they expected to be bailed out.

From this point of view, we can thus argue that emergency credit lines could not be
such a terrible option. Sudden changes in investors’ sentiments are indeed heavy
burdens on affected firms and institutions such that it will really necessitate the
availability of sufficient funds to procure a balancing force against those shifts.
Nevertheless, the issue of moral hazard should be carefully sifted in the decision.

In the end, what is important is market discipline. Transparency, standards,
surveillance and regulation go in this direction. On fears that they are not enough,
Charles Calomiris of the Columbia Business School suggests: a) a roll- back or
elimination of financial safety nets, and b) the conferral on government banking
supervisory agencies of the power to enforce regulations and close down banks. In
this regard, market signals are necessary so that government action is legitimated
especially in cases when a weak political will serves to be a hindrance. Within this
context, he raises suggestions ranging from the issuance of uninsured subordinated
debt up to a qualification test (preferred stock issuance purchases matching the
government’s purchase) for banks applying for recapitalization. 14

Capital controls and external debt limitations: The establishment of capital controls
would direct us to ideological considerations: a choice between free or government-
controlled markets. The key issues include efficiency and transaction costs, since
capital controls will in the end result to additional burden on a firm’s costs, as well as
to an opportunity cost of capital – not being able to make use of capital at a
designated time and place due to controls. It can also possibly render long-term
damage on a country’s capacity to attract foreign investments. 15

What stays in the background and should be promoted is that of actually making
good investments. Simple as that. When the investment policy of a firm is set on
good ground, then there is no reason for it to be caught in the fire of financial panic.
Here, we go back to the importance of risk management, and likewise point to the
importance of academic discussion with respect to appropriate investment policies.

As for limitations on external debt, the reason behind that is logical. Short-term credit
– not to mention – were at the bottom of the financial panic. And hence, it is just
wise to put a lid on them. Debt management should be given the same importance
as risk management.

  Calomiris (1999): Reducing Moral Hazard: Introducing Market Signals to Banking Supervision
  Rubin (1999): Treasury News, ”Treasury Secretary Robert E. Rubin Remarks on Reform of the International
Financial Architecture to the School of Advanced International Studies”, Office of Public Affairs, p. 5.

Exchange rate policy arrangements: Steve Hanke, in the midst of the Asian turmoil,
once proposed the establishment of a currency board in Indonesia as a solution to
the currency troubles. It was largely criticized and the consequences of non-support
of the IMF was not desired such that the Hanke proposal was set aside. Now, the
IMF wants to carefully study the exchange rate arrangements. The G7 is also
stressing an appropriate regime -- a stable one. What this regime should be remains
a question. The reality, according to Volcker of the US Federal Reserve Board, is
that exchange rates of small and open economies are likely to be prone to wide and
disturbing fluctuations when left to the market. But this does not grant us yet
certainty. The crisis was sparked by the unpegging of the baht. That means, we are
dealing here with pegged exchange rates. At the same time, however, we know that
Hong Kong and Macau are doing well with their currency boards. The conclusion of
IMF’s Sugisaki is: Countries that maintained consistent monetary and exchange rate
policies and supported liberalization with financial sector reform have been better
able to handle capital inflows and their subsequent reversals.16 This tells us that the
type of regime may not be the key factor. Stability is the one that ought to be sought.


The demands on the financial market architecture that ensue from the increased
global interdependence are high. Unfortunately, we had had to be wakened to this
reality by the onslaught of an international financial crisis. Although some economists
already foresaw the possible dangers, little was done to actually understand the

The Asian crisis was characterized mainly by a sudden, massive reversal of capital
flows, indicative of a rapid shift in the investors’ sentiments. Along with that, it was
notable that too much short-term credit – more than what they can carry – were in
the hands of the emerging markets. The risk was high. And that was aggravated by
inappropriate policies and a lack of oversight over macroeconomic and
microeconomic fundamentals, as well as lax investment management by investors.

As a result, transparency rules, international standards, improved risk management,
surveillance and regulation are sought. These have been looked into by various
institutions as a solution to the weaknesses inherent in the international financial
architecture. What remains debatable includes the idea of establishing capital
controls and the favoring of a particular exchange rate regime for emerging markets.
But what is worth aspiring for in the long run is stability.

The coming century will for sure still discuss issues concerning the international
financial architecture. The financial crisis is not the only reason why nations and
institutions should endeavor to strengthen the system. The introduction of the euro,
for instance, will, due to its international effects, stay at the front page of various
institutions’ concerns in the coming century. The challenges will continue to be many.

 Sugisaki (1999): The Reform of Global Exchange and Financial Systems Since the Eruption of the Asian
Crisis, p. 2.


Bennet, J. T. (1999): Increasing Financial Transparency in a Global Economy,
    Mimeo, Korea Economic Institute.

Calomiris, C. W. (1999): Reducing Moral Hazard: Introducing Market Signals to
    Banking Supervision, Mimeo, Columbia Business School.

De Long, J. B. (1999): Preparing for International Capital Flows, Mimeo, University of
    California at Berkeley.

Group of 7 Nations (1998): Declaration of G7 Finance Ministers and Central Bank
    Governors, Mimeo, G7.

______: Reports on the International Financial Architecture, Mimeo, G7.

Institute of International Finance (1999): New Approaches Advocated to Strengthen
      Global Financial System, Press Release, IIF.

______: Key Proposals Made for Improving Global Financial System: Markets Need
    Better Information, More IMF Transparency, Financial Firms Need to
    Strengthen Risk Management Systems, Press Release, IIF.

______ : IIF Proposes Actions to Promote Stable Financial Markets, Avoid Crises,
    and Involve the Private Sector in Resolving Crises in Emerging Markets, Press
    Release, IIF.

International Monetary Fund (1998): “Financial Crises: Causes and Indicators“, in:
      World Economic Outlook, IMF.

______ (1999): A Guide to Progress in Strengthening the Architecture of the
    International Financial System, IMF.

Krugman (1998): What Happened to Asia?, Mimeo, MIT.

Radelet, R. and J. Sachs (1998): The Onset of the East Asian Financial Crisis,
    Mimeo, Harvard Institute of International Development.

______ (1999): What Have We Learned, So Far, From the Asian Financial Crisis?,
    Mimeo, Harvard Institute of International Development.

Rubin, R. E. (1999): ”Treasury Secretary Robert E. Rubin Remarks on Reform of the
     International Financial Architecture to the School of Advanced International
     Studies”, in: Treasury News, Office of Public Affairs.

Schwartz, A. (1998): “International Financial Crises: Myths and Realities”, in: The
    Cato Journal, The Cato Institute.

Sugisaki, S. (1999): The Reform of Global Exchange and Financial Systems Since
     the Eruption of the Asian Crisis, Mimeo of the speech delivered at the
     International Conference on Central Banking Policies, IMF.

Supremo, T. U. A. (1998): The Asian Financial Crisis: Facts and Fantasies, Paper,
    Universität Zürich.

Volcker, P. A. (1999): Emerging Economies Navigating in a Sea of Global Finance,
     Mimeo, Federal Reserve Board of Governors.

The Nikkei 225 Index Fluctuations and the Reported Causes

 19500                                                                                                                                                                                                  Wall Street
 19000                                                                                                                                                      18200

 18500                 Wall Street
                        shakeout                                                  Wall Street                                                               17800
                                                                                                                                                            Southeast Asian
 18000                                                                             shakeout
                                                                                                                    Wall Street                             17600
                                                                                                                                                                  turmoil                                  macroeconomic
 17500                                                                                                               shakeout                               17400
                                                                                                                                                            17200                                           (poor data)
     Aug 04            Aug 06      Aug 08     Aug 12           Aug 14            Aug 18       Aug 20     Aug 22         Aug 26            Aug 28
                                                                                                                                                                Sep.05    Sep.07     Sep.09    Sep.13   Sep.15     Sep.20   Sep.22      Sep.26    Sep.29

                                               August 1997                                                                                                      September 1997

                                                                    Income tax cut                                                                                                                                     bail-out or
  18000                                                                 rumor                                     Wall Street rally                         17'000.00                                                 no bail-out?

  17500                                                                                                                                                                                       Hokkaido Bank
                       poor economic
  17000                                                                                                                                                     16'000.00
                            data                                                       Disappointment
                                                                                        over support
  16500                                                                                   measures                                                          15'500.00
                                                                                                                                                                   financial sector                                                   Yamaichi dies
  16000                                                                                                           Wall Street and HK                        15'000.00
                                                                                                                        plunge                                                                    financial sector
  15500                                                                                                                                                     14'500.00                                  scares

  15000                                                                                                                                                     14'000.00
                                                                        Oct 14

                                                                                     Oct 16

                                                                                                Oct 20

                                                                                                         Oct 22

                                                                                                                    Oct 24

                                                                                                                                 Oct 28

                                                                                                                                              Oct 30
                           Oct 1

                                     Oct 3

                                              Oct 7

                                                            Oct 9

                                                                                                                                                                     Oct       Nov       Nov      Nov      Nov       Nov        Nov      Nov       Nov     Nov
                                                                                                                                                                      31        5         7        11       13        17         19       21        26      28

                                               October 1997                                                                                                     November 1997

         positive note from                                                                                                                                                                                                     positive effect from
  17500the government                        positive note from                                tax reduction                                                 17500                                                             government measures
                                              the government                                  announcement                                                   17000
  16000                                                                                                                                                                                                  positive effect from
                                             skepticism and the South                                                                                        15500                                           government
                                               Korean won decline                                                                                            15000                                            measures
                                                                                                                                                                    Southeast Asian
                                                                                                 a food retailer                                             14000     worries
  14000                                                                                       declares bankruptcy
  13500                                                                                                                                                      13000
       Dec                Dec          Dec            Dec           Dec            Dec           Dec          Dec            Dec            Dec                   Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan
        1                  3            5              9             11             15            17           19             25             29                    05 06 07 08 09 12 13 14 16 19 20 21 22 23 26 27 28 29 30

                                               December 1997                                                                                                                       January 1998

                                                                                                                                                              17400          government
  17200                                                                                                                      new tax cut hopes                               intervention          public funds                                public funds
  17000                                                                                                                                                       17200                                  bail-out                                    bail-out
  16400                                                                                                                                                       16800
  16000                                                                                Disappointment over                                                                                                       no tax cuts           no tax cuts
                                                                                       government measures                                                    16400                central bank scandal
       Feb Feb Feb Feb Feb Feb Feb Feb Feb Feb Feb Feb Feb Feb Feb Feb
        05 06 09 10 12 13 16 17 18 19 20 23 24 25 26 27                                                                                                           Mar 2            Mar 5       Mar 10     Mar 13        Mar 18         Mar 23       Mar 26

                                               February 1998                                                                                                                       March 1998

The SET Index Fluctuations and the Reported Causes for July 1997
                                     FIRST WEEK: JUNE 30 - JULY 4

(NOTE: The finance minister quit during the last week of June.)
MONDAY, JUNE 30                                                      down
The Nation: Stock prices dipped amid the increasingly complicated finance company mergers and growing fears
that something is brewing on the currency front.

TUESDAY, JULY 1                                                         closed
(NOTE: The cabinet approves measures aimed at bolstering confidence in the beleaguered finance sector, e.g.
deposit insurance, waiving capital gains taxes, forced mergers for ailing finance firms)

WEDNESDAY, JULY 2                                             up 7.87%
(NOTE: The baht declines 17% as the dollar peg is scrapped.)
The Wall Street Journal: Investors in Thailand's stock market threw a wild party after the government abruptly
reversed its policy and allowed the baht to float.
Financial Times: A wave of foreign funds, which appeared to have been waiting for a resolution of the currency
dilemma, came in.
The Nation: Foreign investors flocked to the bourse following the central bank's decision to unpeg the baht.

THURSDAY, JULY 3                                                       up (17% in two days!)
The Wall Street Journal: Share prices surged again as traders and investors puzzled over the implications of
Wednesday's effective devaluation.
Financial Times: The headlong rush into Bangkok by both foreign and local investors continued.
The Nation: Foreign investors continued buying.
Deputy Secretary General of the Securities and Exchange Commission, in: The Nation: The floating of the baht is
the main reason the SET index has jumped almost 100 points in two days.

FRIDAY, JULY 3                                                         up (25% in three days!)
(Note: The stock exchange agreed to widen the limits on stock price movements.)
The Nation: Buying support from local investors, including mutual funds, were following in the footsteps of the
foreign buyers.
Financial Times: Foreign investors continued to snap up large capitalized stocks.

                                    SECOND WEEK: JULY 7 - JULY 11

MONDAY, JULY 7                                                    down 4%
(Note: Morgan Stanley reports that Thailand was the worst performer among emerging markets in the second
The Nation: Profit-takers pulled the plug.
Financial Times: Bangkok ran into profit-taking.

TUESDAY, JULY 8                                                         down 7%
The Nation: The tug-of-war between domestic profit-takers and foreign buyers looking for bargains continued,
pushing the stock market down.
The Wall Street Journal: Priced dropped as investors and short-term buyers who tried to capitalize on the falling
value of the baht started moving out of the market.
Financial Times: The slide is due to profit-taking and currency worries.

WEDNESDAY, JULY 9                                           up
The Nation: Buyers returned to the considerably cheaper market following profit-taking in recent sessions.
The Wall Street Journal: Prices jumped as buyers returned to the considerably cheaper market following profit-
taking in recent sessions.

THURSDAY, JULY 10                                            up
The Wall Street Journal: Stocks gained as investors bought stronger finance stocks on expectations they will be
awarded commercial banking licenses.
Financial Times: Foreign buyers were said to have sought leading financial stocks.

FRIDAY, JULY 11                                                     down 3%
Financial Times: Mounting worries about listed companies' foreign exchange losses following a sharp fall in the
baht caused the index to fall.

                                    THIRD WEEK: JULY 14 - JULY 18

MONDAY, JULY 14                                                      down 3%
The Wall Street Journal: Shares were dragged down by profit-taking, as investors sold bank shares amid market
rumors that several local banks will be closed.
Financial Times: The SET index slipped as the baht had another see-saw day.

TUESDAY, JULY 15                                                    up 2.25%
(NOTE: Three banks announce unaudited interim net profits in the first half of the year in line with the
expectations of banking analysts.)
The Wall Street Journal: Investors returned to the market after rumors of collapsing banks proved unfounded.
Investors bought blue-chip bank and finance company shares. Financial statements released by some small banks
helped to ease fears.
Financial Times: Bangkok closed sharply higher on bargain hunting amid talk of currency support from the
international Monetary Fund (IMF) and Japan.

WEDNESDAY, JULY 16                                                  up 6%
Business Day (Thailand): For the first time in almost two weeks, stocks staged their biggest rally on foreign
buying on expectations of good bank earnings and growing hopes that an IMF support package may be on the
way for the nation's battered economy.
The Wall Street Journal: Share prices soared, amid growing optimism that Thailand's finance minister will be
able to secure funds from Japan to rescue ailing finance companies.
Financial Times: Bangkok rallied strongly as talk of a combined Japanese and IMF support package gained

THURSDAY, JULY 17                                                 down
(NOTE: Police raided two foreign brokerages in search of the source of faxed rumors that five Thai commercial
banks would be shut down.)
The Wall Street Journal: Stocks slumped on news that Thailand's finance minister said the government will not
seek international financial assistance to help its ailing finance companies.
Financial Times: Bangkok pulled back after the finance minister said that the government would not seek
international aid to bail out the debt-ridden private sector.

FRIDAY, JULY 18                                                       down
Business Day (Thailand): Shares closed mixed with the index down 2.91 points. Speculative buying in the
finance sector ahead of planned mergers and takeovers helped limit losses.

                                   FOURTH WEEK: JULY 21 - JULY 25

MONDAY, JULY 21                                                      closed

TUESDAY, JULY 22                                                   up 1%
Business Day (Thailand): Share prices rose after a long weekend holiday, on speculative buying in the finance
sector ahead of planned mergers.
The Nation: Buying support for finance counters was for speculative purposes as the current prices were
considered appropriate.

WEDNESDAY, JULY 23                                                 down 4.3%
Business Day (Thailand): Share prices slumped, led by banking and finance stocks on concerns about non-
performing loans and the declining vale of the baht.
The Nation: The weakening baht aggravated negative sentiment.
The Wall Street Journal: Bangkok plunged amid fears that Thai companies will be hurt by the baht's weakening.

THURSDAY, JULY 24                                          up
Business Day (Thailand): Share prices gained slightly on news the finance minister would submit a package of
economic measures and was considering borrowings to boost liquidity. Bargain hunting mostly in banks pushed

the index in the positive range, though investors barely reacted to moves by major banks to raise the prime rate
from 12.75% to 13.75%.

FRIDAY, JULY 25                                                      down 2%
Business Day (Thailand): Share prices finished up on speculative interest ahead of the announcement of the fate
of 16 suspended finance companies.
The Wall Street Journal: The market's rise was attributed to foreign buying of large-capitalization stocks in
response to news the Thai government will present its economic rehabilitation plan soon.

                                    FIFTH WEEK: JULY 28 - AUGUST 1

MONDAY, JULY 28                                                        up 5.27%

Business Day (Thailand): Stocks closed higher in active trading as investors reacted positively to news that
Thailand was seeking advice from the IMF and studying if a standby IMF credit line was necessary.
The Wall Street Journal: Share prices soared. Sentiment was boosted by the Thai government's decision to
approach the IMF for a credit line.
The New York Times: The suggestion of an IMF rescue sent the index up more than 5%.

TUESDAY, JULY 29                                                      up
(NOTE: The central bank governor resigns.)
Business Day (Thailand): Despite several bouts of profit-taking on bank and finance issues, stocks closed slightly
higher as investors welcomed news that Thailand would seek help from the IMF.

WEDNESDAY, JULY 30                                                    down
The Nation: Concerns over the economic data scheduled to be released today, together with the upcoming
implementation of a new rule on market trading limits, prompted the stock market to decline slightly.

THURSDAY, JULY 31                                              down
The Nation: Suspicious investors expressed doubts there might be something behind the scenes over the better-
than-expected foreign reserve figures released by the central bank.
The Wall Street Journal: The Thai market fell because of political concerns.

FRIDAY, AUGUST 1                                                     down
The Nation: Amid the news that S&P might review the ratings of some companies, investors also worried about
the economic bail-out package scheduled to be announced on Tuesday.
The Wall Street Journal: The SET index slipped as S&P's ratings group placed Thailand and several top financial
institutions on credit watch for a possible downgrade.
Financial Times: Bangkok moved lower for the third day running as worries about the economy continued to
depress sentiment.

(More in: Supremo, T.: The Asian Financial Crisis: Facts and Fantasies)

Radelet and Sachs: Distinguishing Among Financial Crises

                      Policy-         Financial           Bubble          Moral-             Disorderly
                     induced            Panic            Collapse         hazard              Workout
                       crisis                                            Induced
Anticipation High                   Low                Market         High.                High.
of crisis by                                           participants Creditors are          Market
market                                                 and analysts lending                participants
participants                                           understand based on                 understand
and                                                    probability of state                the lack of
analysis                                               collapse.      guarantees           coordina-tion
                                                                      rather than          among
                                                                      funda-               creditors.
Destruction Not                     High               Low.           Low.         High.
of real     necessarily                                The end of     The end of   Creditor
economic                                               the bubble     moral-       grab race;
activity                                               may improve hazard          liquidity
                                                       resource       based        crisis of the
                                                       allocation.    lending      borrower;
                                                                      improves     premature
                                                                      resource     liquidation of
                                                                      allocation.  the
Lending           No.               Not                Possibly.     Yes. Most or Not
induced by                          necessarily.                     all creditors necessarily.
moral                                                                are
hazards                                                              protected by
                                                                     explicit or
Case for     Macro-                 Lender of          No.           No.           Yes. Public
official     economic               last resort.       Delaying the State          institutions
intervention adjustment,                               bursting of   guarantees may provide
             especially                                the bubble    prolong the a framework
             budgetary                                 can lead to a misalloca-    for an
             reduction                                 deeper crisis tion of       orderly
                                                       later.        resources.    workout.

„In our interpretation, the East Asian crisis resulted from vulnerability to financial panic that arose from
certain emerging weaknesses in these economies (especially growing short-term debt), combined with
a series of missteps and accidents that triggered the panic....Without question, there were
macroeconomic imbalances, weak financial institutions, widespread corruption, and inadequate legal
foundations in each of the affected countries...To attribute the crisis fully to fundamental flaws in the
pre-crisis system is prone to sheer folly...“


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