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					                           THE INTERNATIONAL FINANCIAL SYSTEM
                                     UNDER STRESS

                                          January 26-27, 1998
                                         Marriott Financial Center


                                                  DAY ONE

                                               INTRODUCTION

Marc Uzan: It is a pleasure for me to welcome you to New York for this international conference about the
Asian financial crises and what we have called the International Financial System Under Stress. I'm going to be
very brief because we have a very overcrowded panel for the next two days. I just want to thank you for coming
from all around the world for this fifth of seven conferences of the Reinventing Bretton Woods Committee.
          We met in 1995 in Montreal just after the crisis in Mexico to try to lay out an agenda on crises
management ***7*** on the early warning system to prevent and anticipate resolving financial crises. I believe
this crisis in Asia is a turning point. The European Monetary Union will arrive next year and we have an
important crisis in Asia. These two events will be, to my thinking, two important events for the international
monetary system and we will try to lay out an agenda to find out what kind of international monetary system the
world will need for the twenty-first century.
          So for the next two days I hope that something will emerge out of this conference and I would like to
thank our sponsors for this meeting, Deutsche Morgan Grenfell and ***13*** who helped us for this conference.
Paribas and the UNDP and their Bureau for Asia.
          And now I would like to give the floor to Barry who will chair the first panel and has been for me a
source of inspiration for the last three years. Barry.


PANEL I - LESSONS OF THE ASIAN CRISIS

Barry Eichengreen: Thank you Marc, Thank you for allowing me to chair, I think this is intended as a device
to keep me out of trouble this morning. We should compliment Marc and Reinventing Bretton Woods
Committee I think for its exquisite timing, I know this conference has been in the planning stage for some time
and this is indeed a opportune stage at which to reflect on what we've learned and where we're going, one day
before the Chinese New Year, etc. The timing couldn't be better.
         So we have a packed first panel this morning. I believe we have six speakers on the dais, many more in
the audience, and a bit less than two hours. So the ground rules will be for the speakers to limit their opening
remarks to ten minutes if possible and then we will open up the floor. The one exception will be our first
speaker, Yung Chul Park, who is the president of the Korea Institute of Finance. Professor Park has arrived with
a very detailed paper on the anatomy of the Asian crisis and the lessons and he will attempt to summarize that as
a way of kicking off the discussion in fifteen minutes or so. Professor Park.

Yung Chul Park: Thank you very much. I used to come to conferences like this to talk about Korean miracle.
This morning I have to talk about what has happened to Korea and what we did to deserve such lousy treatment
from the international financial community, and it's not easy. And I have so much emotional involvement in this
crisis, I don't know how objective I could be when describing what has happened and what is likely to happen in
the future. There are many lessons one can draw from the Korean financial crisis for the last two months. But
these lessons are the ones that we have learned from the Mexican crisis and other crises in the past. In fact, the
past crisis, financial and foreign exchange crisis revealed to us, has taught us that there are very serious


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institutional defects in the international financial system and the international financial community has not
addressed these defects or deficiencies in the system and as a result the system has not been able to contain,
prevent these crises and at the same time the system hasn't been able to manage the current ongoing crisis in East
Asia. That is going to be my major argument.
          In fact the crisis in Korea as well as the crisis in South East Asia have been contagious and there are
many pieces of evidence, and in fact it is very difficult to deny that the crisis has been contagious and these crises
have also posed very serious systemic risk which means that the public sector, the official sector of the
international community must intervene to do something about the spread of the crisis. And to prevent the spread
of this crisis some sort of intervention is ***63*** necessary.
          The problem is that if we knew more about the channels through which these defects of crisis are
transmitted to other countries, mainly the channels of contagion, then the International Monetary Fund and other
governments could have done a better job. But simply because we don't know much about these channels of
contagion, many international institutions as well as the major governments, G7 Governments, have not been able
to take appropriate actions at the right time.
          When the foreign investors and foreign lenders lost their confidence in the Korean economy, their
reaction to the situation was rather excessive and they have over reacted to the situation. As a result there has
been this very serious overshooting problem. Interest rates have gone up too much. The increase in interest rates
have been excessive and the magnitude of depreciation has by any measure of a standard has been excessive. In
fact over a period of less than a month, both nominal, as well as real exchange rates depreciated by more than 50
percent. And also interest rates have gone up more than 50 percent.
          There was a cause for this overreaction and the literature will tell you lots of reasons for this. Most of
these reasons apply to the Korean case. For instance, the information problem. The isometric information and
the herding behavior on the part of the foreign institutional investors as well as foreign lenders has been a very,
very important cause of overreaction in the case of Korea. In fact I can show you later on the causes of this
overreaction and the causes of the information problem.
          In the case of Korea, surprisingly, this overreaction and the withdrawal of funds from Korea was led by
American institutional investors and American lenders followed by Japanese and Europeans. Although, overall,
the American exposure to Korea has been the smallest compared to the Japanese exposure and the European
exposure. That tells you how important New York has become as the center of the financial world. According
to a recent study I am working on, the institutional investor channel has been a very important rout through which
the effects of foreign exchange crises have been spreading around East Asia.
          I have spoken to many foreign investors and foreign bankers and they tell you that they didn't know
much about the Korean economy, how serious some of these structural problems were and for how long they
were deceived by many people in Korea including policy makers and at a certain point, their distrust, which has
been building up for a long time, and at a certain point their distrust and the level of confidence couldn't be
sustained any further and like an ***103*** internal and external events they decided to leave Korea at once.
That is the story I hear quite often from many foreign investors and lenders coming to Korea.
          I don't think that story is right. for a long time the foreign investors have known about most of Korea's
structural problems. They have complained about these problems and in fact they have insisted on reforming
policy as well as financial industries as well as the corporate sector. The question is if they knew Korea had so
many structural problems, why didn't they do more careful credit analysis and try to gather more information,
including the information that most of the published financial business statistics are unreliable. If they did more
careful credit analysis, would they have invested as much as they did?
          My answer for their excessive investment in East Asia, including Korea, is that they were lured by
favorable gross prospects in that part of the world. And also, more importantly, the implicit guarantees on their
loans to these countries and as well as their investments. The implicit guarantee has been one of the major reason
for their moral hazard problem that was shown to be very serious during this East Asian crisis.
          I realized how serious this moral hazard problem was as early as September of last year. I went to Hong
Kong, as I am sure many of you did, to attend this World Bank and IMF meeting. During that meeting I gave
some kind of prepping on the prospect of the Korean economy together with our government's deputy prime
minister for economic affairs and I thought we gave a very nice prepping on the future of the Korean economy.



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Afterward, nobody wanted to know about the prospects. Everybody wanted to know whether the Korean
government was prepared to guarantee their lending to financial institutions and their lending to corporations.
Our government officials had a hard time responding to these questions and at that time it was clear that the
Korean government did not have any choice but to give some kind of promise guaranteeing foreign debts at that
time.
          The question is did these foreign investors have enough information to make rational judgments and at a
certain point they realized that much of the information they received was not accurate and the economy much
worse than they thought it was and at that point their reaction was that everything in Korea was wrong and they
had to leave suddenly? I don't think there was really rational behavior. Once the crisis broke out, our experience
shows that it was very, very difficult to reverse market sentiment. Even if we had lots of foreign reserve
holdings, that would not have been enough. At that time, when the crisis broke out, the amount of usable foreign
reserves stood at around 20 billion and even if we had twice as much I don't think we would have been able to
fend off this currency crisis. Especially when foreign investors knew how high the ratio of short-term liabilities
to the reserve holdings, there wasn't much we could do. In fact, that was the most serious weakness, the ratio of
short-term liabilities to foreign reserve holdings.
          And now I go back to the second subject, that is how effective the IMF program has been so far in
resolving the current crisis in Korea and other countries. During the crisis I saw many cases, I have spoken to
many investors, and most of these of these people were putting tremendous pressure on our officials and our
government to go to the IMF for a financing package. Instead of trying to work out some kind of arrangement
with the Korean financial institutions and Korean government, there reaction was that once they realized that
Korea was vulnerable they kept putting more pressure on the Korean government to seek IMF assistance and this
was something that we did not expect but lots of pressure came from the international financial community.
          When we agreed to this IMF conditionality and financing package, we expected that this agreement
would produce some kind signaling effect, that the agreement would signal these global institutional investors as
well as the major lenders to return to the Korean market. They did not respond to this signal for a long time, for
almost three weeks until the IMF and the G7 Countries came up with another financing package amounting to ten
billion.
          Why has the IMF program not been as affective as it could have been? One reason is that it took too
long a time for the Korean government to reach an agreement. As early as the October and toward the end of
October it was clear that Korea was not able to resolve the crisis and had to ask for IMF assistance and then the
Korean officials had informal discussions. That was toward the end of October and the early part of November.
It took more than a month to reach this agreement which was realized on December third. This means that Korea
lost almost a month during which obviously the currency crisis deepened and any of preventing the crisis
evaporated.
          The second reason was that obviously the foreign investors wanted to test the IMF's and G7's resolve as
to what extent the IMF and G7 were willing to rescue them from Korea and in the process and they wanted to
socialize lots of their debt to Korea. They want wanted to receive some kind of government guarantee on their
debts and I think they have succeeded quite well in getting government guarantees on their debts to financial
institutions and to the public sector. They have succeeding in socializing debt. Until they received this kind of
guarantee they were not willing to return to the Korean market.
          And of course there was another problem that some components of the IMF program have been rather
controversial. for instance this tightening of fiscal as well as monetary tightening, whether that tightening was
appropriate or excessive. And there has been this conference controversy and this controversy has obviously
weakened to some extent the IMF program.
          In hindsight, could have the contagion been prevented? I do not think so because give the institutional
deficiencies in our international financial system, I don't think anyone, including the IMF, could have prevented
this contagion of the East Asian crisis. Most of the reasons are well known and one of them is the absence of
regulations and the mechanism which would enforce these regulations. Regulations on the behavior of
institutional lenders as well as international banking institutions. I am sure that speaking about regulations in
New York may not be a very good thing to do but there is an argument for regulating these international capital
flows. At present capital flows are not regulated at their source or by recipient countries at all. The second is



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that there is no mechanism for monitoring international capital movements. There are many international
institutions but none of these institutions specialize or have expertise to tell us the microeconomic aspect of
capital flows among countries and between advanced and the emerging market economies. The problem is that
there is no warning mechanism. As late as October, most of these international institutions and many investment
bankers in New York told us that Korea was very strong and had nothing to worry about because fundamentals
are very strong. Only two weeks later we had to cope with this major financial crisis. Obviously there are
problems of disclosure and better information to the market participants and these things are very glaring
deficiencies of the international system and we have not done much to rectify these defects for the last several
years after the Mexican crisis.
          What about better management of this ongoing crisis? I don't think we could have done a better job
because while the IMF has been serving as a de facto• lender of the last resort, because of the many constraints
imposed on the IMF, the IMF has not been not been very effective in serving as the lender of last resort. In fact,
unlike other central banks in the domestic context, the IMF doesn't have any regulatory or supervisory powers
and without these regulatory or supervisory powers I don't think the IMF can act as an institution which serves as
a lender of last resort.
          In the future, what should be done in the way of reforming the workings of the international financial
system to prevent recurrence of currency crisis elsewhere? Let's for the moment assume that the financial
liberalization in emerging markets as well as developing countries will proceed and this financial liberalization
will help integrate financial markets with these countries into the global financial system. If that trend is going to
continue, then we should ask ourselves: What should we do in a domestic context to preserve the soundness and
stability of the financial system? And then we will do exactly the same for the international financial system. In
the domestic context in order to maintain stability and soundness of the financial system we create a central bank,
we have regulatory structures, supervisory structures. All this financial infrastructure is very important. If that is
so, and we are moving toward global integration of finance, then I think it is about time to think about creating
the financial infrastructure will preserve the stability of the international financial system. The idea is very
simple, if we are moving toward globalization, we do the same thing that we do for the domestic financial
system.
          In that respect I think that one should think about creating some sort of international lender of last resort.
If that is not a viable option, then I think, as we discuss in the domestic context, the feasibility of creating a
privatized deposit insurance system for those lenders as well as depositors. In other words, some kind of
insurance system, which will increase the stability of financial institutions in emerging markets as well as in other
parts of the world. The second thing is that we should try to harmonize the regulatory structure and the
enforcement mechanism among the countries. These are the things we should do. The third and most important
to a country like Korea is we have to do more thinking about is what is the most appropriate exchange rate
system for a country like Korea.
          For the last several years it is my impression that advanced countries have been pushing for financial
liberalization, financial opening in developing countries. In the process they have asked for market access only.
They have not paid enough attention to improved financial infrastructure of these countries. Without establishing
adequate effective financial infrastructure which consists of the supervisory regulatory system, these countries
thrown into the international financial competition and because of this inconsistency between this market
opening on the one hand and lack of improvement in the financial infrastructure in many of these developing
countries has been a major source of financial crisis in East Asia. Unless we address these financial
infrastructure problems in my view, financial crises and foreign exchange crises will recur in the future. Thank
you very much.

Barry Eichengreen: Thank you Professor Park. Our second speaker this morning, David Folkerts-Landau has
seen crises from a number of different perspectives. His current perspective as from Head of Emerging Markets
Research at Deutsche Morgan Grenfell. David.

David Folkerts-Landau: Thank you Barry. Since the time I thought I was going to have to talk to you has just
been cut in half at Barry's instruction, I will confine myself, I will identify what I regard as four policy areas,



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policy issues that clearly have gone off track a little bit and just speak about that rather than giving you a more
detailed view of what I thought as the origin of this crisis. But clearly the ongoing crisis as we have seen it so far
has demonstrated that the continuing integration of emerging market countries into a global financial system
poses much larger policy challenges than anybody had anticipated, let's say at the end of the 1980's.
          The first issue that I would like to address is: Was international surveillance as it is currently practiced
effective? The key issue here is did the fund's surveillance mechanism, the IMF's surveillance mechanism,
identify the problems in Asia sufficiently far in advance to allow for timely remedial policy initiatives on the part
of the countries concerned? The answer is yes.
          During my ten years as head of the fund's international capital markets surveillance work, which ended
when I left to Deutsche Morgan Grenfell in October '97, I had the responsibility for overseeing the work done to
identify financial sector problems in systemically important countries. While this is obviously not the place to
discuss that in detail, what I can tell you is that for all four countries that are currently still at risk, Indonesia,
Korea, Malaysia, Thailand, and I might also include Japan in that,***346*** forcefully and unambiguously
confronted policy makers at the senior most level both at the central bank and at the ministries of finance as early
as the spring as last year. In some cases, notably Indonesia and Japan, years before that. The authorities were
presented with a strongly worded negative assessment of their financial systems and they were given very
specific suggestions for remedial policies.
          Let me give you two examples. After a significant amount of background work and extensive visits to
Japan, the Japanese minister of finance and BOJ were told in unambiguous terms that their estimate of non
performing loans in the banking system was less than a third of the actual number as estimated by us and that any
delay in addressing this issue would greatly increase both the final direct cost of the cleanup, as well as be a
continuing drag on the performance of the economy. In this regard I would recommend that you take a look at
the 1993 international capital markets report. Every year since then, fund officials have gone to Japan to make
these points. And you will of course know that in the meantime the size of the non performing loan problem has
now risen to near, officially estimated over 75 trillion yen, and in my estimate will rise to 100 trillion yen, with
serious implications for the performance of the Japanese economy as well as risks for the international financial
system.
          Likewise, and importantly so, with Korea. After clearly extensive discussions with the authorities in
Korea and with market participants in the region, we presented as early as the early part of 1997, our sharply
critical findings regarding the state of the banking system at the balance sheet of the chaebols to the Bank of
Korea and the Ministry of Finance. The Koreans took note but obviously did not address the issues raised in
these discussions.
          The point here is that the fund has the capability and the integrity to identify problems in its member
countries and as part of its surveillance activities has consistently done so. But in the absence of a formal
stabilization program, it cannot induce a timely implementation of appropriate remedies. Indeed, it has been my
experience that in normal times, countries are much less concerned about what the fund says than about what the
rating agencies say.
          At this juncture there are some clear choices. Should the fund be a trusted confidant and advisor behind
a throne, enjoying the full trust and confidence of the governments and with fairly unrestricted access to
privileged information? Or should the fund be more of an outside watchdog, thereby perhaps foregoing certain
types of information, but using its prestige and integrity to put public pressure on countries whose economic
performance potentially generates systemic externalities?
          Having been a practitioner for the last 15 years of the former approach, I have come to believe that it is
ineffective and no longer appropriate in a world with open capital accounts. My experience over the last three
months at Deutsche Morgan Grenfell has only served to strengthen my views in this area. Deutsche is one of the
largest creditors in Asia and a significant player in local currency markets in these countries, providing both
settlement and custody services in many of these markets. As a result, this kind of private sector now has much
greater access to senior government, banking and corporate officials and can obtain more and better information
about these countries than, in many instances, the fund can.
          This is why I believe that the existing surveillance model, where the fund is the insider with access to
privileged information and policy intention, and with policy advice given in private, is no longer effective in the



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current environment. If the IMF is to be effective in providing surveillance of the international financial system
in the coming years, it will have to assume a far more open and far more confrontational stance in its surveillance
activities. And to be fully effective, such an approach will need to be formally endorsed at the G7 ministerial
level, or perhaps at the next summit.
          Second point: Is the current crisis resolution method appropriate? This is an easy one. The concerted
international intervention in Mexico in 1995 was both necessary and it was highly successful. But bailing out the
Tesobono holders, including the leveraged structures of the Mexican banks, did introduce significant moral
hazard on the part of the lenders. During the Mexican crisis, all of Asia's emerging markets were tested one way
or the other, and all withstood the test. After that, however, the flood gates opened. Capital inflows and domestic
credit growth accelerated sharply in the two years since the crisis. The resolution of the Mexican crisis provided
some comfort that investments in systemically important countries such as Korea and Indonesia would be
supported by international liquidity supply and that as a condition of such support the domestic economies would
be forced to undertake an adjustment program that would make these credits whole again. If seen in isolation, the
Mexican rescue package was clearly successful, but if seen against a backdrop of current events in Asia, the
picture is much less clear.
          I am fully aware of how difficult it is to put together a package that includes a significant sacrifice on
the part of private external creditors. The same creditors could pull their exposure from other countries in the
region and thereby make the contagion worse. Possibility of a systemic widening of a crisis is real and few
would want to be blamed for having precipitated such a serious widening of a crisis for the sake of teaching
lenders a lesson. But somewhere this lesson has to be taught. Can the industrial countries afford to continue to
support a system where the claims of foreign and domestic lenders are made whole, save for some relatively
minor losses to marginal finance companies and merchant banks, and where the economy in crisis has to bear the
full adjustment burden with the fund or the G7 bearing the resolution risk?
          The third item concerns the financing for the fund. If the IMF is to play the difficult role of lender of
last resort in the international financial system, by stepping in to supply liquidity in return for adjustment effort
by the country and with the ability to impose more efficient sharing of losses among all classes of creditors, then
it will need to have the requisite amount of funding available. I submitted the current situation in which the
ability of the fund to play its role fully is being questioned every now and then is not confidence inspiring. The
fact that current rescue packages have required recourse to G10 resources on a bilateral basis is clearly evidence
that the fund does not have sufficient resources and the apparent reluctance of the US congress to move the
relevant appropriations bill forward is not only shortsighted, but it is also not in the broader interests of the US,
who, after all, is going to be the major beneficiary of the opening up of the Asian financial system that has been
achieved in the last three months.
          Lastly, the mechanics of working out debt problems. In order to make the resolution of debt problems
smoother and to achieve a more efficient allocation of the losses, it will be necessary to strengthen our ability to
achieve and orderly work out of delinquent international obligations. In this regard there is very little I can add to
what Barry Eichengreen already has done in this important subject other than to say that I fully conquer with it.
          Thank you very much.

Barry Eichengreen: Thank you David. Actually I do think there is one thing to add to that previous work
which didn't touch on corporate debts but that's presumably something to which we can return.
        Our third speaker is Simon Ogus, who is Chief Asian Economist at SBC Warburg Dillon Read.

Simon Ogus: O.K., On request I stand up, although if you see how ugly I am you may not be so keen on this.
(laughter/applause) Well, that's the biggest clap we're going to get today.
         If you're alcoholic, one of the first steps on the road to recovery is actually admitting you are an
alcoholic. And with all due respect to most of the Asian countries that we are looking at (and I'm right in the
middle, I'm based out in Hong Kong) Most of these guys have been denying they had a drink problem really until
very, very recently. We are starting to see a few of them saying "Oh maybe I touch the odd drop or too," and
some of them are even thinking about checking into the Betty Ford clinic at the moment for a bit of rehab. Albeit
they, in many cases, want to take a few bottle of scotch in with them to just sort of keep them going.



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          To me the reasons behind the crisis have been gone over many, many times. Seminal papers the like, I
strongly agree with David's assertion that the IMF basically identified these problems years ago, in fact many of
us sitting in Asia similarly had the diagnosis correct. But the issue is you can't impinge on national sovereignty.
And unless countries are actually willing to actually listen, and or learn and implement policies that are going to
change things around, every attempt to throw money at the region is just going to be a complete waste of
taxpayers' money, and is not going to do any good. And as we've seen, its just been a subsidy to foreigners to go
short again, and a subsidy for locals to get out at a better price than they would have otherwise.
          The problem is basically from a lack of monetary stability inherited through fixed exchange rates, badly
regulated financial systems, Open capital accounts--I don't think we need to go into it now.
          The remedies, which have been on the table, and I'll talk a bit very briefly about where I do disagree and
agree with the IMF. I've also been set out for *** 502***six nine months. We can all come up with very clever
restructuring plans and the like. But the fundamental issue is the admission that you've got a drink problem and
the admission that you have to go into rehab, go cold turkey and actually try to help yourself.
          Now that is the fundamental difference between those countries in Asia who maybe are starting to put a
floor under what's happening at the moment, and those countries who are risking spiraling into hyper inflation.
And I think the big macro call for this year is going to be to work out which countries put in place the policies
over the next six months or so which do lead to eventual recovery on the sort of one and a half, two year view,
and which countries are going to lose it. Because countries do lose it. And in places like Indonesia and Malaysia
at the moment, I believe we are risking seeing the Peru's of the 1990's.
          However, for the international financial system, the key one is Korea. With all due respect to Malaysia
and Indonesia, they don't matter very much. O.K., it's all in our interest to sort of wander around and the US
sends out Summers and Cohen to sort of say nice things to the leaders, but in the big scheme of things in the
international financial system, no one really cares that much and I don't think that if these countries do want to
self-destruct, we are going to see money coming in in big size.
          Now why do I think that have got these two groups emerging. Well I think you have to look at the
inherent political structures in these countries. Flawed though the democracies are in Thailand and in Korea, you
do have a mechanism for changing the government. And what we're seeing in Korea, and maybe in Thailand, is
classic western politics. The new guy coming in saying "Oh no, I never realized it was quite as bad as this, these
guys really lied to you and to me. I know I promised to create ten million new jobs during the election process,
but actually we're going to have to have some flexibility." Yup, you're management's going to go down with you
but I think that's the process in which you can actually start to put in place your policy remedies.
          Fundamentally it comes down to how the political institution structures are set up in the countries. If
you take Lee Quan Yu's school of benign dictatorship, Lee Quan Yu would argue that just about everyone in this
room is basically incapable of making a decision in the best interest of their country, and that what we actually
need is a benign dictator, an enlightened despot coming out of the Confucian or Aristotelian philosophy to tell us
how to behave and run our lives.
          And that's fine if everything is going in the right direction. The Faustian bargain is we all shut up and
basically the country goes in the right direction and the trade-off is lack of political freedom in return for
economic prosperity. Now the reason that Singapore and Hong Kong colonial governments have got away with
this and made it work, even during the crisis, is that Lee Quan Yu does understand the very great importance of
the rule of law. Also they have the advantage that you're dealing with pretty small countries, city states, which
are pretty easy to run. It's the same a Mayor Giuliani here having zero tolerance for J-walkers. He'd have a pretty
difficult time doing this in California I would guess.
          The key strength of having a rule of law is that the bureaucrats can actually take measures that are in the
best interest of the country very quickly, and you flexible systems. Whereas the fundamental problem in many of
the Asian countries outside of Singapore and Hong Kong has been the natural reaction. In this respect, what Dr.
Mahatir has been doing has been entirely rational, or Suharto and the like, is you protect friends, families,
cronies, acolytes and the like.
          So fundamentally, although we're all economic rationalists, we actually have to make a political call at
the moment. And the political call is: Where is the institutional structure strong enough or adaptable enough that




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we can get some change coming through? And I believe we are seeing that in Korea now. I think we may be
seeing that in Thailand, in the Philippines the jury is out. I think other countries still are in denial.
          So when it boils down to it, as I'm running out of time, I won't go into the IMF side, but I think, although
its very trendy to beat up on the IMF, I think probably 80-90% of what the IMF is saying is pretty sensible. But
unless the political will is there at home to implement, at least to a good extent, the policies that are being
demanded, there is no end in sight for some of these countries.
          I guess I'll leave it there. That's the sobering message I'd like to leave and I'll pass on to the next
speaker.

Barry Eichengreen: Thank you Simon Ogus. Our fourth speaker is Reimut Jochimsen, President of the State
Central Bank of North Rhine-Westphalia, and Member of the Central Bank Council of the Bundesbank

Reimut Jochimsen: Maybe its the best to try to speak from here before my voice gets completely spoiled by
refrigeration which is taking place.
          Well ladies and gentlemen, there are two starting points for today's discussion, and I think both are right
but insufficient to cover the subject.
          One is the confidence and the trust for those investors from western countries going into the emerging
economies to be bailed out at all costs and doesn't have a lesson to be learned by these investors themselves. And
the second question is of course is it really as our first speaker said, a serious institutional deficiency in the
international system which is worrying us? To my mind it is more the lack of acceptance that the national
economic performance both financially, economically, structurally and in terms of growth and development
perspective is at stake.
          I missed in this very first paper any reference to anything of responsibility by the national government.
And I think this is a lesson Europe, and this is the first conclusion I want to draw, Europe had to learn, not in the
80's, but in the early 90's when in the EMS crises of '92 and '93, it had to be made clear. There is no indefinite
bailout. And even if the Mexican crisis (I would say Mexico two, because in the Mexican one crisis in 1981-'82,
we did not have such a complete bailout as in the '94-'95 crisis) set the signals entirely wrong. And so, I would
venture to say the international financial institutions are part of the problem, and not only of the solution.
          And the same, in my view, applies to Japan. Japan has been in breaking of a bubble now for more than
seven years and it has not yet managed to solve its problems. It has propagated the impression that somehow
mysteriously by stretching out solving the problems you avoid them. But now the real problems come back to
you. And of course the degree of intervention and participation from Japan in all these east Asian countries is
very important and very large and it's of course something which has to do with the reason for the south east
Asian crisis namely the inability of the US and the Japanese to settle their trade issues and their future exchange
rate issues in a way which would somehow protect the developing countries or the tiger states in south east Asia
from repercussions.
          To my mind, by mid '95, when the Mexican crisis seemed to be solved in a very generous way by the US
congress and US government putting in billions of dollars and investors got the reassurance that they will be too
big a group to be hurt. That the south east Asian countries, and it was said before when it was tested they
survived the test of the peg to the dollar, but after mid '95, the US dollar from extreme depreciation, remember 80
yen per dollar, then appreciated up to 125-135. Nobody could think that in real economic terms anyone pegging
to the dollar would be able to survive such a roller costar trip. And this roller costar trip has now been on for
three years and an end is not yet in sight. So I would just make the conclusion, which to my mind is very
important, is that it is not just the international monetary fund which can be blamed, which can be asked to find
the solutions to bail out each and every one, but that it is first of all the national economic and political system to
solve the problems.
          And here you have very different aspects, cultural, religious, economic, political, and it is something of
an intellectual miracle to see that all these countries have been affected by the same problems. And to my mind it
is a pegging to the dollar which was borrowed credibility which could not be sustained once the dollar
appreciated in such a magnitude and the yen depreciated. Secondly because of the fact that the reaction on the
side of the Japanese in their economic system had not been forthcoming.



                                                                                                    8
           I think one has to mention another player, the role of which is of utmost importance for a solution to the
problem: that's what will happen to China, what will happen to Hong Kong, will they be able to sustain their
pegging to the US dollar? Which so far for political reasons is taken for granted but to my mind this is posing the
question to the tiger states including Korea: What type of exchange rate regime do you want to follow after this
crisis? And I don't even see much of a start toward this matter.
           The second one is the international economic and financial system. One usually overlooks that the
Korean problem is also related to this race of newly industrialized states to join OECD. And it's hardly noticed
that the OECD has made it an entrance requirement to have full capital convertibility. Much beyond what IMF
***75 asks in article 8 where it just stipulates that you have to have convertibility on current account. And now
talks are: When do members of IMF have to change over to get into full capital account convertibility? And with
this success which Korea provided in the end of '96 and '97, it's just a year ago, of course put a foul egg into the
nest, particularly of banks from Europe which particularly have been engaging themselves in credit extension
namely that for credit extended to the state in member countries of the OECD, no capital has to be put into the
underlying. It's just zero capital. Well that's an invitation to earn money. So I would say it is not just IMF which
has to be addressed, but OECD and others as well, and of course World Bank.
           I will just end my few remarks by saying that to my mind not enough attention has been paid to the fact
that it is the financial system as Paul Krukeman in a very clever piece analyzed in the national set ups of the tiger
states at the nucleus of the problems. If these are not being resolved, I think no solution can be forthcoming. I
want to call attention to the fact that there is a division of labor in existence between the Bank of International
Settlement on the one side and the International Monetary Fund on the other side. Namely that it is not the task
of the IMF to devise rules for banking supervision and accounting standards and other things but to apply them.
This is the one part where in the analysis attention on macro economic factors and on balance of payments may
lead you astray from the structural deficiencies which many of these economies still have and unless resolved
will not be able, in my mind, to get out of this situation very soon. Trust building, confidence building has to be
on tough inner reforms on such rules of supervision of which the Bank of International Settlement has just
published a new and updated version and to my mind this is the biggest task ahead. The difficulty is how do you
regain confidence once it is lost, not just in financial systems, but in political regimes and the responsibility as
well?
           Thank you.

Barry Eichengreen: Thank you. Our fifth speaker on this panel is Desmond Lachman who is managing
Director at Salomon Smith Barney.

Desmond Lachman: Thank you. At this stage in the batting order much that I'd have to say has been said, I
guess I would just put it in a different order, to give a different pitch to the lessons that can be learned. But in
some sense I feel some kind of better understanding of what Chow En Lai said in 1989 when asked what lessons
did he draw from the French revolution in 1789 and he said it was perhaps a little bit too early to come to
conclusions (laughter).
          I think that this is true in the case of Asia right now, you know we really are right in the middle of a
crisis that hasn't really played itself completely out. We might be through the financial crisis, we're going to get
the economic crisis coming later, the political crisis will follow. So I would say that it is premature to draw the
lessons. But the lessons that will be drawn will have to be fairly profound given what's going on. And in that
sense somehow this might throw into light what occurred in Mexico in 1995 and some of the speakers have
alluded to the moral kind of hazard question that I think is really the key lesson we really are going to have to
learn. We are going to somehow install the notion of bankruptcy, of failure, so that we don't get repetitions of the
case. I think that we've really got a crisis drawing across a wide range of countries that have got different
circumstances and there are plenty of lessons that can be learned.
          I think that what surprised us as market observers wasn't that the crisis occurred or that the crisis spread,
but I think that it's the extent of these currency selloffs. And I would venture to say that you've really got to look
at what is driving these currency crises to draw the lessons that might be learned to prevent this in the future, or
to deal with it. What I would say that we've seen is an enormous amount of short term external indebtedness, not



                                                                                                    9
so much the overall indebtedness, but the short term external indebtedness. We've seen a lot of corporate
borrowing that has taken place in foreign exchange that once a crisis begins leads to a lot of hedging. We have
also seen very great weaknesses in banking systems. We are talking about banks that are bust to the tune of 15-
18% of GDP might need to be capitalized. And we're talking about sectors that are totally bankrupt and where
the real prospect of default is occurring.
          Once when one looks at it in that light I think a lot of lessons flow out of it. One of the lessons is that I
would say that there is plenty of blame to go around here. Different parties are going to have participate in
rectifying this in the future. But some of the lessons that I would draw are that fixed exchange rates for too
prolonged a period of time are not the smartest thing to do, particularly if you inculcate in people the notion that
those exchange rates are going to stay fixed and that you can just happily borrow in dollars. It's the same thing as
borrowing in local currency. I think one has learned that that is not the case.
          When this kind of borrowing occurs without sufficient banking supervision with very weak banks, we've
got another set of problems. Lending takes place to property sectors or else one has very poor investments taking
place because there are fundamental problems in the banking sectors. I don't think that is an international
problem. I think that that is a problem domestically that has to be rectified. That's easy for us to see this now
which we might not have seen before.
          So I think I've got some sympathy for regulation of sort, certainly on the banking side. Improved
supervision. And I would have some sympathy for short term borrowing by corporates in foreign currency isn't
the greatest idea, that maybe the Chileans have got something to teach us.
          As far as the international side, in terms of addressing this crises, I think from the Mexican crisis, a
couple of lessons were drawn at the time. One was we should have better early warning systems. The other was
we should have better statistical provision of information. I think on the early warning systems, a lot of work has
been done, but I think with the benefit of hindsight we might now, instead of paying attention to current account
deficits and stuff of that sort, the position of the budget on employment, those sort of things. We should look far
more at the financial indicators: How leveraged are the economies? What is the composition of the debt? How
much is short term? Are the corporates properly hedged? I think that those things need to be added to the list on
the early warning side.
          In terms of statistics, the IMF has done a lot of work on the statistical side, but I think intrinsically we
might have a problem here. The kind of statistics that we were already looking for was how much short term
corporate debt was really out there. We now know that foreign exchange numbers don't really mean much when
countries engage in heavy *** 177*** exchange operations. We also know that banking sector... They are telling
us that only 2% of their loans are nonperforming. When we scratch a little bit we find out that it is more on order
of 20%. I'm not sure what one can do about this but one does need to have an international agency looking at this
a lot more.
          Let me just conclude by saying what I've seen about this is that is that the cost of these bailouts is fairly
staggering. We are on a learning curve that, in the case of Thailand, we thought it was something like 17 billion
could do the job, 40 billion in the case of Indonesia. Now we're 60 billion in the case of Korea and then we're not
even sure that that is sufficient. I think that this is telling us something about the future. If we don't have
bankruptcy in the system, eventually public funds have to run out. It's just a question of time.
          I would just end with one line that I thought was rather good. somebody said that capitalism without
bankruptcy is sort of like Christianity without hell (laughter) . I think that we really do have to introduce that into
the system.

Barry Eichengreen: The final speaker is the very patient Tom Bernes, who is Executive Director for Canada at
the IMF.

Tom Bernes: Well very patient and coming sixth on a panel of such eminently qualified speakers is a very
difficult task.
          I think I was asked to participate because I was involved in the preparations for the G7 Halifax summit
which looked at the operation of the international and national institutions in the context of the immediate post




                                                                                                   10
Mexico situation. What I would like to do is just very briefly bring a perspective from there and what did we see
and do and what didn't we see and haven't we done.
          In Halifax and in the work that was done, we had reviewed the IFI's and there was a general conclusion
that the IFIs had responded well to a changing environment. But that further changes were indeed necessary. I
think we focused on a couple of things. One, the need to take a number of steps to prevent crises from occurring.
But secondly we recognized that we would not always be able to prevent or foresee crises, and therefore there
was a need to be able to respond more quickly. Well we've certainly confirmed our conclusion that we would not
always be able to foresee crises, the question is how well did we did we do on the rest of it?
          In terms of prevention, the first big focus was on, a point other speakers have mentioned, data.
Transparency. Getting more information out. Getting information out so markets could work better, so they
could asses the risk better. And progress has been made on that. But the IMF has put in place a special data
dissemination standard, which is now up on the net. This is a voluntary scheme. In fact countries only need to
come into compliance with by the end of this year. I think we can already see as a result of what we've gone
through in Asia that clearly some of the data requirements need to be expanded. Things like central bank swap
and forward positions, maturity structures of foreign liabilities, and we need much more coverage of domestic
financial institutions. We also need to put pressure on governments to participate. South Korea is not a
subscriber to this data standard.
          Why did we think this data was necessary? As I said, it was to enhance surveillance. Not just
surveillance by the IMF, but surveillance by markets, by the private sector, by the OECD, by others. We
certainly said at the time at Halifax that the IMF needed to be much stronger and tougher in its surveillance and
in its conclusions. In the IMF we've agreed that we will have a postmortem and review just in terms of the
current crisis once, indeed, we've got a little bit of space between it, hopefully. What we did right, what we did
wrong. But it is not just the IMF. The IMF is not a rating agency and it never will be a rating agency, and I guess
that is one point I disagree with David on. While the IMF has to be tough, at the end of the day it is an
intergovernmental organization. It's based upon voluntary cooperation.
          Now economists, as we all know, predicted seven of the last two recessions. they have about the same
track record with crises. These are questions of judgment. It's like somebody who's an alcoholic, smokes too
much, watches too much TV; I mean you can come to a conclusion that a crisis may be coming, but is it going to
be next week, next month, next year? These are very difficult judgments and there's always going to be
constraints on governments.
          But I would go back. Where were the rating agencies? For Moodys, Standard and Poor to come in
when there was full melt down and say we're going to downgrade you, was not very prophylactic. Where was the
BIS? The BIS is charged with the Basal Banking Committee, IOSCO, the Securities Regulation, there are a
number of these other organizations that should have been sending up warning signals too. So I think we have to
review that whole process, and not just look to the IMF.
          I guess the financial sector the third area that was clearly identified in Halifax, that this had been the
start of a number of problems and would continue to be in the future. And there was a need to enhance
international cooperation. And so work has started. I mean through Basal Committee, there being a series of
initiatives through the G7, the G10, but clearly a lot more needs to be done.
          The second element, as I said, was the rapid response, and how have we moved there. One, the IMF
clearly has enhanced its capacity to move quickly. I think that's being demonstrated in the current crises.
Secondly, in terms of financing, what we said in Halifax was there was a need to insure the IMF had the
resources to do its job. clearly, it has had up to now, we have in place the new arrangements to borrow, which
still needs to be ratified. We haven't reached agreement on a quota ***261*** 1/2 increase which needs to be
ratified. We will be in a problem if these are not ratified and those resources made available. And I guess I
would just say that as a Canadian sitting here, as a foreigner sitting here in the United States and watching the
domestic debate when, I guess I get a little bit worried when some politicians try and use this for their domestic
purposes and talk about using taxpayers' money to bail out these countries. I think as Secretary Rubin said, the
IMF has not cost the United States taxpayer one dime. These resources are loaned when they are used, interest is
paid, as in the case of Mexico, the US Treasury, I think, made half a billion dollars. The United States has very
vital interests at stake here, and I think it's problematic when politicians play with it for cheap purposes.



                                                                                                11
          I think the last big issue I just want to focus on is the debt work out which others have highlighted. And
this clearly has come to the forefront in terms of the Asian crisis. But with a focus I think which is different from
what we've seen before. We are not for a large part dealing with sovereign debt here. We're dealing with private
sector debt, sometimes with implicit or explicit government guarantees. But the question is how should we
approach this when there is a huge problem with the dimensions we in a Korea or an Indonesia. The debate
earlier, certainly drawn at the time, but Halifax had been more in the context of sovereign debt, and talks about
international bankruptcy proceedings. Should we have a bankruptcy court for countries. That's been looked at,
there's been a lot of debate on that, there's obviously a lot of problems and one's going to need come back and
review that.
          In terms of the private sector though, there are bankruptcy proceedings. One could have just said in
Korea, fine, we'll let these banks default, we'll let these corporations default and then we'll go through the
proceedings. The real question is, is that in the interest of the international community, the financial sector, and
those countries? And I think clearly the conclusion that a number of us came to was no, it was not. But the
answer cannot be on the other hand that the IMF is going to turn around and fund all those necessary resources to
cover those debts because the IMF does not have and will never have the resources to do that. And so there's
going to have to be some approach in those sorts of situations to deal with that. We're working our way through
it in Korea. We're working our way through it in Indonesia. These are very early days, but we're going to have to
explore, and I think this going to be potentially the biggest issue and the newest area we're going to require a lot
of thought. Therefore I'm looking forward to the subsequent panel discussions for some ideas in this area. Thank
you.

Barry Eichengreen: Thank you. We have a bit less than an hour left for general discussion. I think what we
might is give each panelist, if he so desires, a minute or so to respond to comments from the other panelists if
they were so provoked. And after no more than six minutes having gone around once we'll open the discussion to
the floor.

Yung Chul Park: I would like to be very clear on one issue that Korea and most of these east Asian countries
are responsible for the current ongoing financial crisis. That's the point I tried to make and I think I made it. But
the problem is that all of these countries have a very weak financial structure and have lots of problems in their
banking system as well as in their industries. Now at the same time, these countries have been pressured to
deregulate their financial markets and at the same time open up these markets by advanced countries and
international organizations. In the process of deregulating and opening up the markets, these countries tend to
lose, in fact they have lost all of their macro economic instruments to deal with the macro economic instability.
          My question is, and in fact many people are saying that the problem is ours and we have neglected the
warning signs and the recommendations made by many international institutions. Well, that's our problem. But,
what about the international lenders? They have known about these problems and what have they done? If we
are asked to open up our markets while we have such a lousy infrastructure, how could we solve these problems
all by our selves?
          So the only solution in my view is that if, in fact we have resistance in South Korea, resistance for a
long time because of our structural problems to open up our capital markets. But the for the last two years,
especially after we joined the OECD we have opened up our markets completely. In fact, after we went to the
IMF, we don't have any regulations to speak of on capital movements.
          And at the same time the international community is complaining that we have a lousy banking system.
What do you want us to do? We cannot rectify our problems at and the same time open up our markets, we can't
do the two things at the same time.
          The question is whether the community is prepare to wait until we fix in house problems. I think that
more attention should paid to this question of to what extent and how fast we should ask these emerging market
economies to open up their markets. As I said before, most of these foreign lenders are only interested in market
access.




                                                                                                 12
Desmond Lachman: I think I'd just like to just expand a little on the problem of moral hazard, and how the
system works, how I see it now. I've been at Salomon just a year and a half and it's really interesting to me to see
what moral hazard is really about. We might be aware, keenly aware of problems in countries, yet we are still
going to get large flows of money going to those countries as long as one has the notion that one is going to get
bailed out in the end. I'll give you a very specific example. I get frequently asked what are my views on the
Russian economy, which I think is quite an easy one in terms of the fundamentals. I tell people that I think that
the fundamentals are rather poor, that they can't attack the budget problem, that they've got an internal debt that's
going to go up. that commodity prices are falling, that oil is a big thing, the whole works. And at the end of this
conversation the investor will patronizingly tell me, "Desmond, when we are buying Russian GKO's we're not
buying Russian credits, we're buying G3 credits at high interest rates. And I think that really how the problem
that somehow has to be addressed is how do you regulate these flows, what is the role of the international
organizations in making it clear that things are awry or that things aren't going to turn out as well as they do,
otherwise we're just going to be getting money continuing to flow in big scale and we're going to be facing a
whole series of these problems before... There are many other emerging markets that one can point to where
fundamentals aren't good yet where money is flowing on the notion that people are going to be bailed out in the
end.

David Folkerts-Landau: Just one point on this issue that was raised by the speaker from Korea regarding the
challenge of joining the international financial system with with open capital flows. Clearly, that's one of the key
trade offs that a medium size or small size country in Asia or Eastern Europe faces in the sense that if you want
to be a full fledged member of the international financial system with open trade and financial flows, you are
facing an enormous policy challenge. You will make sure that the financial system is sufficiently liquid to deal
with the withdrawal of funds at very short notice. This will require restrictions on the banking system to do, not
just with the capital requirements of course, but also with loan to tier ratios in the mortgage markets. It will have
to do with the overall liquidity structure in the bank balance sheet. This is expensive, to have a liquid balance
sheet in the banking system is expensive. In addition, it's a question of exchange rate regime, the ability to allow
the exchange rate to adjust in such situations. Or, in the absence of that, the ability of the monetary authority to
sterilize the monetary impact of exchange market interventions.
           All of these things we sort of say it in the litany, we've gotten used to saying that. But these are in
practice, extremely difficult conditions and, in my mind, this choice between having some form of capital
controls or, to use a somewhat nicer word, prudential controls, vis-à-vis the benefits from being a full fledged
member of an open trade and financial system is not at all clear. I can very well imagine a small country in South
East Asia, let's say Thailand for that matter, to forego the benefits to some extent of, for instance, completely free
capital flows in various segments of the economy. Or completely free outflows of various institutional investors
in Thailand, such as pension funds through various capital controls. But at the same time, then gain a certain
amount of stability within the financial system.
           That's a very difficult choice. I would submit that we should at least entertain the thought that we may
have overshot in the direction of liberalizing these markets and some rethinking there might well be in order.
           Thank you.

Reimut Jochimsen: Well I take up this point. I think the present state of globalization and to the foreseeable
future, enhances the separation of the financial markets from the real economic development. And I think one
should look into bridges. In capital flows, to my mind, there's no way to return to capital movement controls, but
maybe to apply the brake in the speed in which these are implemented. And to make a difference between direct
foreign investment, which is an investment in management, in techniques and in further cooperations where the
looseness of the capital able to return any minute to the western markets is somehow subdued, or at least made
more difficult.
         We have been losing in the talk on emerging markets this essential difference between direct
investments and portfolio investments. And of course, in bailing out investors behavior as we had in the
Tesobono case in Mexico, it was quite clear that the lender of last resort function of the IMF would be extended
to each and everything. And to my mind, this has now hit its logical end because all the funds you will have to



                                                                                                  13
put up in this case, if even more countries would collapse, which nobody can exclude, then it shows that you need
to have some principles to apply where lender of last resort policies end. The terms systemic risk and meltdown
is so easily applied for each and every proposal to expand this scheme so that I think this is in part really helping
to enlarge the problem rather than to contain it.
          If you have a country like Estonia, which went on a currency board system and installed at the same
time free convertibility on current account as well capital account, it could manage to do that because of a very
clear cut economic national policy agenda. I would venture to say that this is not a very general recipe which
would help.
          And the fixing of the IMF on fixed exchange rates, or on pegging the exchange rates, in my
understanding is of more recent nature than of the 70's or 80's. But it is a question which is ahead particularly if
Europe now forms with ***460***1/2 a block with fixed exchange rates inside the continent will be an important
element.
          And I think one should discuss very keenly, and I would say practically with a negative result, the idea
of Soros to set up a kind of IMF as a cooperative mutual insurance company which will insure against each and
everything, hopefully without any fees to be paid. And of course this can't work because it is an invitation then
really to get into either a kind of dictatorship of supervision, or into a situation where you have to bail out each
and every one, which will not function.
          So I think we are at a turning point. Marc Uzan very rightly pointed this out and I think its important to
determine the role of the international institutions, which they will have to play in this in a cooperative manner,
and not just for selfish institutional reasons, though I can of course follow them intellectually.

Barry Eichengreen: Thank you. The floor is now open. We're going to need some technical help I think in
getting the microphone to speakers from the floor. I would urge everyone to identify themselves and their
institutional affiliation when they are recognized

Ricardo Hausmann: Thank you, Ricardo Hausmann, Inter American Development Bank.
          Let me ask the panel if we're not sort of over using this moral hazard argument and under utilizing other
models that are out there in the literature. And that may have a more explanatory power than just the moral
hazard argument. To begin with, a moral hazard argument does not explain the timing of crises. It's a permanent
thing so how come Korea has been at it for 40 years successfully and the crisis happens just now? Or Indonesia
or other countries that did not go through the liberalization that Korea went through? And secondly, a lot of
people have lost money in the stock market so, how come there is so capital inflows into stocks that don't have a
moral hazard argument?
So let me point to two alternative models in the literature that would point to two very different policy responses.
          The first one is multiple equilibrium problem. That if there is sufficient short term debt there are two
equilibria, one where everybody renews a debt, and all the loans made by banks in construction and so on are
great and happy and so on, and one where people do not renew short term debt and then exposed you will find
that banks have been misallocating resources because they made all these investments that make strictly no sense
now that GDP is dropping by 8% and the exchange rate has depreciated by 400%. So, that is a similar problem to
what generated the logic of a lender of last resort and that is a typical argument that is made in institutions to
sustain equilibria where there is a lot of short term liability.
          So that's one type of argument that's out there. The second type of argument is the idea that since this is
international lending, international lending is subject to sovereign risk. And sovereign risk arguments typically
lead to a national debt ceiling. That you wouldn't only lend to a government to the point where it wouldn't be in
their self interest to stop payments. That means that the market would impose something like a national debt
ceiling, but since debts are contracted in a decentralized manner, then everybody has an incentive to borrow
quickly before they hit the ceiling. And that would generate periods of over borrowing followed by periods of
crisis, in which case the policy intervention would be much more substantial, it would require some mechanism
to allocate the quotas for borrowing. You would have to sort of have a bidding process for quotas of borrowing
under the national ceiling.




                                                                                                 14
         So, these are things that might explain probably a little better the dynamic sequencing of crisis, the
timing of crisis, than just pure moral hazard problems and might lead us to a very different direction. So I don't
know if the panel might want to comment on that.

Barry Eichengreen: I will recognize one or two people from the panel if any of them wish to mount a defense
of the moral hazard point.

Desmond Lachman: Sure, you know I do agree with Mr. Hausmann that moral hazard doesn't explain timing at
all. We are talking here, I think, about bubbles developing. I think that what moral hazard does do is it
encourages lending at stages where lending should not be justified. The notion that you are going to be bailed
out in the end means that you don't really look at the fundamentals, you don't have to look at the fundamentals
because you know, the example that I used in the case of Russia would be a case in point that if you are giving
signals coming very clearly from the international institutions from the G7 that countries aren't going to be
allowed to fail, I'm not sure that it's a question now of looking at where the debt ceiling is. We've got additional
players coming into this game. Namely, the international institutions, the G7. So, irresponsible lending takes
place. When a bubble bursts, you know you're absolutely right, it's fairly amazing that these Asian countries, a
little while ago were being regarded as miracles, now they are regarded as somewhat basket cases. But, you
know, you've really got, I think, bad fundamentals that markets didn't pay attention to and I think that's really the
challenge of the international institutions. It's not to throw additional money and to make whole a lot of the
investors. You're right that some investors lose, but a whole lot of other investors don't lose and we're just going
to get the cycle repeated and I think that's really the challenge. Not to provide the money that gives the wrong
sort of signal to do more in terms of early warning to increase transparency, to fundamentally change the rules of
the game. It's easy for me to identify that I don't know how to do it but I think that the rules of the game have to
be changed, otherwise it's going to imposed by just running out of the money to continue this game.

***594*** 1/2 Who is speaking? So, you would argue that the stock market should provide the right signal
when there is a moral hazard problem? Because they are not going to protect themselves we should look at the
stock market as that there is a moral hazard problem.

Desmond Lachman: Well I think that, in terms of the stocks, that might be a good indication, you know that
investors, you might not get money going back to buy in these countries. That I think is a lesson that's been
learned. You're not going to be getting that direct investment flow the same way as you had before. But I am
referring more to stuff like bank lending, or portfolio lending, the Tesobono kind of stuff. You look what's going
on in Mexico with MTN's, that really has to give one some pause that we are getting this flaring up again. I think
that's because we don't have the right kind of institutional rules.
***Tape Ends***
          That capital markets and equity markets and bank lending on the other side is extremely important. The
moral hazard argument applies much less to the former than to the latter. There's no question that securities
markets have adjusted very quickly and investors have taken tremendous losses in securities markets, particularly
in domestic currency markets. It's bank lending that's the problem. It was in 1982 and it is again. And if you
look at the growth in bank lending over the last two years you see that's where the big growth occurred, both at
the short end and somewhat longer as well. And what you have is, you have an industry that has a fairly low cost
of forming a very closely knit coalition in the negotiations that securities holders just don't have. That allows
them, for instance, to move much further along on the contract curve than anybody on the securities markets
could do. So, when I refer to moral hazard I specifically referred to moral hazard arriving in the context of bank
lending.

Question: Why did the stock market in Korea not go down two years ago?

Yung Chul Park: Because everybody was telling us that our fundamentals are very strong and we are immune
to this kind of crisis. And I'll tell you that the stock market in our case triggered this crisis and the moral hazard



                                                                                                  15
has deepened our crisis, and there is the difference. The global institutional investors are also responsible for this
crisis. And the moral hazard as he pointed applies to the commercial bank lenders.

***22***2/1 Unknown panelist: I just want to respond to why did the stock market, the Korean stock market
tank when it did. Often times stock markets behave in particular ways if short term interest rates move in a
particular manner. During a currency crisis, when you have short term interest rates going up, you've got your
discount factor rising in terms of what you're doing on the earnings, that's the one side of it. The other side is on
Korea, and this is a fundamental weakness in the Korean case, is their corporates, on average, are leveraged, their
gearing ratio, their debt to equity ratio is something like 4.5 to 1. When interest rates rise to protect a currency,
that has some bearing on the state of corporate sector when you've got those ridiculous kind of gearing ratios.

Mr. Shigehara, OECD: Since some speakers talked about an implication of the accession of the two new
member countries to the OECD who unfortunately got into difficulty, I might first like to say a little bit about
how I see the relationship between the member countries accession to the OECD and the difficulty they got into.
          First, with respect to Mexico. When the accession negations started, already that country had completely
liberalized capital accounts. There's no difficult negotiation between the OECD and Mexico with respect the
state of affairs on the code of OECD capital liberalization. We had a problem, obviously, about how to asses the
troubled banking situation and also the statistical standards and so forth. But that was not related to the code of
capital liberalization. The situation with respect to the code of capital liberalization was different when Korea
wanted to join the OECD. Again here, it is not really the issue of short term capital flows. We have always been
very flexible with respect to portfolio capital flows, short term banking flows, and so forth. ***44***2/1 to the
matter in the negotiation of Korea with respect to the OECD code of capital liberalization that we thought that
direct investment inflows into that particular country, and also long term capital flows in other forms, must have
been more liberalized, and that was the heart of the problem.
          I think that the problem of maturity transformation, at the time when the Korean market***49***2/1
and also thought that the fixity of exchange would continue, so that the risks involved in borrowing short in
foreign currency was not just a matter of maturity transformation, but in case the exchange rate moved, there is a
very important problem of exchange risks would affect the credit worthiness of borrowers from the Korean banks
and foreign banks. So that was the heart of the problem, in my view.
          Now coming to the question of the exchange regimes of those countries that got into difficulty. I foresaw
when those countries, including Korea, before its succession, the problems would easily arise if the yen exchange
rate would change the pattern against the US dollar. So already in 1995, when the yen rose to 80 yen to the
dollar, which was unsustainable, sometime to be reversed so that enormous flow of funds from Japan to these
economies, ***61***2/1 there was an export boom in those countries would be reversed. I have argued that they
should probably continue to use baskets of currencies, but in fact in that currency basket the weight of the
Japanese must be increased so that they can be protected to a certain degree this kind of shock coming from the
exchange market. So as the Asian economy becomes more and more integrated with each other, it is very
important to be more flexible in terms of the currency basket. I'm not talking about the generalized floating of
currencies, there is indeed a problem of exit. How can these countries become more conscious about the
exchange rate effects and also that is important for lending foreign banks who themselves don't carry the foreign
exchange risk, but to the end the final borrowers are not really against a exchange risk, in fact the problem is
becoming the credit worthiness of borrowers in other channels.
          So I think the question I have in those countries who have now experienced the difficulty, to what extent
the exchange regime can, after this generalized floating, move toward somehow, a more coordinated effort of
exchange rate management that includes obviously Japan, but more so important, trading partners Korea and so
forth?
          Another question I would have is how do you think in that context the exchange regime of Hong Kong,
and more importantly, China?
          Thank you.




                                                                                                  16
Barry Eichengreen: Perhaps we should collect a couple of more to add to these questions about exchange rate
regimes in Asia generally and the case of Hong Kong in particular. So let me ask the panelists to hold their
responses for a moment.

Nancy Northrop, Alliance Capital: This isn't a question about exchange rates, it's more a question on the
earlier discussion on bailout and moral hazard. I kind of found that whole discussion fairly interesting because
looking at these countries, and in particular Indonesia, I wonder really where the bailout is and whether or not
we're not premature in talking about issues of moral hazard. When I looked at Mexico right the bailout, it was
quite clear who the bailout money was supposed to be directed towards, that was the Mexican government, and
then who that money was going to be ***88***2/1 on lent to, which was the Tesobono holders. It was very
integral as to who exactly was being bailed out. But when you look at the countries in Asia, and in particular I
am thinking here of Indonesia, we talked about the size of the package, how large these packages are in Asia, and
in Indonesia's case it's, depending on which accounting you're using, something between 32 and 40 billion
dollars. But virtually none of it has been lent. And it's not even clear to me who the money is supposed to be lent
to. Certainly, I guess it's supposed to be the government, and maybe it will part of the, if they come up with a
restructuring package for the private sector. But I wonder if one of the lessons learned out of this is that really
the international community is not willing to go in and bail out countries. They are willing to let these countries
fail. It's kind of hard to argue at this point that Indonesia hasn't failed. This country's currency is really testing
the bounds of how far a currency can actually drop. I just wonder if we are not being real premature on this
whole discussion of moral hazard.

David Hale: Barry, you were at the IMF, and maybe Mr. Bernes could contribute as well.
         At the time that Thailand was under pressure to devalue and the subsequently did float its currency, just
how much awareness was there in the IMF, in your discussions at this time, of the magnitude of these unhedged
short term dollar liabilities in the region? Did they rank high on your list of concerns or were they quite marginal
compared to other things, such as the size of the current account deficit, trade competitiveness, the more
traditional things that dominate press coverage on this area? I think it would be very useful for the group if we
had some sense of how the IMF itself perceived the trade-offs. As we first had Thailand, then Malaysia, then
Indonesia abandoned what had been long standing exchange rate pegs and float and then suffer the consequences
through this rush to hedge.

Barry Eichengreen: My arrival at the fund coincided with the Thailand devaluation. You shouldn't read too
much into that either (laughter) rather than preceding it, but there are at least two people on the dais who I think
can speak to that if they wish, more authoritatively than I can. So, let me turn things back to the panel. We have
a series of questions now that I think panelists can address.

David Folkerts-Landau: Yes, on this last, David Hale's question of who knew what, when? I would say that by
May last year we had a reasonably good idea about the order of magnitude of exposures. The size of the
unhedged exposures and also we had some idea that institutions like Peregrine were creating regional junk bond
markets by allowing Korean merchant banks and Thai finance companies to pick up paper from domestic
corporates in the region relying on their domestic guarantees. I say, it's order of magnitude. We're talking about,
it could be 5 billion plus or minus, but that was going on was well known. Essentially, as you know, there is no
data base to this. So the way we do it is we have a mission going around talking to market participants, hundreds
of them to get a feel for what's going on in the region. Certainly our group in capital market surveillance, as I
said, by May when we reported back on these issues, we had a pretty good idea that in Korea there was major
exposure, that any rapid change of the exchange rate would precipitate significant losses.
         But I would not be entirely truthful if I allowed you to interpret that as saying we expected the
magnitude of the reaction. It wasn't. It was just that we expected losses to occur if there was a sudden exchange
rate change and that these losses might knock off some marginal players. There was never a question of
undermining the sovereignty of the entire corporate debt market for instance in Indonesia. So it was not for want




                                                                                                  17
of trying, it was just, there is no international data base. You can go and talk to Peregrine about they are doing
and they'll tell you to some extent but you've got to go to a large number of players to add it all up.

***141***2/1 Unknown Speaker: I would like to address the question on the future of exchange rate
management in the region. I totally agree with your point that there is going to have to be significant increase in
yen weightings in any basket that comes through. I guess you have to look as to whether we're going to see
moves towards regional exchange rate management cooperation, and I think that is highly unlikely. I think that
the whole sham of these repro agreements and the like was exposed very clearly by the Asian crisis and that once
Thailand went it was good old beggar thy neighbor, nation state politics once again.
          In terms of managing your exchange rates against the basket of your trading partners, I think for
countries that have such high degrees of trade to GDP, it makes eminent sense. And obviously the trade off, the
smaller the country, the more the exchange rates focus does make a lot of sense. And I think that in Singapore
and New Zealand, we probably have the two best examples in the region of where these countries should be
looking to go, in that they target a trade weighted index, but with the implicit target of trying to stabilize the real
trade weighted index. So the Singapore authorities, for example, try to appreciate the trade weighted Sing dollar
much in line with what their expectations are for relative unit labor cross growth. I think that is a sensible way to
go.
          I think that the Hong Kong situation is somewhat unique. I mean obviously we're not dealing a quasi
independent or completely lack of independent central bank trying to manage exchange rates, we are dealing with
a currency board. As Dong Tsang, the financial secretary put in Hong Kong the other week, it's a bit like
virginity, you've either got it or you haven't, there's nothing in between. I think at this stage for Hong Kong,
given its unique political background, why the exchange rate mechanism was put in place, I don't think Hong
Kong can be counseling ***164***2/1 any change in regime. And I think that Hong Kong will just have to take
the deflationary aspects which its flexible labor markets, its flexible fiscal policy, and more importantly, its
flexible bankruptcy laws. The fact that Peregrine was allowed to go under was a very strong signal for Hong
Kong. I think we'll allow it to occur.
          But I think going forward to three years down the line, they will also have to move to that more
Singapore style policy.

***171***2/1 Unknown Speaker: Just very briefly, You know I agree with the point on Indonesia, that's it's a
little early to know how this is played out. When we're talking about moral hazard, it's more looking forward that
when you get governments guaranteeing what were thought to be private debts, that introduces some moral
hazard. There's an implicit guarantee. You're right about Indonesia, it is too early to say.
           Just on the exchange rate question, it's very difficult to prescribe what the right exchange rate policies
should be for a group of countries that are very different. For some countries to stabilize, they presumably are
going to eventually have to fix the exchange rate, it might be a good idea.
           But the point that I was making is that it's not a question of the composition of the basket that got some
of these countries into trouble. That was a problem in terms of the trade side with the Japanese yen moving in
the way in which it did. The point I was trying to make was that if you give people assurance that the currency is
not going to change and people begin to believe that, you can then get into trouble with corporates going out who
are not naturally hedged and borrowing big sums of money. So it just reinforces my prejudice against fixed
exchange rates for too long a period of time. They've got uses at some stages but it is very difficult, it's never a
good time to exit from those kind of arrangements, but exit you have to do.

Yung Chul Park: About this exchange rate regime, we just moved from a managed floating system to a
completely free floating system and, in my view, especially during a crisis, when the crisis breaks out, no
exchange rate regime is going to work very well and the question is when and how we could go back to some sort
of managed floating system because it is clear that in a financially liberalized open economy like Korea, the
floating exchange rate system is not working very well. And about the exposure of Korean merchant banks;
according to some of these newspaper reports, their unhedged exposure to, as you said, junk bond market, is
somewhere around, on the order of around 5 billion. I don't think that exposure could have triggered this kind of



                                                                                                   18
major crisis in Korea. And the problem with this merchant bank was that during the process of financial
deregulation, we lifted up all our regulations on their lending behavior. That was a part of financial
liberalization, including prudential ones. But in managing regulatory structure, it is very difficult to differentiate
prudential regulations from not so prudential regulations at all. In fact, once you're in this process of
deregulation, everything goes. So that for the last several months, and especially the last couple of months,
before the crisis broke out, no one was looking very carefully into the lending and borrowing behavior. That was
our mistake, but that was the price we had to pay for the financial market opening.

Reimut Jochimsen: Well first to the question of an optimal exchange rate regime. Well, frankly I don't see a
general solution to this. I think, country by country, it has to be analyzed whether it's possible to re-normalize the
overshooting, which we have experienced of course everywhere, because I think the exchange rates ultimately
will again go up. By setting up yard sticks of currencies you want to measure yourself against and from where
you may borrow credibility. But only for a short time period. I agree with what has been said before that the exit
should not be too long. I think this could be part of the problem if the orderly debt work out would take a long
time, a longer time, and this is of course (*** 227 2/1ahead ***) in some of the countries now, whether there is a
debt moratorium or whatever type of rescheduling comes out.
          I just wanted to mention Bulgaria here which has moved over to a currency board system last year with
some quite impressive results because of the decisiveness of the political leadership to do just that.
          Toward this bailout question, I have two remarks. I agree that what the young lady said about Indonesia.
I fully understand that this is still going and it may be that the markets won't accept the package of 40 billion.
What will the fund then do? So the real question for the fund is: Should it go in in proving if it's not acceptable?
Well I would say the part of the story is the reform of the financial institutions, which is not just the banks, to
restore confidence in this and I think it is a very good lesson to study.
          Looking back at the end of the 80's and early 90's here in this country when the savings and loan
associations went astray, and there was the moral hazard problem of congress guaranteeing to bail them out all
around. And I remember very well when it exploded, there was of course a lot of business to be made and profits
to be earned by high interest rates and many other things and selling the assets, etc., and the poor and bad loan
credits and I remember that sometime in the early 90's there was an estimate in congress that this would cost
about 450 billion dollars. Now I looked into the final report, it came out with 180 billion dollars. It's a huge sum,
but it is a question of whether you are following by setting up bigger and bigger sums or whether you, as you
have to do, I am not against providing an aid scheme of IMF standard, I think you should apply conditions very
narrowly, also interest rates with this new facility which is in a very fast track making ready. But the real issue
which is behind it to my mind is what kind of conditions are being put out and in what time to they have to be
followed. And here I sense that treating the macro economic and the financial systems questions to be quite apart
from the political issues which are very tricky of course to tackle, no doubt. And I know what we speak about
when we speak about Indonesia in this instance. It is to my mind very clear to see that in bailing out as well the
managing director is saying we need more money to be able to throw in, maybe not in Indonesia, but in other
cases, you are, as a matter of fact, inviting the stability of systems and not bringing about the change necessary. I
agree, this is maybe overburdening IMF. And it's no coincidence that in the case of Russia, it was the G7 which
took over some of the responsibility. Which to my mind is also not helping because government cooperative
venture of an important government in the world cannot substitute for this. I remember very well there were
some talks at the end of last year that there was to be a victory announcement that by spending more and more
money we would just kill this financial crisis. But I am sure we will not. We will have to go into institutional
reform much deeper and this takes of course a longer time. So there's no easy way to get out of that and the
Indonesian problem is still evolving.

***Unknown Speaker 284 2/1***: I'll try to be very brief.
         On the moral hazard issue, I think there is a whole panel on it. It's a difficult problem but I'll just make
two points.
         One, when the Fund goes in there is always very, very tough conditionality associated with it. There is
no free ride here and no country is going to screw up their economy in order to have access to IMF funds, I can



                                                                                                  19
assure you and Jack Boorman could assure you even more. The real issue though is if the country is prepared to
undertake the necessary steps to reform its economy, what should the international response be? The response of
the Fund is if countries are prepared to take the necessary steps, then we are prepared to provide funds to support
in that effort. And the funds clearly go to the government. It's true in the case of Indonesia they've not drawn
down much because their foreign reserve position in fact, unlike the situations that we have found earlier in
Korea and Thailand.
          The other part of the moral hazard problem in dealing with banks, I mean, how to insure that everybody
gets a sufficient haircut and that there is some spreading of the burden of the restructuring. And that's, as I tried
to indicate, a question of we're all going to look at more carefully.
          On David Hale's question, I think David partly responded to it, but I think, my sense saving the board, is
the focus has been more on the traditional measurements, partly because of lack of data, I think as David said, but
it has more of a traditional analysis. In Thailand, its now known, the board focused discussion, obviously we
have the staff report that goes through the board and the board has its own discussion. But the board focused on
two questions; exchange rate regimes, and the weaknesses in the financial sector. It was the very strong view in
the board that Thailand should introduce greater flexibility in exchange rate. The response from Thailand was,
"we agree with the policy prescription, but the timing's not right." Well, in hindsight, had they moved the
problem might have been much less.

***321***2/1 Unknown speaker: On the issue of the exchange rate, it's always an interesting intellectual issue
as to what the right exchange rate is, depending on how the country is structured. That's not the point with these
discussions. This is not an exchange rate crisis. This is a financial crisis. In none of the countries the difficulties
were caused by having the wrong exchange rate. In none of these countries were aggravated very much by the
exchange rate. This was a financial crisis. As such, in terms of the remedies what should be addressed too was
the financial crisis and not towards the choice of an exchange rate regime. That's the first point.
          The second point, our friend from Alliance Capital on Indonesia. Absolutely right. Indonesia is going
to be a test case. Now you have a country here where it's basically in gridlock. You have deposits running out
into currency at the rate of about 30% in the first two or three weeks of the year. You have banks that don't lend
to the corporate sector anymore because it can't tell if it's solvent. You have a corporate sector that isn't paying
anybody, neither domestically or externally. And the whole thing just comes to a standstill. The question is,
there are several approaches here. One of them is to guarantee everything that moves, starting with deposits, then
going on to bank loans, then going on to external creditors. Another way would be to go through a situation of
having a write off both domestically and write off externally, and do that fairly quickly. I suppose time will tell
as to how this is going to come. But there is no question, as far as this question is concerned, that Indonesia is
going to be the test case, not Korea, not Thailand, but Indonesia. And so we shall see.
          Finally, as far as the lender of last resort and the fund is concerned and the size of its resources, I do not
believe that the size of the resources themselves constitutes a moral hazard. It's a question of how it's being used
and what methods are being used. We could hardly think of the central bank that creates moral hazard because it
has an unlimited access to a supply of funds to the banking system under its control. It's a question of when it
applies it and how stringent the conditions are. The flip side of that coin is that if your role is of trying to
backstop liquidity in the international financial system, in a very legitimate sort of way, liquidity crises do occur.
They occur in domestic banking problems, they occur internationally. If that is the role of the International
Monetary Fund, and then we have to make sure that it's got the resources to do that, otherwise you're running the
risk of making the problem a lot worse, if you're half way through and you find that you don't have enough money
to spend on calming markets.
          Thank you.

Barry Eichengreen: I think that's probably a suitably sober and provocative note for us to pause on for coffee.
We will pause until 11:25 and return when the next panel will answer the questions now raised.




                                                                                                    20
PANEL II - THE BRETTON WOODS INSTITUTIONS AND THE RESOLUTION OF THE CRISIS:
CHALLENGES AND CONSTRAINTS

John Welch - Chief Economist, Latin America, Paribas.
          An alternative title for this panel could be: What role for the IMF and World Bank. And interestingly
enough, this recent crisis in Asia has brought back many of the criticisms that we heard during and since the early
80's when Latin America went through a somewhat similar crisis. Oddly, many of the arguments are exactly the
same. Many of them appeal for differences in structure of the economies or historical circumstances to criticize
the austerity measures that IMF and World Bank help, impose is not the right word, or go along with the
agreements. Most of this criticism, to my mind, doesn't hold up to scrutiny. To start things off, I wanted to put
bit of argumentation I find particularly interesting, and probably wrong. The argument goes something like this:
The debt owed by Asia is primarily private sector, as opposed to government sector. That differentiates this
particular crisis from the Latin American one. And therefore World Bank and IMF austerity, whatever that is,
doesn't really apply in this particular case.
          First, it's not quite correct from a historical point of view. The southern cone countries from Latin
America borrowed primarily in the private sector, some in different degrees. And really the way they came out of
it really what differentiates probably good policy from bad policy, and I think we're now going through another
experiment here in Asia. For example, in Argentina, the Argentine government in the early 80's, pretty much
nationalized not only the external debt, but the internal debt, but from a position of extreme fiscal weakness,
which then led to a decade long battle with hyper inflation and trying to stabilize from there.
          Another country, Chile, also partially nationalized their debt, but from a position of fiscal strength. I
think what this does first of all, to my mind, is it tells me that fiscal strength is important whether it is private
sector debt or not because the temptations to nationalize are going to be there, especially if the countries worry
about being cut off indefinitely, whether they are public or private sector, from international markets. And
secondly, I think, perhaps when it is private sector debt, the IMF and the Bretton Woods solution may even make
more sense.
          Anyway, with those thoughts, I would like to turn it over to our panels, who probably have much better
and much deeper criticisms or insight into the process we're living in Asia right now.
          The first person we have here is Jerome Booth, Head of Market Research at ANZ Investment Bank.

Jerome Booth: Thank you very much.
          What I want to talk about is carrying on from that. Just to focus on the various criticisms of the IMF. I
don't know if anybody overheard me, my colleague told me the microphone was on when I was chatting to my
friend and I said, not meant to be for public consumption, that whereas I felt there was an argument for closing
the World Bank down, I didn't think there was one for closing the IMF down. I do think that the IMF needs
support. Going through the arguments, I think the two sort of serious attacks, if you like, on the fund are actually
coming from opposite extremes, which must say something. It must say that their basically doing something right
if they've got some sort of balance there.
          On the left, if you like, or on one side, you have people like Jeffrey Sachs, who, unfortunately is not here
today, but obviously he has had a problem with the IMF for a number of years. He, and other people like him,
and this doesn't necessarily represent all his views, but this view sort of comes from the argument that, first of all,
that there isn't a fundamental problem in Asia. That one needs to have bailouts, if you like, but without some of
the tough monetary and fiscal conditions in particular, which have been very heavily criticized. And also that
somehow the IMF should be more transparent, etc. Presumably so that other people can scrutinize everything.
          firstly, I do think that the assumption that there isn't an Asian problem is completely wrong. There is an
Asian model. The Asian model has been successful, but that is not the same as saying that it will continue to be
successful. I, actually, very much draw the comparison with Latin America, not just in the 80's, during the crisis.
Go further back. Talk about the ISI model, the Import Substitution and Industrialization model. Here was a
model which also, not just for the non-tradable sector, but for the whole economy, had allocative inefficiencies
built up over time because the market really was not allocating resources. And also, a model which led to very




                                                                                                   21
high rates of growth for a couple of decades. The similarities probably end there because in Asia you have far
higher savings rates, and you have an outward oriented export sector. So there are benefits there.
           But I think, whereas Latin America went through two decades of very high growth, and then that was
probably the time when it should have stopped that model. Then came along the petrol dollars as we know,
negative real interest rates, and they got to live off borrowed time for another eight year or so. And so when the
crisis came it was that much deeper. But I also think there is another similarity, and that is the political economy.
We had this in the last session, a little bit hinted at, the sense that there is no alternative to crisis because it is a
political economy issue. The IMF does not get invited in to solve problems unless the government has no
alternative. And I don't think it's any coincidence that what happened in the 80's in Latin America, in terms of
economic changes, was associated with democratic change. I don't think that is surprising at all. Basically, the
word "shock treatment" is a misnomer. The first example in Bolivia in 1985 took four or five years to
implement. And it was tough. And it required, for all that period, political legitimacy. That required a new
government. It required a completely different political realization of the need by the population to have this
pain. In a way, that's the answer to try and analyze what's going on in Asia right now. The countries which are
going through a political process as well as sort of facing the economic issues, the technical issues if you like, are
the ones which are probably going to come out best.
           The second point, if I can call it the Sacks Argument, is this need for looser monetary policy. I don't
think it really needs saying, but I mean time/money is being used for external balance and to regain confidence
rather than internal balance. I think there has been, initially, a bit of misunderstanding about that.
           I also think, one of the issues that was raised in the first session, that there needs to be, there was this
question asked, "what should be the role of the IMF." There is this sort of confusion of somehow we are no
longer all seeing. I don't think that is a surprise. Gone are the days when people can sit in Washington and
educate governments all around the world. We don't know better sometimes. So I don't think it is surprising that
we have a program and then suddenly we find it doesn't work. So we adjust it. I think the important point is that
the IMF has realized its own mistakes at a technical level very quickly and has adjusted. But I also think there is
another element to this process, which is that it reflects a bargaining situation. I would strongly resist the
temptation to try and create a more formalized, institutionalized, regulatory structure, which in effect would lose
the element of discretion in such a negotiation process. It's not as simple as saying, "Oh, well what structure do
we need to prevent future crises, or manage future crises?" I really don't think there is a lot to be done, because I
think one needs flexibility above all. One needs not to know what the institutions are going to do next. And that
means that essentially, you don't try to create a technical gloss on what's fundamentally political issues.
           Lastly, on this particular criticism, and I'll move on quickly to the other side, I think that we now live in
a world where flows now affect fundamentals, and not just the other way around. If anything, obviously, greater
scrutiny of the IMF, independent scrutiny, is not necessarily helpful. Just as moral hazard has a Washington
word, and therefore meaningless, (laughter) so is transparency. The word transparency is completely
misunderstood and it's sort of a broad concept. There is a difference between a maximum and an optimal level of
something. I do believe that people get confused about this and I think there is a very big difference between the
optimal level of transparency of the fund, which is essentially a government organization, and maximum
transparency, from my own experiences, because previously I did work in Washington myself for a brief period.
I think there is this strong desire in multilaterals to have evaluation departments which are very strong, and I can't
really see much use in them at all because what they tend to do is really state the obvious, cause a lot of
justification after the event. In fact they can even take away from the sense of responsibility of staff members so
I don't think they are particularly productive.
           Moving on to the criticism from the right, I would characterize this broadly by two phrases. The first is
that it is ideological. The second is that it is obsessed with moral hazard. I think there is a difference between
equilibrium, the concepts of equilibrium, and the process of getting there. There is such a thing as development
economics. There is such a thing as historical contingency and institutions. We're not talking about perfect
markets. We're talking about patterns of behavior here, self reflective, multiple interconnections. If you look at
the history of development economics, and there is a very good book from ***I.D. Bier, a compilation by Luis
Emori SP?***129***2/2 on this. You can see that there has been a shift backwards and forwards and we are
coming back to the idea that things are not quite so simple. And yet the whole intellectual thrust, it appears to



                                                                                                    22
me, at the moment seems more and more focused, we have to focus on everything all the time. We have to target
every policy action. We have to get more and more reductionist, and I don't think that is productive at all. I think
we need to be going the other way. I think we need to be concentrating on the imperfections of markets, the
complexity. There are no simple solutions. That means you don't have rigorous institutional structures, nor do
you have broad ideological statements or views which define policy either. I think there is an impracticality there
of using theories of rational expectations in a very general sense, to determine how one copes with situations in
developing countries.
          Just talking very briefly, because I know we have another session on this and my time is running out.
On moral hazard, I think there are four questions that I hope would be answered in the session on this. Firstly,
for which specific decision makers does moral hazard exist. I think this is very important to distinguish between
the actual people making the decisions. Secondly, how significant is it? Thirdly, whether it is actually desirable
to avoid moral hazard, which means that obviously you have take into account the costs of moral hazard. But
maybe there are some benefits as well. If moral hazard leads for instance to greater capital flows into emerging
markets, as a result we have excess risk in the short term, or an imperfect market, but we also have the education
of investors who will then maybe come back to the market later on. Maybe there is a benefit to that. I don't think
it is nearly as simple as it's made out to be, this issue. And finally, which I think is also a very big issue, is it
really a policy issue in the sense that are there any alternatives?
          That's really the criticism from the right and the left. There are of course criticisms from both sides at
the same time, like Jack Kemp, who would like to see lower interest rates and defense of the exchange rate,
which I don't think needs to be gone into in great detail (laughter).
          And then my last point really is sort of a general point, a more atmospheric, philosophical point. I think
there is, increasingly, a split at the popular level between people who are frightened of globalization and people
who embrace it. And I think this is a serious concept. This is a serious problem. I think people are aware that
98% of capital flows got nothing to do with trade, and they're worried about it. People see each crisis as
potentially being bigger and bigger. We had a panelist this morning saying "you see the size of the IMF fund
required going up, is it going to go up more and more?" I don't think it will, frankly. But the way I would really
answer that issue is to say that I think what we're seeing in emerging markets now, is part of a very much bigger
historical picture. I think we've progressed beyond ***171 2/2 Hobsboum's*** Short Twentieth Century . We're
now seeing a completely different global environment which has been started since the end of the cold war. And
that environment is market economies spreading to country after country. And in that environment, yes, you get
crisis. But there is also a great benefit to that, and this comes from my very last point. You will not get the
benefits of these crises without the crises. And the reason for that, coming back to what I said earlier, is that this
is essential a political economy dynamic we are talking about. It's not a technical dynamic. It is a political
economy dynamic. There is a need therefore to look at the politics. That's why I'm positive about Korea now.
That's why I think Suharto has got to go in Indonesia before anything gets better there.
          Thank you.

John Welch: Thank you very much. Our next speaker is Jose Louis Daza, Head of Emerging Markets Research
at J.P. Morgan.

Jose Luis Daza: Good morning everybody. Thanks for being here.
         It's interesting that I agree in some of the broader conclusions with my colleague here to the right, but I
profoundly disagree of some of his analysis. Let me start by just asking the basic question about the need for
some supra government organizations to come and intervene in the market. Why does the market not deliver the
optimal solutions, the optimal amount of regulations? Why does the market not deliver a private sector IMF? I
think that in order to go into this question we need to give a little bit of structure and economics provides us that
structure to a great extent. I think that economics tells us that the reasons for government interventions under
very, very clear conditions, and broadly in general terms, those conditions or those justifications for government
interventions in market come along two lines. Number one, market imperfections, externalities. Number two,
the role of government agencies in enforcing contracts, in having an agent that enforces contracts between third
parties. Clearly the second option is not relevant here. The IMF has no capacity to enforce contracts between



                                                                                                  23
private agencies in other countries. The reasons for the existence of the IMF must be found in the first one, in
externalities. That is, if we did not have an IMF, the world, the private markets would not deliver us an optimal
solution. We can have a better world with IMF.
          I think that in order to look at this question is what type of externalities we are talking about. It is easy
to conceive a world where you have externalities that justify the IMF. The most common type of argument in
favor of this is the classical liquidity problem. The issue of bank runs. Where you have a set of institutions that
are optimized in their borrowing requirements and does have important short term debt. However, for contagion
reasons, at certain points in time, if all of those contingent short term debt were called, efficient companies would
not be able to serve them and they would go bankrupt. This is not clearly an efficient solution. So here is where
the lender of last resort comes. This is the classical argument in defense of banks. And I think that in the case of
the world as we look at countries, it is perfectly conceivable that countries that are solvent, countries that have an
efficient economic framework can face short term liquidity problems because of issues of contagion. And under
these circumstances, an agent like the IMF could come and deal with the liquidity issue.
          However, the mere existence of an externally does not justify or does not forsake that the natural
conclusion is that you should have government agents intervening. Government intervention should clearly lead
to a better result than if there is no government action. I think that the person that best put this was Stiggler.
Stiggler said that those people who see an externality and immediately say that the government has to act
reminded him of the emperor who had to judge between two musical contestants and decided to give the prize to
the second one after only hearing the first one (laughter). So I think that the mere existence of the externality is
not a justification for the creation of these types of organizations.
          But let's face it. The IMF exists. The World Bank exists. So, given their existence today, we are facing
a reality. What should they do? From my point of view, it is very clear that they clearly define their role. Their
role as acting as a lender of last resort that intervenes in liquidity crises. It is very important that the IMF, the
World Bank institutions, and I agree with you that it is more difficult to justify the existence of the World Bank
today but of the IMF it is more of an open question. If the IMF is to play a role, from my point of view, it is very
important that we are sure that we are dealing with a liquidity crisis, not with a solvency crisis. For well
functioning markets, for a healthy functioning capitalist system, it is necessary that those agents that make
mistakes in the market get penalized. If agents who make erroneous decisions in the markets do not get
penalized, we will not have a sufficient allocation of resources. So it is very important that solvency issues are
addressed as such and that they deal to defaults. That they may create other sorts of problems ***242 2/2***and
defaults themselves create secondary term affects. But the IMF should be focusing on those, on the externality
caused by the defaults, not on the defaults themselves. So I think that the first and most important issue that we
have today is a clear definition of what the IMF role is, and that the IMF must limit itself to that.
          The second question I want to touch, very briefly, is a issue of, given that the IMF exists, and given that
the IMF is given policy prescriptions that in general require fiscal and monetary tightening, I think that anybody
who has been in one of these financial crises will tell you that criticizing the IMF will for its austerity measures is
just nonsense. What you have is essentially a significant reduction of financing available for the country.
Spending in that economy, both from the private sector and form the government sector will decline. It will be
imposed by the markets because financing available for the markets has declined. And the question is, how is
that decline in spending materialized? Is it done in an orderly fashion, or is it imposed by the markets through
higher rates of inflation that impacts on real wages and the whole classical destabilization model. I think that it is
absolutely essential that the IMF continue to recommend its classical combination of fiscal tightening and
monetary tightening to the countries across the world.
          And let me finally touch on one issue which has to do with monetary tightening today in Asia. It is
extremely surprising to me that it can be said that Asia today is facing monetary tightening. It is surprising for
two reasons. Number one, I don't know on what basis it can be said because we don't have the data. Monetary
aggregates on Asian countries are not being provided. On Indonesia, on Korea, on enough data bases. And here
is an area where the IMF can clearly play a role. If there were mistakes made, on the decision making process
that led to the currency crisis, a lot of them have to do with lack of enough information. And here the IMF could
be playing a role providing more timely information, asking these countries to provide more timely information
on monetary aggregates, reserves, etc. That's number one.



                                                                                                   24
           Number two, I just do not understand how, in circumstances of capital flight, in conditions where we see
currencies moving by 10-15% per day, you can have interest rates, overnight interest rates, or one week interest
rates of 3,5,6%, sometimes negative interest rates. What that is telling me is that in Asia, in Indonesia, it's very
clear in Indonesia, you have significant amount of liquidity in the front end of the yield curve. Significant
amount of liquidity that any time of day, if people see more shocks coming, they can go ahead and buy dollars.
There has been a significant decline in the demand for money. This is a standard effect of this crisis. But I do no
see the corresponding tightening in monetary policy, and maybe we will get more on this issue later because I
think it's something that, more than anything, it's an open question. I think that we do not have enough answers.
So, I think that with respect to Asia, my view is that unless we see a very significant increase in short term
interest rates, an inversion of yield rates, we are vulnerable to see further declines in the currencies. Nobody
argues that the currencies have overshot. It is very clear. It is very clear that they overshot. The question is, will
the correction come through nominal appreciations, or through hyper inflation. Everything in Indonesia is
pointing today that the chances that move toward hyper inflation is very high.
           I would like to end it here. Thank you.

John Welch: Thank you very much. Our third speaker is David Hale, Global Chief Economist from Zurich
Kemper Investments.

David Hale: Thank you very much.
          I would like to begin first by thanking Marc for organizing this conference. This is the first major
conference I've seen on the Asian crisis and I'm sure it's just the first of many. But it does provide a useful forum
to begin to come to terms with the extraordinary events of the last twelve months.
          The first point I'd make is I think the history of the last twelve months makes if very clear we need some
kind of organization like the International Monetary Fund. This has been the most extraordinary example of
financial contagion I can find in the history books since Credit Anstal***302 2/2***back in 1931. What's
different about this environment is just how much further we've gone, what was a real estate lending crisis in
Bangkok, well known for two or three years did, over the space of twelve months, evolve into a crisis that
destabilized first the markets of Asion***305 2/2***, then Taiwan and Hong Kong, then Korea, then Russia,
Estonia, Hungary and Poland then Brazil and other countries in Latin America. I can't think of anything quite
like this in the modern period. Now, in recent weeks, major organizations like the OECD have cut their forecast
for the world economy by 1% in 1998. And all of this began in Bangkok, Thailand just twelve months ago. The
question I think we have to focus on is not do we need the IMF, the question is does the IMF have the confidence
and sensitivity to manage the challenges of what is now a very different world than one we had for most of the
period after 1945. The fundamental question is can they handle a world in which capital flows to developing
countries are approaching 300 billion dollars per annum, compared to 50 billion dollars just five and six years
ago?
           And I think the nature of this crisis does indicate that there were some major shortcomings in the
surveillance process, in the monitoring process last summer. In my opinion, we had enough information, despite
data inadequacies about the magnitude of short term dollar liabilities with no currency hedge in the East Asian
region to have had a much more far reaching debate about the desirability of letting the devaluations that
occurred in Thailand, Malaysia and Indonesia, get out of control the way they did. There is no doubt there was a
case for Thailand to devalue. It had a bad banking system, a large current account deficit. The fact is once that
process began, and then spread to Malaysia, Indonesia, with Indonesia going from a wide target band, floating its
currency, it set in motion a rush to hedge that became very destabilizing. and enough brokerage houses and
various other private sector channels did publish information about corporate liabilities in the region that I think
there should have been more awareness of this. Needless to say, the bond rating agencies, the credit rating
agencies, didn't get it right, so we have plenty of excuses. But I still think we could have had a better
understanding of the vulnerabilities that were there in East Asia nine months ago if we had focused on the
magnitude of the capital flows to the region over the previous five years, and in particular the nature of the bank
lending. Short maturities with no currency hedge as companies in the region tried to lower their cost of capital
by using external currency liabilities.



                                                                                                  25
          Let me move on to the question of the IMF response. I think the IMF programs that we have had so far
are quite desirable. They do address some very, very important issues involving micro economic reform.
Certainly in the case of Indonesia they set a very important and far reaching precedent in curtailing the economic
of the First Family itself. The final program here a few weeks ago was really quite extraordinary in addressing
what I think, twelve months ago, was Indonesia's major micro economic problem, the Suharto children.
          The problem with the IMF program though is it simply doesn't address the core issue which has been
driving this crisis. Indeed the IMF program for Indonesia in particular is analogous to what would have happened
if Homer had written the Iliad without mentioning Helen. The fact is this crisis is very much driven by this issue
of large dollar liabilities which need to be serviced, and now in the case of Indonesia, a collapsing exchange rate.
I was in Indonesia, Malaysia and Singapore last week and then spend a day in Beijing discussing my finding and
I can tell you that Indonesia right now is in a state of paralysis that I just can't find any good comparisons for. I
can't find an example of a currency falling on this scale without a major inflation differential or some other factor
or some other factor. And the fact is it makes all discussions about monetary policy academic at best. The
Indonesian banking system is simply ceasing to function. Any attempt to benefit from the devaluation on the part
of Indonesian companies is now being hindered by the fact their losing access to letters of credit. Goods simply
can't be shipped because the banking system has become so non functional.
          In my opinion, the IMF should have used its moral persuasion powers in developing this program to
basically promote some kind of debt rescheduling. and the reason the IMF should have played that role is that
there was no other government that could have could have done that. In the case of Korea, the week that we had
the US intervention occur before Christmas, Alan Greenspan and Bob Rubin could use their moral persuasion
powers on the US banks as well as other banks to try and promote some discussion about immediate restructuring
after the program. In the case of Thailand, where over half the external bank liabilities were Japanese, the
Japanese government was able to use some moral persuasion powers on Japanese commercial banks not to slash
the credit lines.
          In the case of Indonesia, the nature of the credit is very different. It's much more spread over the
corporate sector, not concentrated in the banks, and we have everything from German Landis banks to Korean
banks to American banks to Dutch banks to Japanese banks playing a role. But I would say in view of the nature
of this problem, it would have been appropriate for the IMF to take on the moral hazard risk of promoting some
kind of rescheduling. What I find extraordinary is the private sector itself didn't play some kind of role. The fact
is if we had had some kind of agreement on debt rescheduling, the rupiah would not now be at 15 or 16 thousand,
it would be at 4 or 5 thousand, greatly enhancing the quality of the credits in the corporate sector. With these
exchange rates, most of Indonesian corporate sector is simply bankrupt. There will be a de facto debt
moratorium, but it will be occurring informally through bankruptcies, not through an orderly process that might
have helped to restore confidence in Indonesia's economic prospects.
          There are other issues there that the IMF cannot address, in particular the issue of presidential
succession and who Suharto will name as his vice president. It's quiet possible he'll overwhelm all the good will
and all the good efforts of the IMF by naming a madman such as Science and Technology Minister Habibi
***377 - 380 2/2*** as his replacement. But that said, the environment I think could have, on the margin, be
stabilized somewhat if we hadn't attempted debt rescheduling coincident with the IMF program. I realize it is
very, very hard to make decisions on this because there are the moral hazard problems we'll be addressing later,
but the fact is the Indonesian case is very, very unique.
          The third point I'd make is we need to broaden the debate about the role of the IMF if we are going to
persuade the US Congress and the American public to rally around it for new funding. We had a problem
developing already with congress before the president's recent scandals, my fear now is that he's been so
consumed by the scandals that it will be almost impossible to get the funding through in this session of congress.
          But the point I would stress to you is to look back to 1945 and the IMF's founding to get a sense of what
its mission might be in Asia going forward here in the next few months. The IMF was formed in the final months
of the Second World War because the people of that period recognized that economic crises, competitive
devaluationism, bank failures played a role in setting the stage for the Second World War. They set the stage for
the rise of Adolph Hitler and Mussolini and they set the stage for fascist dictatorships that eventually gave us a
military conflict.



                                                                                                 26
          I would suggest to you right now, the situation in Indonesia has become so serious, it does have a
potential to create a military conflict. After my visit to Jakarta, I flew to Beijing to do a briefing for senior
Chinese government officials on my trip and help one of them prepare a speech for this week's Davos World
Economic Forum. While I was briefing them on my concerns about racial tension there, an anti Chinese pogrom
because the Chinese are three percent of the population and eighty percent of the economy, one senior official,
the foreign minister, reminded me that in 1959 the government of China sent boats to collect Chinese refugees,
several thousand of them, from what was then a Sukarno program against the Chinese. I was not aware of this
history so I called up on our internet service for China, a screen of all the Chinese language press coverage of
Indonesia in the 1950's and I found that, in that period, Chinese journalists based in Taipei and Shanghai covering
Indonesia, believed that Sukarno, over 15 years, probably killed close to a million people in his pogrom, as well
as impoverishing many of them. And finally it got so bad China felt compelled to intervene in a very modest way
in 1959-1960. Now I can stress to you right now that nobody in Beijing wants to intervene in Jakarta today.
They would like to just have this be resolved internally. But if over the next six months, the ***413 2/2***
crisis continues, and coincides with a crisis of political succession, and the fall of Suharto, we could have very
wide spread violence, bringing on the kinds of bloodshed that we saw at the time of the 1965 coup that we had
with Sukarno in the 1950's. And if that were to happen, this would go from being just an economic crisis to
being very much a threat to regional political stability.
          Now you could say, "Why should we care about genocide in one country, albeit a large country?" And I
would just add that the fact is the Indonesian archipelago is so large that every year, 40% of the worlds shipping
tonnage goes through it. This is a country that does have major strategic importance, and therefore it does have
global implications, not just local implications.
          So to summarize, there is no doubt, based on this crisis, we need a global organization. The fact is the
nature of the human condition is such that we will from time to time have financial crises. We'll have excesses
that will get out of control. We can debate forever how we are going to try and guard against that with various
kinds of safeguards, but the fact is financial crises are part of human history. But it is also very clear from this
crisis that the IMF has to go through a tremendous evolution, and because of the nature of this crisis involving
private sector lenders and corporations, and environment of boom like conditions, we have to also think through
how we are going to deal with issues like debt rescheduling. And I would submit to you the case of Indonesia
now is so extreme, and so unusual, we have to reopen this IMF agreement to try and have some formal attempt at
a debt rescheduling, not just a lot of defaults and a de facto moratorium which could cause the rupiah to fall from
15 thousand this morning to maybe 20 or 30 thousand over the next few weeks.

John Welch: Thank you. Our next speaker is Don-Se Cha, President of the Korean Development Institute.

Dong-Se Cha: Thank you Mr. Chairman.
         I'm going to present my views on the nature and the causes of the Korean crisis as a way to describe the
challenges and the constraints that the IMF is facing, and comment on the IMF rescue plan for Korea.
         First let me talk about the nature of the Korean crisis. In understanding what has gone wrong in Korea
over the past year, I think that it is best to sum up by saying that the crisis is a triplet crisis, a currency crisis,
financial crisis, and business crisis. There is no question in defining the Korean crisis as a currency crisis.
Evidently the unrest in financial markets has escalated for the past three months as the dollar price of Korean wan
collapsed resulting in about 50% depreciation and precipitous foreign capital flow out. However, underneath this
foreign exchange crisis lies a financial crisis combined with a business crisis.
         As of today, two deposit money banks and a large portion of merchant banking corporations are at near
bankruptcy. And it is not a secret some other deposit money banks are having trouble in raising the DIS capital
advocacy standard. Besides, it is the banks and the merchant banking corporations that take the most heat over
the foreign debt problem since the foreign debt of the financial sector amounts to 70% of the total. It has now
been discovered that the merchant banking corporations and the foreign branches of deposit money banks have
excessively investing in long term assets with short term liabilities, and that much needed regulations or
monitoring mechanisms did not work appropriately.




                                                                                                   27
          However, in my view, a unique aspect of the Korean crisis is that it is coupled with the business crisis.
Since the beginning of the last year, an unprecedented number of highly leveraged large business conglomerates
went into bankruptcy. Moreover, many other conglomerates reported to be under financially vulnerable
conditions. Why did this happen?
          What triggered the crisis initially was a series of large adverse shocks. First there has been constant
deterioration of tons of trade since the second half of '96 do to the plunge in major export prices, such as
semiconductors and automobiles. Then there was the currency crisis in South East Asia since last July. While
these adverse shocks were the first causes of the crisis, structural problems of the Korean economy contributed to
making the situation more serious. Among this, most notable are the following three: First, the government
directed financial system which bred moral hazard of financial institutions. Second, Inefficient corporate
governance structure, which indulged highly liberated over investment of large conglomerates. Third, structural
inflexibility over the labor market.
          Now let me turn to the IMF reform package for Korea. Having defined the Korean crisis as a triplet
crisis and emphasized the structural problems in the economy as main causes, the remedy for the crisis seems to
be Korean financial sector restructuring, corporate governance and corporate structure reform and labor market
reform. Indeed, these three items constituted the major part of the IMF reform agenda. With respect to the
financial sector restructuring, the IMF proposed that financial sector supervision be strengthened, and that the
soundness of balance sheets of the financial sector be restored promptly. As for the corporate governance
reform, according to the IMF proposal the system of mutual loan guarantees among chaibols affiliates be made
transparent by introducing consolidated branches. finally, for the labor market reform, labor market flexibility
will be enhanced by easing layoff restrictions under mergers, acquisitions and corporate restructuring. Given my
assessment of the Korean crisis, I am in complete agreement with the scheduled IMF reform package. I think that
none of the reform agenda would surprise sensible economists in Korea because all of them have been much
discussed in the academic society in the past.
          However, I am afraid that the same degree of approval will be difficult to obtain for macro economic
policy prescriptions in the IMF package. I agree with the general objective of fiscal and monetary tightening,
which is to maintain price stability and improve the current account balance by controlling the aggregate demand.
But what I am worried about is the extent of such ***538 2/2***. In particular, I am afraid that some signs of
excessive monetary tightening is already visible. First, interest rates have risen devastatingly. It has been more
than doubled. Now it is hovering around 25 to 35%. The exchange rate, which was about 900 per dollar in
November, is now fluctuating between 1,700-1,800, while capital inflow is still stagnating. Finally, the default
rate of promissory notes has skyrocketed to 2.25% from less than 1%. Looking at these developments, I cannot
help but to say that the economy is shrinking with an alarming speed and even the possibility of a worse scenario
cannot be ruled out.
          The rational for the high interest rate prescription appears to be provided by the famous interest rate
parity. In fact, as a temporary measure to address depreciation pressure, high interest rate policy for a limited
time may be inevitable, however, the observed comovement of interest rates and exchange rate for the past two
months tells us that the reality contradicts the usual prediction of the interest rate parity theory. I can give you
two reasons why the usual prediction does not hold in Korea. First, over leveraged balance sheets of the private
businesses. Second, the ongoing financial restructuring. In the presence of these two simultaneous factors,
increase in interest rates does not necessarily lead to capital inflow and appreciation of wan. Instead, it may
bring about the opposite effect. Given the vulnerable balance sheets, unexpected serge interest rates boosts the
bankruptcy risk of companies abnormally. Also, when financial restructuring is already in operation, acting as a
source of credit tightening, regional monetary contraction is likely to give rise to over squeeze of credit. In other
words, a vicious circle may begin between corporate bankruptcies and rising non performing assets of financial
institutions, which may in turn bring in exchange crisis. In terms of the investors point of view, therefore,
increase in interest rates raise the risk Korea's financial assets. Consequently, foreign capital is not flowing in,
and the exchange rate remains at a high level.
          I want to emphasize again that the Korean crisis is a financial crisis coupled with a business crisis in its
nature. but I don't think this nature of the crisis is fully appreciated by all of us. Since the foreign exchange
squeeze occurred do to the deterioration in the balance sheets of the financial sector and the business sector as



                                                                                                  28
well. It can be cured only when the soundness of these sectors is reestablished. And I am doubtful that this can
be done by raising interest rates unbearably. On the contrary, I believe that the monetary policy should take into
consideration the adverse affect of financial sector restructuring. However, I'm not making a case for the blind
*** 624 2/2 *** monetary expansion. I understand that interest rates remain relatively high when several
financial institutions are closed and rules for capital requirement are strengthened. And ***Tape Ends*** What
I'm against is the excessive monetary contraction which provides the ground for the vicious circle of unbearably
high interest rates, chain bankruptcies of even sound internationally competitive companies, and the panic in the
financial and the foreign exchange markets.
         Let me conclude by emphasizing another reason why flexible monetary operation is desirable in Korea.
The government is planning to accelerate its program for the corporate governance reform to consolidate its
balance sheet will be introduced next year, earlier than the original plan. And the timetable for the gradual
abolishment of mutual guarantees among chaibols affiliates is set up. Considering the current financial state of
the chaibols, these institutional changes will have the same effect as negative credit shocks with a large
magnitude. The case of Korea was thought to be different from those of Latin American countries in many
aspects. To the extent that this perception is correct, resolution of the Korean crisis presents a different challenge
to the IMF. I hope that the IMF appreciates this difference properly and so succeeds in resolving the Korean
crisis. Korea used to be called a tiger. The tiger is now in trouble. But I am sure with the help of correct
prescriptions from the IMF, it will get out of it soon and will be remembered as a vivid example demonstrating
the importance of international coordination and IMF's role in dissolving an economic crisis.

John Welch: Thank you. Our next speaker is Jack Boorman, Director at the Policy Review Department of the
IMF.

Jack Boorman: Thank you John.
          There does seem to be a fairly supportive tone to the comments in both sessions this morning as to the
approach that the IMF is taking in these countries with the notable exception during the remarks of the last few
speakers on interest rate policy. Let me remark if I may, and without being alarmist, that I do agree with what
David Hale has said about Indonesia. Contrary to the view that was expressed this morning, or even if the view
expressed this morning is correct, that Indonesia is unimportant to the financial markets, I believe Indonesia is
key to the political and social stability of the region. And if that country is of 200 million goes up into flames,
which it has every potential, I fear, to do, which is why I agree with David Hale, it is going to be a crisis of a
magnitude that the current crisis has yet even begun to approach.
          Let me take the topic of the session, constraints facing the Fund and, if I may, talk specifically to those.
I'd like to talk about two constraints that the fund faces in what perhaps is its more important task than fire
fighting, which is what we are doing now, at that is the avoidance of the fire, and two constraints which we face
particularly when we do get into that situation and the crisis develops. The first challenge is obviously to avoid
the crisis. I think there are three aspects to that, all of which have been touched upon by various speakers this
morning. One is transparency, and I would agree with the remark that there is optimal transparency which is not
necessarily the same as maximum transparency. The second is avoiding systems that create distortive incentives,
and I'll come back to that. And the third one is better analysis, better regulation, better supervision of financial
sectors.
          Now all the previous speakers have talked about various aspects of these three dimensions of avoiding a
crisis. On the data side, some of it is really quite straight forward, some of it not going to be easy to resolve. In
every one of the Asian countries we in the Fund, not just the markets, had problems. Thailand hid from us, not
just from the markets, the extent of their forward transactions. We became aware of them only at the beginning
of negotiations on the program. Korea overstated its international reserve position by counting in international
reserves, deposit claims on its own deposit money banks which in fact were not usable. Korea also hid the extent
to which they were assisting the commercial banks in Korea that couldn't role over their lines of credit, which
was depleting the level of usable reserves. That was not just from the markets, it was again to us. And on that I
would note in response to my friend Yung Chul Park's comment this morning that it too long to negotiate the
arrangement with Korea, we became aware of this situation the day before Thanksgiving. Seven days later we



                                                                                                  29
had a program, the biggest in the history of the Fund, approved by the executive board. I'm not sure that's too
much of a delay. All these countries hid their short term liabilities or, more accurately, were not able to produce
data on their short term liabilities, to ascertain extent in the financial sector, but much more importantly, in the
corporate sector. Information about off balance sheet items, almost unknown. The problem loan portfolio, either
misreported or unreported. Misreported in the sense that some of the criteria and some of the standards used in
establishing records of problem loans were simply faulty in a number of these countries.
          Some of this is very easy to deal with. Countries simply have to be forced by us, and this goes to the
pressure that's exerted in the board and by the staff to be more transparent on simple things like reserves and
measuring reserves. Other things are going to be much more difficult. We're working on processes to bolster the
special dissemination standard to included reserve related liabilities, forward swaps, derivatives, and so forth.
That's not going to be simple as any of you conversant with those instrument knows. We're also trying to build
better systems on external debt. That's not simple. The systems simply exist in the corporate sector. Report
systems don't exist to do that simply, although we have to press the issue. The same is true on macro prudential
measures, there needs to be much more of an effort to bring BIS standards to all of these countries, and also to
report transparently on them. So much for transparency.
          The second aspect of the challenge in avoiding crisis is what I said is to avoid distorting systems in
economic and financial structures. And this crisis has surely highlighted a host of those. Certainly
informationally deficient systems has been a major problem in these crises. The exchange rate regime, which has
been commented on by a number of speakers. The fixity of the rate in Thailand, for example, certainly did create
a complacency about holding unhedged positions which was a very big part of the unwinding of the problem after
the rate began to go. As it was in Indonesia as well, even though there had been some flexibility there people
racing to hedge their positions. The other, and this is where I think the issue needs a lot more discussion in light
of the comments that were made this morning, poorly sequenced capital account liberalization. Korea's capital
markets were not open. Korean capital markets were distorted. Short term flows were permitted through the
banking system, and as a result very large short terms were developed to fund the corporate sector which was far
too highly leveraged, as Desmond Lachman said, with gearing ratios virtually unseen anyplace in the rest of the
world. That's a recipe for instability. Part of the reason that developed was not because of the openness of the
capital markets, but because of their closedness. The inability of people to get into the equity markets at anything
other than very low interest in particular corporations, the maturity limitations on access to the bond markets and
so forth. We have pressed in the Fund extremely hard, as you know, to open these markets and we have
succeeded, I think, beyond a lot of people's initial expectation. The reason for doing that is not, as we have
sometimes been accused of doing, namely carrying the water for the united state or for some other western
investors so that they can have access to the Korean markets, the reasoning for this is from the other side. That
until corporations in Korea have access to sensible equity possibilities, to sensible bond funding possibilities,
they would remain reliant on the banking system and they would remain with these leverage ratios and there
would be no need for them, for example, to be as transparent as they need to be if they're going to, in fact, attract
in equity investors and bond holders. So we see it as much at least from the other side as from the side of people
coming in from the system.
          The third aspect of the challenge of avoiding crisis is basically to increase dramatically, and it really
does have to be dramatically, the quality of financial sector supervision and regulation in these countries. And
this is going to require much better systems in the countries themselves, and that's part of our responsibility as
someone noted this morning, to bring the BIS standards to these countries in the context of our surveillance
activities, and to assess the power and strength of the supervisory and regulatory systems in these countries. This
is also going take a lot of technical assistance. It's going to take much better cooperation between the regulatory
agencies and the major money market countries, and cooperation between those regulatory agencies and agencies
in the developing countries as well.
          This takes me to the second aspect of this challenge of avoiding crisis and that is what is the specific
role of the Fund? I've touched on a number of the things we need to do, we need to press transparency. We need
to develop the special data dissemination standard better. We need to do better in the context of surveillance in
assessing the supervisory and regulatory capacity of the countries involved and perhaps publicizing this. We
need to do a lot more on financial sector vulnerability. We need, again, as a previous speaker has said, to focus



                                                                                                 30
not just on the macro economics, but also on banking sector issues. On asset pricing. On the use and destination
of high rates of credit expansion. On banking standards. On the use of bank guarantees. On off balance sheet
items. On a host of things in the financial sector that do require more attention than they have been getting.
          The other thing we have to do is find the means and the surveillance process to be more convincing , or,
to bring more pressure on countries to take the policy actions that are needed. In Thailand, I think we got
surveillance right. I agree with what David Folkeerts-Landau said this morning in the general context of the work
he did on capital market missions, the warnings were given, and the specific context of the Article Four
consultations with Thailand, the warnings could not have been clearer to the authorities. In that sense
surveillance succeeded. In another very important sense, surveillance failed. We didn't convince the authorities
to do what was necessary. How do we do that? I think if we did more on some of these issues that I mentioned
about banking supervision, if we did more in the way of stress tests on countries to see what various shocks could
produce, maybe we could be more convincing to the authorities, and I think we need to try a number of these
things. The other possibility is again one that was mentioned by a previous speaker, its the other side of
persuasion, and that is pressure. Are there mechanisms where we can be more public in our in our
pronouncements about our judgments on the policy situations in countries. I don't know what the answer to that
is. A discussion is beginning and I think it is a good time to have this discussion. There are tremendous forces
working in each direction here. We do have a confidential relation with countries and I think it's important not to
be too dismissive about giving that up. On the other hand, we are also a cooperative international organization.
There was a report done after the Mexican crisis by Alan Widdam, who was my predecessor in this position, who
said as well as having peer pressure in the board of the International Monetary Fund, there is also a certain degree
of peer protection. And there needs to be a breaking down, to a certain extent, of that peer protection so that
there is the necessary criticism and focused criticism on countries.
          There are other possibilities here that are under discussion like regional surveillance and a role for the
IMF in a more focused, perhaps more critical regional surveillance. There is also a question about how we
interact with the private sector, and here I would only throw out some questions. Do we do enough? Is there
scope for a better dialogue between the IMF on the one hand and investment houses, banks and so forth on the
other. How do we do it without breaching confidentiality. How do we do it without favoring some institutions
over other institutions, in a completely neutral fashion? What impact would this have on Fund surveillance and
our relations with member countries? I don't know the answers to any of those questions, but I think, like the
issue of the Fund going public with its criticisms of countries, there's a need at this stage really to have a debate
and dialogue on those issues.
          What if we improved in all these areas and the crisis still occurs? In the three cases in Asia, and in
Mexico, it took two rounds for us to come to grips with the situation in a way that crafted both a policy response
and a financial package that dealt with the situation. Why does it occur this way, and how do we do better? One
of the key issues is getting in early. When the policy actions that need to be taken are less dramatic. When what
has become truly denial syndromes on the part of officials of countries when they reach the precipice, and are not
willing to recognize the degree of adjustment that's required, or politically cannot muster the support to be able to
take policy packages of the strength that are required. We have avoid going to the precipice. As I said, when we
got to Korea, literally, the team found out what the situation was as regards Korea's reserves and you had a
choice. You could either let Korea default, or you could, within literally a number of days and nights, put
together a package that you hoped could deal with the situation, including the associated financing. That is not
an atmosphere for terribly deliberative thought. It's an atmosphere where you've got to run as fast as you can
simply to get the basics done. We've got to get countries coming in early. We've got to find ways of getting over
the denial syndrome which affects these countries. And we've got to get the financing packages right.
          Getting the policy side of the story right in these countries I think has probably not been helped by the
debate that's taken place about whether or not the Fund approach has been correct in these case. Now here, with
the exception of the one speaker on interest rate policy, there does seem to be common support for the Fund. But
given the way the media focuses on differences of view, if you read the press you would think that the general
consensus out there was that the Fund had basically screwed up on most aspects of these policy packages,
whether it was interest rates or fiscal policy or the size of the financing and so forth. And frankly, for someone




                                                                                                 31
who has been frustrated by working 14 or 16 hours a day and then getting up the next morning listening to NPR
bashing what we've been doing, it's rather nice to come and hear your support on these issues.
          On the interest rate side I really do take issue with the idea either that interest rates have been high, or
that they've been sufficient to the task. I think they've been neither. There has been, for years and years, a
resistance in Asia on the part of countries to use interest rate policy. This is not something that has emerged
simply in the context of this crisis. We have in the Fund, in our advice, for many years had difference of view
about the conduct of monetary policy in these countries. It has of course come to the fore in these cases. I think
a fair amount of damage has been done by the reluctant way in which we have been able to force, and I would say
force because that is what we had to do in the context of a number of these policy packages, force even a
modicum of increase in interest rates. I firmly believe that if we had had a really aggressive policy up front,
where the markets became convinced that the authorities would do what was necessary on the interest rate front
to stabilize the exchange rate, you might well have had a different situation than we have now. I do agree that
there's two sides to this coin. The other side of the coin of using interest rates to stabilize the exchange rate is the
cost on debt service to corporations. And so this vicious circle does develop. But the less convincing you are up
front, the longer the period of time you're probably going to have to use interest rate policy, and the more likely it
is you may get into this vicious circle, and so from that point of view I think we are beginning to see unfold what
has been criticized by the previous speaker.
          Let me talk just briefly as what I see as challenge number four, and then I will stop within one minute
before the piece of paper comes over here, two minutes, (laughter) thank you.
          The fourth challenge is twofold. Both of the aspects of it that I see going to the issue of making sure
that the handling of one crisis does not provide perverse incentives that could make future crises even worse.
And here there's two things I'd touch on. One on how the crisis has affected member countries, not just in Asia
but elsewhere, as far as relations with the fund is concerned. And the second aspect, and I won't go into this, it's
the moral hazard aspect, because it's been touched up and it will be talked about later today too. On the first of
these there is a thesis that's beginning to be voiced that we have made, in the Fund, a serious mistake in the way
we handled the crisis in Asia, from the point of view of something that has been problematic for us and that I
pointed to for some time. Namely, how do you get countries in early? And the thesis is that this was a balance of
payments crisis and we should have gone in and dealt with it as a classic balance of payment crisis, macro
policies, basically that being the end of it. And by going as far as we have gone in the area of structural of
policies, in the area of governance, and all of the other aspects that we have touched upon, we have put off other
countries who might think about coming to the Fund. To put it terribly crudely, we'll kick them when their down.
There are fundamental in their structural regime in the way the corporate governance is operated and so forth, we
go in in the midst of a balance payments crisis and we use the opportunity to force these structural changes. I
don't believe that myself because I don't think we could have dealt with these countries other than the way we
have. I think a simple tightening of monetary policy is adjustment of fiscal policy, some exchange rate
adjustment simply would not work in these countries because people knew the problems in the banking system,
they knew the weaknesses of supervision in that sector, they knew the rot in the system in some of these countries
and it had to be dealt with. Similarly in Indonesia. People knew the distortive way in which decisions are made
in the industrial sector that has led to the misallocation of resources, and if we didn't deal with it, I don't think we
would have been credible. But I still worry about the issue, that by being perceived as going as far as we have
had to go, other countries may indeed be somewhat reluctant to come and request the assistance of the fund,
which works against exactly what we need to do the job better, and that is to have them come in early.
          The other aspect of this challenge is the financing package side of it, but as I say, we'll touch on that in
other sessions.

John Welch: Our final speaker today is Daniel Liepziger, Chief from the much maligned World Bank of the
Private Sector (laughter) and Regulatory Reform Division

Daniel Leipziger: Thank you despite that introduction. (laughter)
         Well I would like to answer three questions. Basically how do we at the bank see the crisis? Two, what
was the banks response? And third, what lessons or future questions emerge.



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          On the first, how we see the crisis, clearly its unparalleled in size and speed, but I think distinct from
other crises in Latin America or other parts of the world in so far as its origins are more on the micro and
institutional area. I draw here mostly upon my knowledge of Thailand and Korea, having led the team that made
a 3 billion dollar loan to Korea in December. A lot of the cracks in the East Asian Model, I think, were known.
But could easily be hidden when you grew very rapidly, could not be so hidden in a crisis contagion situation. I
think the real concerns at the world bank has is first of all that much of the gains of East Asia as a region over the
last couple of decades in terms of poverty alleviation and income gains are now put at risk. And whereas in the
past the fact that East Asia did not spend heavily on public sector programs is now a liability in so far as the
safety nets in East Asia are a lot more fragile than in other parts of the world. This all speaks to the fact that
whatever adjustment needs to occur, needs to happen quickly, and so the issues of denial and waiting around
speak to that.
          But the second point is that East Asia is a region that has grown very rapidly, in a way needs to grow
very rapidly, to maintain these gains for the bulk of their population. Therefore growth rates that are significantly
below the rates we've expected for the last decade or two, cannot persist for long periods of time. It is within this
context that one should look at some of the macro issues and the choices of instruments.
          One should also be concerned about the speed with which exports will rebound. With the exchange
changes that have occurred, and given East Asia's historical ability to export and penetrate world markets, you
would expect East Asia to do very well once it gets over the immediate crisis, let's take Korea as an example. but
it cannot do well if there is a shortage of credit for anything that is called Korea. And I think that is really at the
crux of this moral hazard term, which as someone noted has moved from the academic literature now into the
vernacular. But, if moral hazard means that people refrain from doing do diligence, and refrain from
distinguishing one firm from another firm because they viewed it all as sovereign risk, that is a problem now
because credit needs to be reestablished to those firms and those entities that are viable. Particularly those in the
export sector. Why do I say that? Well, any way you cut the macro program, consumption is going to fall. Any
way you cut it, investment is going to fall. Any way you cut it, government spending is going to fall. Therefore
the only thing that can possibly keep growth rates from really tumbling, is exports. And many of the countries in
this region, particularly Korea, require credit in order to export. It's part of the structure of their economies. So, I
would say that the World Bank's concern over the last few months is focused primarily on the human element and
the safety nets, as well as the restoration of growth rates.        Now what was the bank's response? Well first
of all I should say that the distinction between longer term development and what is shorter term stabilization
was long ago blurred in the aftermath of the oil crisis. But it was never as apparent as this current situation. It
was so clear to the World Bank that it was impossible to deal with longer term development issues and structural
adjustment in the midst of crises such as the one we've seen in East Asia, that our board approved a new lending
instrument called a reconstruction loan, which we hadn't used since 1947 in Europe, on the theory that to do
structural adjustment, you first have to stabilize the patient, and its impossible to deal with structural issues in a
crisis atmosphere. This new instrument enabled the World Bank, within one week, to disperse 3 billion dollars of
an ERL, Economic Reconstruction Loan, which will be tied to a series of structural adjustment loans, more
traditional ***322 3/1*** as we call them, in areas that have been preidentified with the government. Notably,
corporate governance, competition policy, and financial policy, as well as safety net. If you want to look at
flows, please combine the 3 billion dollars that the World Bank dispersed on December 23rd with the 2 billion
that Asian Development Bank dispersed, and you have almost half of the international money that flowed to
Korea prior to Christmas. I think one of the things that one needs to look at in crisis management is why the
announcement effects don't work. They don't work because people like you are knowledgeable. You know
exactly 60 billion and you know what the components of 60 billion were. And up until Christmas, probably one
fifth or one sixth of that amount was actually made available in the case of Korea.
          The second thing the World Bank is heavily engaged in is technical assistance. Yes, countries can buy
technical assistance, and many of them do. But many of them prefer to get it from a neutral source. So at the
moment, although Korea, I'm going back to the Korean case because it's being heavily discussed here today,
Korea closed down its merchant banks, and said O.K. in order to reopen you need a rehabilitation plan that's
approved by the government. Unfortunately there was no one in Korea that knew what a rehabilitation plan
looked like, and there was no one in Korea who had a set of criteria by which to judge whether rehabilitation,



                                                                                                    33
recapitalization plan was viable or not. And that's where the World Bank has had a team in Korea continuously
since the middle of December working with the government on the rehabilitation program, not only for the
merchant banks, but also for commercial banks, which have until March to provide recapitalization plans. So
there is a major role for technical assistance and I think one could argue that there is a public good aspect to that
provision.
          The third area involves how we respond to crises, and our board last week approved the creation of a
new unit to deal with crisis management. And I think we will continue to work collaboratively with our friends
at the Fund, but we realize that for some of these areas, such as bank restructuring, we don't have a luxury of
time, and we need to react quickly. And that was the reason why Jim ***360 3/1*** created this new unit.
          Let me turn now to the third question. What lessons have emerged from this crisis? Clearly the
vulnerabilities that existed in the East Asian model were magnified by the crisis. One of the thing that was paid
inefficient attention to, I believe, and I think some speakers have mentioned it, is the area of governance. I refer
to this both in the context of corporate governance, as well as in the more traditional political economy sense. I
think we are reaching a stage where do diligence does, as some previous speaker referred to, involve a judgment
on the political structure of the countries involved. There is of course a question about who does do diligence.
And I'll leave that for the moral hazard panel, but clearly there were failures on the parts of many actors.
          One question which is frequently asked recently is whether the East Asian miracle is over. And
obviously only time will tell. I don't know if we'll have to wait for Cho En Lai's 200 years, but the major point is
that some of the fundamentals that East Asia managed to achieve over the last three decades are hard to reverse.
Education levels, hard to reverse. History of productivity performance and TFP performance, reversible but it
would take a lot of wrong steps. Economic management, clearly had been a strength, been some major failures
lately, probably related to political economy factors. The traditional checks and balances that existed in Thailand
in terms of key agencies that up until the early '90s, performed their functions reasonably well, ceased to perform
them quite well. Supervision, always a problem, considerably more of a problem with the short term finance
companies in Thailand and merchant banks in Korea who seem to have fallen off the radar screen of the
regulators, regardless of the quality of the regulator.
          So there are some problems, I would submit however, that growth rates can be restored. Obviously '98
will be a bad year. They can be restored if the fundamental microeconomic problems which caused the crisis in
financial policy, corporate governance and other areas, are dealt with.
          The second question which is frequently asked, and it was alluded to earlier in the OECD context, is
liberalization a bad thing? And my answer there is obviously not. But you can't liberalize and ignore the
supervisory aspects. Its sort of ironic but the last economic report that we did at the World Bank for Korea prior
to their graduation in 1993, dealt exactly the pace of financial liberalization and the sequencing thereof. They
obviously followed a slower pace than we recommended, but they also, I think, did quite poorly in the
institutional side of regulation and supervision which was critical.
          So, I think there are some lessons from this crisis, and clearly I do think that the world bank continues to
have a role but we submit ourselves to the market test. It's not a question of what's written in the newspapers, it's
a question of to whom countries turn when they have a problem. And so far we haven't had a lack of business.
          Thank you.

John Welch: Thank you very much. What we'll do is we'll take a number of questions from the floor and have
each of the speakers answer them in turn either responding to the questions or comments by the panel.

Tom White, MetLife: Does either the IMF or the World Bank see any responsibility for improving the
bankruptcy legislation in these countries?

Alan Meltzer, American Enterprise Institute and Professor of Economics, Carnegie Mellon University: A
three part question. I would like to respond to Mr. Booth's comments about Moral Hazard. Let me explain to
him, if he will, that moral hazard has nothing to do with development economics. It has nothing to do with
complexity and imperfections. It has nothing to do with rational expectations. It has to do with developing
institutions that equate social and private risks. An institution, for example, that privatizes profits and socializes



                                                                                                  34
banking losses is not such an institution, and that's really what's involved here. That has very little, if anything, to
do with the issues you raised. So, we want to ask in this context, particularly the context in this session, is the
IMF an optimal institution in the sense of providing an answer to moral hazard? In my view it is not. The reason
is because it encourages the privatization of profits and the socialization of banking losses.
          To David Hale, I ask, was the moral hazard created by the IMF make the problem worse? It seems to
me that in your comments you skirt the question as to whether in fact a lot of this lending was being done because
people believed, after Mexico and other experiences, that there was going to be privatized profits and socialized
banking losses, which in fact has to some degree occurred. Finally, I would like to ask you, would the lending
have been smaller without the IMF?
          And finally I would like to say to Jack Boorman, we have had experience all over the world with
regulatory and supervisory arrangements as opposed to market arrangements, such as failure. Many countries,
not just me, but many countries including New Zealand, The United States, Chile and Peru, have moved away
from the regulatory supervisory model because there is never enough information in advance to get people to
agree that something has to be done. It is, as someone said and as I will repeat later, that capitalism without
failure is like religion without sin. You not only don't know that it is occurring, but there are different ideas as
whether it should or should not be handled at this time. And the attempt to solved these problems by regulatory
methods has been rarely successful in heading off crises and problems in advance.

Charles Blitzer, DLJ: Following up on the last point and questions posed by Jack Boorman about relationship
between the IMF and the financial markets. It seems to me that an important lesson from this episode is that
asymmetric information, episodic information and incomplete information have badly contributed to the severity
of the crisis in ways which are rather obvious. And I think that looking forward in terms of the IMF, far more
crucial than rethinking the balance between fiscal tightening and not, is the question of rebalancing the role of the
IMF as a confidential advisor and with its role bore broadly in a far expanded international financial system with
private flows far dominating public flows in a way that was not true before. And I think that rebalance has to be
rethought in a very drastic way.
          Some examples. The statistics, the data is difficult to come by, but the IMF still has more data, more
frequently than the markets themselves have. I would certainly encourage the Fund to begin to make data
dissemination to the private sector part and parcel of its performance criteria in a way that, to the best of my
knowledge, has never been there along with other performance criteria with anywhere near the importance for
maintaining a program that other elements of a more traditional nature have found. Yes, the data collection and
statistical work are difficult. Countries will have difficulty in putting up the right web sites over night, but
clearly the cost to the world economy and to these economies of this type of crisis, would justify literally
whatever amount of technical assistance is required to get the job done quickly and there are 3,4,5 other emerging
markets out there which are potentially crisis countries in the next year or two for which we simply do not know
basic information about reserves, forward books, state of the financial sector, even capital account and so on.
That should be doable in the context of Fund programs outside of crisis situations.
          Now what about countries which are not actively engaged in the fund program, where article four is the
primary vehicle for discussion with the countries. Well, here thoughts have to be given as well. Technical
assistance needs to be provided to many of these countries as well, before they get into trouble, before they have
a program. But maybe the Fund should consider pre-eligibility for future programs. And a condition to be
eligible to come to the fund in a crisis ought to be, over the next couple of years: Have you been providing the
information, not only to the Fund, but also to the markets which are funding you?
          Final suggestion is that the Fund really needs to not be a rating agency, but can and should publicize and
publish much more regularly, its analyses of countries, particularly on the factual side. Particularly the statistical
annexes which go with the reports which go to the board with Article Fours, those should be published. The
factual, positive aspects of the report should also be published. Clearly a line is going to have be drawn with
some aspects of the analysis, which in initial stages, you would want to hold confidential for important reasons.
But that doesn't mean that the two paragraph or one page summaries which appear, or the actual reports which
come out months late, that process simply needs to be speeded up to avoid future crises.
          Thank you.



                                                                                                   35
John Welch: Let's let our panel answer these great questions.

***unknown Speaker 572 3/1***: I will start by talking about this moral hazard issue. What do I mean when I
talk about ideology and reductionism? Well, one of the things I'm talking about is the view that reduction of
moral hazard is the goal. Irrespective of other goals, and outside the bigger question of whether we want to
reduce moral hazard and how big a problem it is, my comments about complexity and development economics
were not in the context of talking about moral hazard. The are four questions I raised, just to repeat them were:
For which specific decision makers does moral hazard exist? How desirable is it to avoid it? Is there a policy
alternative?
           I think the first issue, really pointing towards what the role of the IMF is say, I think the moral hazard
issue has been sort of blown out of proportion. I do admit that there is a problem, there is moral hazard. But the
issue which I think is more relevant is one of poor credit decision making in banks and the role of credit rating
agencies. no one this morning has really mentioned credit rating agencies yet. Maybe we will sometime later in
these two days. But I think that is actually a far more relevant issue. Certainly with my discussions with some of
the agencies, I've been certainly trying to pressure them and I hope that this will happen, that we will see some
movement there.
           I think this also addresses the last question we had. I don't think it's the role of the IMF to address issues
of information in this way. I think we have to look at rating agencies to try and increase the number of
gradations, increase the number of times they review. I would like more continuous service.
           And the third think I would like to see them do is have a greater perception of what market flows, what
the market sentiment is doing. I think to talk very simply about moral hazard being the one issue, and therefore
the IMF causing moral hazard being a being a big issue, I think is incorrect. I think the IMF inevitably, by its
very existence, will create moral hazard issues. I don't think that's the point. The point is, as David Hale was
illustrating, what do we want? Do we want a world with a little bit of moral hazard, or do we want war? Do we
want bigger political problems? There are costs and benefits ***3/1 ends *** In the first half of this decade,
75% of Mexico's capital inflows were securitized capital flows, in particular the sale of pesos and ***2 3/2***
securities, equities and bonds to US investors. And then in the last twelve months, heavy sale of the so called
Tesebono, dollar index securities. The IMF program and the US Treasury intervention, which was the biggest
international aid package since the Marshal Plan in 1948, did rescue the Tesebono security holders from what
would have been a default. But it did not rescue anybody else. Equity shareholders, people who had bought peso
cd's, suffered very large losses. Since 1995 there has been a great recovery in the Mexican stock market, in dollar
terms it has tripled. And if we had not had the IMF package, its quite possible that Mexico would have defaulted,
it would have defaulted, we know that. It would have lost access to the capital markets for several years, would
have had a much worse recession, would have failed to have a fair and free democratic election this summer, it
might have had a military coup. So, everybody would have lost a lot more over three years. So in that sense the
IMF package did prevent even larger losses than occurred. But in my opinion, that alternative scenario would not
have been very desirable, because it would have created situations that would have produced extraordinary
political and social conflict, not just losses for American mutual funds that bought these equities and peso
securities.
           Now what effect did this have on Asian lending practices? I was very much part of this debate at the
time in Asia several times a year, and I can tell you the first reaction of the Asian financial community was,
"we're not Mexico." Many articles were published, documenting quite amply, that most of the capital flows to
Asia were quite different in character from those to Mexico. Securatized capital flows, portfolio capital flows,
were, in the first half of this decade, probably at most 20% or 25% into Asia. The Asian countries relied far more
on foreign direct investment, or in some cases such as Thailand, on bank lending. And syndicated bank lending
as well. The great surprise, I think, of the crisis of the last twelve months is what it taught us about the
vulnerability that goes with syndicated bank lending, in the case of Korea, or, in the case of Indonesia, Malaysia,
and Thailand, bank lending without any kind of currency hedge. We're still learning the full consequences of this
as the crisis evolves. But I think, even if we had not had not had the Mexican bailout, the capital flows to Asia
would have stayed quite large, simply because of the sheer optimism and enthusiasm for the region. We had had



                                                                                                    36
many years of high rates of economic growth. We had a kind of language, the tiger economy, the miracle
economy that drove the psychology of the capital flows for that region. And indeed just six months ago, Jeffrey
Sachs himself produced a book for the Asian Development Bank on why this would continue. The fact is he did
not understand factors such as syndicated bank lending, issues of unhedged bank liabilities. These are very much
micro economic issues and they were simply overlooked by the credit rating agencies, by investors, by bankers
themselves, as this boom went on. Here we get into the issue of the human condition. The fact is that history is
full of examples of cycles that go too far. They may be well founded for several years, but then eventually their
own contradictions. That's just part of the human experience. And the reason we need an IMF, in my opinion, is
to limit how far the damage can go from these errors and these mistakes which are part of human history. There's
no doubt we have a moral hazard problem. There's no doubt we're going to have to compel the banks to take
some losses with this Asian crisis. How big they'll be, whether it's 10%, 20% or 50% will depend on events that
are still unfolding. But I would add the American congress, as we can see from this current debate, will insist
that the banks take some losses. But I have no doubt that the alternative to an IMF type intervention could have
been, in the case of these countries, a worse crisis, a situation getting more out of control, and in the case of
Indonesia, the process not just ending in defaults and bankruptcies, but racial and ethnic warfare, which could set
the stage not just for a national crisis but perhaps a regional crisis, because of the comments I heard in Beijing in
the days after I was in Jakarta.
          It's a question of trade offs. And I do think we can devise systems to contain the moral hazard problem
so as to get the benefits of several forms of international cooperation to prevent the really extreme outcomes.
Again I would remind you, we formed the IMF in 1945 because 100 million people died in the Second World
War. I think we learned something from the experience of the 1930's. That there is a capacity for people
working together, through collective institutions, to contain the magnitude of the damage that comes from
national economic crises. We can debate forever the rules, the process, the procedure. But there is no doubt,
base on our history, that we can benefit from working together.

Jose Louis Daza: I would like to comment on this issue because it goes to the basic source of the question of the
panel. I think that there is very little doubt that once the IMF is in existence, once we are in a situation like the
one today, it is better to have the IMF intervene and to lead us to a solution. The bigger question is that by
having the IMF intervene today, are we creating a problem for tomorrow, a different type of problem? Or, if we
have the IMF intervene today, we can have the IMF do it in a way that we minimize the risk that we are creating
another crisis for tomorrow?
          As a person who regularly talks to investors, I can tell you that moral hazard is an extremely serious
problem. The amount of investors who tell you "I will buy this debt because there is going to be an IMF bailout"
is sincerely very large and surprising. And you see it, not only in Asia. Perhaps today, the biggest discussion
about the moral hazard issue that has been created has to do with Russia. There is very, very clear understanding
of what the risks in Russia are, but we have an issue of moral hazard where the most compelling argument that
investors have to go on investing in Russia's high yield is that it is going to be bailed out by the IMF because the
IMF because of its importance to the west. I think that the moral hazard issue is extremely important because
while today we have to deal with some specific problems, it may create more problems for tomorrow.
          I think that it is very important when we say that there can be externalities and that the cost of moral
hazard is not so high, I think that it is important to attack the source of the externality. If we want foreign
investors to learn more about these countries because there is an imperfection doesn't lead them to learn as much,
let's subsidize courses on emerging markets. Let's not provide the financing for a steel mill in Indonesia, or in
Korea, which is maybe not needed.
          So I think that the moral hazard question which will obviously treated later is of extreme importance.

Jack Boorman: Let me answer the first question by following up on that point. If people are flooding into
Russia because they think what is being done in Asia is going to protect them, they better look at what is being
done in Asia. Tell my brother in law, who was sold a bill of goods on Asia funds a couple of years ago that this
is the only place to put your money, that nobody is losing any money in Asia, and that they're being bailed out.
The equity holders are not being bailed out. The bond holders are, for the most part, not being bailed out. The



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banks who lent to the chaibols in Korea, the banks who lent to the corporations in Indonesia, hopefully, will not
be bailed out. The moral hazard problem has been narrowed down I think to something quite specific, it's almost
solely short term bank lending to financial institutions. That's where the issue has to focus right now. Everybody
else is losing very large amounts of money in this exercise. And those going into Russia had better realize that.
That's very important and I think to get that message across and to stop the general talk about the fact that
somehow or other the IMF is bailing everybody out is very important. Let's get the right message across to
everybody who is involved in international investment.
          On this question on whether or not the fund is the best institution to provide against moral hazard, in
some absolute sense no, because of what's been said before. The very existence of the institution, like the
existence of a central bank, is to a certain extent an element of moral hazard. A balance has to be found. It's
important that these losses are being taken so people can see that we're trying to find some balance. It's very
important that, to the fullest extent possible, international lending be basically private to private. And more
important than that, that it be kept private to private. One of the reasons we're in the difficulties we are in in
Korea is because of this vague guarantee that was put out by Korean authorities on August 25. Nobody quite
knows what it meant to this date, but there are at least suppositions that it could have some legal authority. And
it clouded the situation tremendously. If everything had been kept private to private it would have been easier to
deal with.
          And that goes to the point about bankruptcy. We are, in the Fund, not experts on bankruptcy by any
means. But you can rest assure we are pressing the development of bankruptcy systems in these countries
because, to the extent debt remains private to private you can then deal with it and hopefully deal with it totally,
through an efficient bankruptcy mechanism. To a large extent that is going on with corporate sector in Korea,
whereas it does not seem to be feasible because of the weakness of the legal system in Indonesia.
          The point about the US and others moving away from regulatory systems, I'm not sure that's quite right.
The US in particular has certainly changed the way it regulates and supervises, and has gone away from balance
sheet examination to asses risk and credit exposure and has gone to assessing the systems that the financial
institutions have in place to do their own risk and credit assessment. that's a different way of doing business.
What's exactly right in any one of these emerging market countries I think needs to be tailored to the situation of
those countries, and done by people who know a lot more about that than certainly I personally do.
          I agree that episodic information has hurt. That point is well taken. The announcement of the forward
book of Thailand immediately after the approval of our program led a lot of people to say Thai's reserves are
zero. Which of course was not the case because the maturity structure of the forwards said that they had a
relatively robust reserve position for a period of time. In terms of making data part of the performance criteria
programs, I think the system we are trying to develop is better. The special data dissemination standard is a
voluntary process into which countries will subscribe. It is on the Internet. We're working to connect the
country's data sites through hyper links specifically to that site on the Internet and 7-9 countries already have that
connection between the SDDS and their own data systems. That's going to become a very disciplining system I
hope. Because even though it is in a transition period from now to the end of the year, at the end of the year, if
countries do not meet those data disseminations standards and post the data that's necessary, they're going to be
removed, or at least this is going to be the staff proposal and I hope the board goes along with it, they're going to
be removed from the system so that the system isn't polluted and that anybody knows that a country that is on the
system is indeed adhering to the standards that are necessary in that context. Pre-eligibility for assistance, I don't
know, we're debating that frankly in the Fund. The Fund is an international cooperative organization. If a
country has misbehaved and they get themselves into trouble and they come for help, can you really stare them
down and say "we would have helped you if you had been better citizens of the world in the last couple of
years"? I am not sure. There's a really difficult question there.

Unknown speaker***127 3/2***: I guess on the question of bankruptcy, having corporate restructuring is
really the priority in countries like Korea now. I think there is some movement in terms of consolidated balance
sheets and other transparency measures, but I think that the basic mind set is probably what needs the largest
change, and a clear indication that equity holders will lose for past mistakes. The difficulty of doing this,
particularly with respect to banks, but also the corporate sector, is that it is very hard to do it in the midst of a



                                                                                                  38
crisis because you have confidence problems to weigh at the same time you are trying to weed out bad corporates
or bad banks. So I think the challenge to the Korean authorities right now is how to maintain confidence and not
get caught up in doing things as short term crisis managers which they will regret later in terms of actually
working out some of the financially sick parts of the corporate and banking sector. But I very much agree with
the point being made that bankruptcy procedures really need reform, and the bank is working on that area.

John Welch: Well I hope this very good discussion spills over to the afternoon session, but in the interest of
getting you to your lunch, I wanted to thank my panelists and the people in the audience that participated for their
interesting and provocative statements. Thank you very much. (applause)

PANEL III - THE MORAL HAZARD PROBLEM AND DEALING WITH SYSTEMIC RISK

Ricardo Hausman, Inter American Development Bank: After listening to the discussion this morning and
the speech right at lunch, I am very happy to be where I am (laughter).
         We have panel this afternoon that is going to discuss the issue of moral hazard vs. systemic risk. We
heard this morning that there are many people in this group concerned about moral hazard, because they fear that
public institutions that may generate the impression of some sort of public guarantee may make markets
misfunction so that there is a case against government intervention for its moral hazard effect. And there are
other people concerned about systemic risk and the need for some form of government intervention in order to
control the systemic risk, maybe at the cost of some moral hazard. We are going to have a very distinguished
panel address this issue. And it may be, as a member of the audience and as a moderator, maybe we should try to
press our panelists in terms of generating some degree of evidence for their positions on this issue, and to back-
up the cases for either moral hazard or the risk of systemic problems, not just with anecdotal evidence or a repeat
of a theory, but some evidence that this theory is sort of relevant for the issue at hand, and in particular is what
we are observing the consequence of moral hazard induced behavior, is what we are observing something
systemic, and if so of what nature.
         So, without further adieu, let me turn the floor to Gerry Corrigan who is Managing Director at Goldman
Sachs, but many of us know him in his former job as president of the New York Fed.

Gerald Corrigan: Thank you Carl and good afternoon ladies and gentlemen. In the interest of disclosure I can
start by saying when I walked up here Alan Meltzer said to me, "What do you think constructive ambiguity
now?" I was, I suppose, a godfather of that idea and I said I thought we needed more of it! And I think that's
very much tied up with this moral hazard thing. But clearly I think we all recognize that this so called "moral
hazard" issue is a very real issue and I thing we all recognize that it constitutes a very serious problem, as
illustrated once again by the events in Asia over recent weeks and months.
          Now just in the interest of making sure we are all on the same page, let me share with you what this
concept means to me, because I do think there are some shadings, if not outright differences of opinion, as to
what it really means. To me the essence of the so called "moral hazard" doctrine is that the mere presence of the
so called "safety net" surrounding financial institutions, or more pointedly, the mere fact of extraordinary official
actions aimed at stabilizing financial disturbances, will have the effect of encouraging imprudent actions by
financial institutions and investors alike, due to the fact, or the perception, that they will be protected from loss,
or at least protected from serious loss. I think that probably is as close as I can come to a statement of what the
moral hazard thing is. Now having said that, at each step along the way over the past roughly fifteen years or so,
we have seen new and different and sometimes more complex aspects of the so called "moral hazard" problem.
And indeed, the Asian crisis has done it again, in that it has surfaced some new and even more complex
dimensions to the problem.
          Just to site one or two examples that are not totally unique to Asia, but in orders or magnitude are, and
that is, for example, the very large amounts of private sector foreign currency problems, particularly in financial
institutions, reflecting themselves on both sides of the balance sheet, the asset side and the liability side. Second
of course, which I'm sure was discussed this morning, is the shear size of the inflows of particularly of debt and
equity portfolio investments over the past five years or so, again, much of which worked its way into the private



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sector, which was in sharp contrast to the Latin American experience of the '80s when most of the problem, of
course, was with the sovereign itself. And finally, in Asia, we've seen new, and very clever at times,
manifestations of a capital flight problem and a related problem of the citizens not to repatriate offshore income
on the part of both financial institutions and corporate conglomerates. Again, at least in order of magnitude,
these are not things that we saw in the Latin American experience in the 1980's.
          Now as was already mentioned, in almost every case that I am familiar with, the moral hazard problem
arises due to fears among authorities and practitioners as well, that the failure to do something will produce the
dreaded systemic meltdown. Now, as we all know, the phenomenon, including the fear of systemic meltdown,
has been seen, literally, in several dozen countries over the past fifteen to eighteen years. And the countries in
which this phenomenon has manifested itself, have come in all sizes, all stages of economic development, and
very differing stages of the maturity and development of the so called "safety net." Indeed, we've seen this
phenomenon in countries that have deposit insurance, and countries that have no deposit insurance. So it is not
something that is unique to so called "emerging market" countries. We had it in our own front door here in a
very real way in the mid to late 1980's as well. It won't surprise you for me to say, coming from where I come,
that I think the issues and concerns surrounding the threat of this systemic shock or meltdown cannot be
dismissed. I say that for a number of reasons, I've said if for years for a number of reasons, but just to touch on a
couple of things that I think are relevant, for example, in the short run, these fine distinctions that I heard
mentioned at lunch between solvency and liquidity problems are virtually meaningless, you can't tell one from the
other, and even if you could, in the very short run it probably wouldn't matter. I think it is important to recognize
that as we speak today, the linkages that help create the systemic threat have gotten larger and more complex by
order of magnitude over the past five seven years. And again, I have stressed for years and I will say it again here
today, that when all is said and done the focal point where those pressures would manifest themselves most
directly moving in the direction of systemic damage, of course in my judgment still are, the world wide web of
payments, clearance and settlements systems. This is the hot button.
          Let me give you a couple of quick examples. Take something as seemingly plain vanilla as the lying
down of Yamamichi Securities a few weeks ago. I'm sure that every financial institution, Bankers Trust included,
had been monitoring that case very closely, knew precisely what their net exposures were coming up to the event,
then you get the weekend, Monday we're closed for business. Once that happens, the world changes because you
can no longer look at these nice, neat precise scientific net exposure numbers. The minute that event happens, it's
the gross that matters, not the net. And the minute that happens, every single financial institution in the world
starts looking at the thing very differently. They say to themselves, "at eight o'clock tomorrow morning I got to
pay out 20 million dollars and I'm not going to see the 20 million or equivalent in yen for eighteen hours. Should
I pay?" That's what happens in the real world. And that's what happens when you have these temporal problems
in splits between time in which payments are made and received. So the minute there is the threat of credit losses
in the system, much less the reality, behavior changes.
          Now if we take a more recent case, the Korean case. We have tricky little problem of rather substantial,
but not wildly large, off balance sheet and derivative liabilities of certain Korean financial institutions. You put
them all together and again, the central bank of Korea does a wonderful job of this and we look at them all and,
gee, they net down to some trivial 150 million dollars. But once again, it's not the net that matters, it's the gross
that matters. And when the grosses and the nets differ by a time or by individual payers and payees, it matters a
whole lot. It's a very, very, very, complex world. And it is that phenomenon that I think really stands at the core
of why it is so difficult to untangle these situations once they start to develop.
          Now on top of that of course, as was mentioned I am sure many time, in the Asian crisis we also have
very, very, very weak financial institutions pretty much across the board in just about every country under
consideration.
          Before saying a couple of words about solutions to this problem, although there is no one, I think I do
want to make one other observation. That is to note that the widespread perception that official actions shield
everyone from all losses is plainly overstated. That ain't the way things have worked. In most cases, bank
shareholders and bank managers have not been and certainly should not be protected under any circumstances,
any place, any where. That alone seems to me to go at least some distance in reconciling the moral hazard
problem in banking institutions because if the managers and the shareholder know they're going to get fried in the



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event of failure, it's a little hard for me to believe that they set out to run their affairs in a reckless way since they
are not going to benefit. So that's one case where I think constructive ambiguity has no place.
           I think it's also important to note that the countries themselves have surely paid a high price. I think it's
think it's fair to say that it's sad, and in many instances the largest cost falls on those having little or nothing to
with the problem and have little or no capacity to adjust to the problem once it occurs. In sovereign crisis,
contrary again to public opinion, banks have paid a price. And indeed, when all was said and done, certainly, in
Latin America they ended up paying a pretty high price. And again, while there are unfortunate examples such as
the Tesebono case mentioned earlier, in most cases investors have incurred real losses as well. But having said
all of that, the problem remains. The system is too dependent on official intervention. I don't like that one bit.
           Now, what do we do about it? In very summary fashion, I think there really are only four alternatives
that I can think of, and I'm not nuts about any of them.
           Alternative one, I suspect, is the one Alan will speak to. That is simply say let's let the markets sort it
out by itself. At one level, particularly at an intellectual level, that may have a certain amount of appeal. But
from my perspective, without going into detail, it's just too damn risky. The invisible hand needs some help and
guidance at least some of the time. I am very certain that whatever you might think of that approach as an
intellectual matter, at the end of the day its costs would be greater than what we're doing now, both short term
and long term. And finally, in talking about that approach, I think it's very, very important to keep in mind the
obvious fact that markets overshoot, and overshoot significantly in both directions. They may get it right in the
long run, but they sure don't get it right in the short run.
           The second alternative would be to find ways to narrow or reduce the scope and reach of the so call
"safety net." Here the prime subject or discussion is deposit insurance reform, particular in countries like the
United States. And again, without going into detail, I actually think there is a lot to be said there and if I were
king for a day I would try and get a fresh approach to deposit reform in place in the congress right now when
things in this country are really in pretty good shape with regards to our financial system. So again, I think there
is some room there. But again, it's not a panacea. Keeping in mind, among other things, that we're one of the few
countries where we've seen this phenomenon where there wasn't even any deposit insurance, but that sure didn't
take away the so called "moral hazard" problem.
           The third alternative would be to try to find acceptable ways, and you're all going to choke when I say
this, to find some sensible approaches to domestic and/or international credit or capital controls. We all almost
want to get sick when that subject is mentioned, but I think it has to be thought about a little bit. For example,
the Chilean formula, with regard to their treatment of short term portfolio debt inflows, I'm not sure that's all that
crazy. You can dress it up and give it some nice names so you don't call it capital control, but I'm not so it's all
that crazy, and I think it probably should be thought about. Similarly, we do have cases in other countries where
strict and universally applied limits on leverage, especially in real estate, have been reasonably successful. So
again, there may be some things that can be done there but here I want to emphasize that they may help a little
but they're not going solve the underlying problem. More important, this of course is a very, very, very slippery
slope. And it's a slippery slope that politicians will love because it looks too easy. Finally, as I think everyone in
this room would recognize, these things are very, very, hard to enforce.
           The fourth alternative is probably the one that has the most pay dirt but the longest time, and that is in
many, many countries we do need broad based, fundamental reform, restructuring, recapitalization of domestic
financial systems from top to bottom. Along with that, there is an incredibly long list of institution building
things that have to happen. And just to site and example, everybody says, "we've got to improve banking
supervision." We can all genuflect that, but let me tell you, it's going to take a long hard time to do that. Base on
my experience at the Federal Reserve Bank of New York, taking kids from the best universities in the US., top
students across the board, best schools you could find, it would take at least two years to train a bank examiner in
a context in which they were working hand in hand with people with twenty years of experience. To think that
you're going to be able to train and develop a staff of qualified bank examiners in Thailand or Korea, or for that
matter, Japan, next week, is a sure pipe dream. But the fact of the matter is that this institution building is the
critical missing link in the context of how to get these financial systems back on their feet. Again, there's a whole
bunch of issues there that I don't have time to go into except to say that as a part of that, these tight, cozy
relationships between banks, industrial groups and governments have to go. Clearly, the lessons there are clear



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and I think the experience is clear, and I think it should be clear, by the way, for those people in the US. who
think it's a good idea to have IBM own Citibank and so on. Those things are just trouble looking for a place to
happen.
          Then of course the last thing is the whole transparency set of questions which has with it a series of
other issues that I can't get into here either.
          Now when all is said and done, if we're really serious about trying to get this moral hazard problem
under control I think we have to work in all of these channels. I've thought about this a lot, for many, many
years, and I at least have never been able to come up with the smoking gun that will make this problem just go
away. We're going to have to work at it and that's where I'll stop.

Ricardo Hausman: Thank you very much Gerry. Now for a slightly different view, let's turn to Alan Meltzer.

Alan Meltzer, Senior Fellow, American Enterprise Institute and Professor Economics, Carnegie Mellon
University: Not entirely different enough. Let me begin by pointing out one of those selective ambiguities that
Gerry Corrigan is so fond of.

Gerrald Corrigan: Constructive, not selective! (laughter)

Alan Meltzer: Constructive ambiguities. One of those constructive ambiguities is called "Improved Bank
Supervision." The idea is very simple. We're going to get a $35,000 a year clerk to make better judgments than a
$200,000 a year bank president. He's going to come in and point out the errors that the bank management
committee couldn't find. I think that misses what the nature of the problem is. The problem is that people have
loans and they have different judgments about whether those loans are going to be repaid. And after a while we
suddenly find out that maybe some of them will and maybe many more of them won't. But the idea that we can
hire somebody, whether he comes from the best school and is trained for twenty years, to make those judgments
better that the people who are charged in the management for making those judgments is, I believe, one of those
soporific ambiguities. (laughter)
          Between 1990 and, now I'm going to be more agreeable (laughter), slighter more agreeable. Between
1990 and 1996, capital inflows to emerging market countries rose from 60 billion to 194 billion. Mexico's
problems in 1995 changed the form of these capital transfers. Portfolio investment decline, but direct investment
increased. Inflows remained at 140-150 billion dollars a year, and then resume their rise. Bank loans rose with
them. No one carefully monitored these flows. When problems developed in Asia last year, neither the
International Monetary Fund, nor the private lenders, knew the magnitude of each country's debt within a large
range. Firms borrowed directly and through their subsidiaries and in different countries. Often the total was not
shown on any balance sheet. The provisions of the IMF Articles of Agreement requiring surveillance, and the
decision to strengthen surveillance following the 1995 Mexican problem, proved to be of little use.
          Though important, the IMF's failure seems small beside the elementary mistakes of private lenders. The
lenders ignored three principles of prudent behavior that history has shown repeatedly to be a major reason for
financial failures. To use the current lingo, these were not rocket science problems, these were elementary,
ordinary, historically based reasons for failures. First, Asian banks and other Asian borrowers used short term
renewable credits from foreign banks to finance long term loans. Of course all banks do this to some extent. But
the extent matters a great deal. When the foreign loans were not renewed, the Asian banks and corporations
faced large defaults. Second, Asian banks and corporations borrowed in foreign currencies, yen, marks and
dollars, and loaned in local currency. They accepted the exchange risk without hedging. The reasoning is
appalling. Interest rates were lower abroad. None realized that the difference in interest rates, or cared to pay
attention to the fact, that differences in interest rates, after allowing for differences in inflation, included the risk
of currency depreciation. I suspect that that risk is now more apparent.
          Foreign lenders shared this myopia. They didn't show concern about making short term dollar or yen
loans to borrowers that finance long term domestic assets. US and other bankers added a third elementary error.
Many, perhaps most, did not ask to see consolidated balance sheets. They did not monitor the total assets and




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liabilities of the borrowers. And they didn't know what those assets and liabilities were at the time that defaults
threatened.
           What has been the result? Equity investors, debt holders, and owners of claims denominated in foreign
currency have taken large losses. By mid January 1998, stock markets in Indonesia, Malaysia and Thailand had
lost about 75% of their value on December 31, 1996. In the Philippines and South Korea, the loss was 65%. In
the year to mid January, holders with claims in Indonesian rupiah lost 70% of their value, and now it's probably
about 150% of their value. And rupiah devaluation has continued. The Thai baht, the South Korean wan and the
Malaysian ringgit fell 40 to 50% in the same one year period.
           What about the US, Japanese and European banks. Their loans are in dollars, yen and other hard
currencies. They want repayment in full. The IMF and the principle governments lend money to the Asian
governments so they can pay the interest on their bank loans or repay the principle. It helps the Asian banks to
avoid default, but the money goes to the foreign bankers. Instead of taking losses like the holders of currency,
stock and bonds, the banks collect the smaller zero loss. In an exchange for extending repayment, the banks
demand government guarantees of the loans they made to made to banks, financial institutions and private
corporations. That's where moral hazard comes in. This policy is the fourth mistake. I believe it is the greatest
mistake of all. It invites a larger financial crisis in the future. The Mexican bailout required 40 billion. This
time the IMF and the developed governments have promised 117 billion without much success.
           Capitalism without failure is like religion without sin. It doesn't work. Bankruptcies and losses, even
the threat of bankruptcy, concentrates the mind on prudent behavior. Prudence is the missing element in the
Mexican and Asian problems. In its absence, bankers and other lenders have taken excessive risks. They don't
concern themselves to learn about how many loans the borrowers have outstanding, how much the borrower has
borrowed short and lent long how much, how much currency risk has been assumed. The lender don't care much
because they believe they will collect whatever happens. This is a crisis generating system. A common
argument is, in its defense, is that Mexico repaid its loans to the US government and the IMF. That argument
misses the point totally. If banks and financial institutions have taken losses in Mexico, they would have
exercised elementary judgment, or more elementary judgments, about risks in Asia. Too big to fail is the first
cousin of moral hazard. Moral hazard arises when the social risks exceed the private risk. Too big to fail was a
flawed idea when applied to US savings and loans. and to Swedish, Japanese, Latin American and other banks. It
is no less flawed when applied to US, Japanese and European banks and financial institutions that have lent in
Asia. Secretary Rubin was right when he said in September, "What we don't want to have is a situation where
people can do unwise things and not pay a price." But that is the system that Secretary Rubin and the IMF have
created and sustained for the banks.
           Many arguments are used to justify these policies. Some are misleading. some are based on
misunderstanding, we've heard a lot of those this morning, some are simply wrong. One common argument,
repeated many times, is that South Korea is a large country; the worlds eleventh largest economy. It sounds
impressive. And indeed, growth of the Korean economy since 1950 is a remarkable achievement. But the
inference is that a financial collapse in South Korea would be a world shaking event. In fact, Korea has a GDP
about equal to the GDP of Los Angeles country. It may be the eleventh largest economy, it was until this crisis,
but it has less than 5% of the GDP of the US economy. Its total imports are about 25 billion, a quarter of 1% of
US GDP.
           One of the most serious misunderstandings concerns the role of the lender of last resort. Historically,
the function of the lender of last resort is to prevent unnecessary financial failures during periods of panic. It
functioned at its best in Great Britain after 1866, at its worst in the US during the Great Depression. The role of
the lender of last resort is not to bail out failed banks, or to pay people for their stupidity or error. Its job is to
assure that solvent financial institutions do not fail because of lack of liquidity. The Asian central banks have the
power to stem a domestic liquidity crisis.
           The remaining problem is the need for foreign exchange to repay foreign currency loans. The IMF
offers two services. It lends foreign currency on condition of reform, called conditional lending. It acts as a
consultant to troubled countries. Unlike most consultants, It pays the borrower to take its advice by offering
favorable terms for its loans. For example, 4.7% on loans to Korea where the domestic interest rate is 20, 30, or
40%. Asian problems do not require large international loans from the IMF and developed countries. These



                                                                                                   43
loans are more likely to delay than to promote reform. The IMF may threaten to withhold payment, but as history
shows, the threat is empty. The IMF has a stake in "successful recovery." Client governments understand that.
They know that the IMF does not want a failure. They call its bluff, delay reform, but they get the loan
payments. The IMF has not been able to demonstrate that countries meet the conditions they promised to fulfill.
Some do, some don't. But some would have done more to reform without the loans.
          Many critics of the IMF oppose the policies of fiscal stringency and control of inflation. I do not share
these criticisms in all cases. In countries with inflationary policies, control of spending and inflation is essential
for reform. This is not the problem in Asia. The present predicament was not cause by imprudent spending
policies, excessive demand and high inflation. Much of the problem arose because one of the principle markets
for Asian products, Japan, has grown slowly, and because China increased its share of the Japanese market after
devaluing in 1994. Also because the US currency, instead of depreciating, began to appreciate, and the Asian
countries didn't do much to change their policies to recognize that change in the dollar.
          I applaud the IMF for urging structural reforms to increase competition and reduce and local cartels
supported by the government. However, I believe such reforms would come faster in this crisis without
conditional loans.
          The IMF errs when it urges Asian countries to reduce demand one country at a time. What is needed is
expanded demand, produced not by inflationary policies in each of the countries, but by increased demand from
Japan. The IMF is wrong to treat the macro problem one country at a time. The key to the Asian problem is to
end mistaken Japanese policies and reform the Japanese economy. Japan's problems are internal. It should
restructure its financial system and end its deflation by increasing money growth. It has the power to do this
without any international help or without any international loans. As Japan expands, Asian exports to Japan will
expand demand in the troubled Asian countries. The principle beneficiaries will be those countries that
restructure by breaking up government protected and subsidized industries. As these countries expand, others
will benefit, and economic growth will be restored.
          Since 1971 the IMF has been looking for new things to do. It has now solved its problem by ignoring
moral hazard, allowing banks to avoid the risks they undertake, and by imprudent lending. The IMF encourages
the behavior that creates the problems. To prevent an even larger future financial crisis we must end this system.
Dr. Hausman has said he would like to see some evidence. I can't produce on the spot all the evidence that would
be required, but I would like to use the example of Mexico. The US Treasury and the Federal Reserve have been
helping Mexico since the 1930's. The 1930's. The first Mexican loan was in 1939. The IMF has been at it since
the 1970's. Successive Mexican governments have learned that if they face a crisis, one or both of these friends
will lend them money to make the immediate crisis appear less onerous. Investors have learned that they get
bailed out, particularly if they're banks, so they continue to invest. I believe that goes far toward explaining why
Mexican policy has been erratic and undisciplined at times. The Bank of Mexico and the government take
excessive risk and incur large losses from Mexican taxpayers. The planners don't deserve all of the blame by far,
but they contribute. The results have been disastrous for the Mexican economy and its people. Despite
enormous growth in the world, Mexican real income in dollars was the same in 1996 as in 1974. In the same
period, Mexican debt in constant dollars increased from 40 to 160 billion dollars. Much of this is the price
Mexico paid for US and IMF assistance. Without the IMF and the US Treasury, Mexico would learn to run
better policies.
          The IMF and the US Treasury have now extended these policies to Asian countries, perhaps postponing
a major crisis. But the risk of a bigger crisis is increased. Too much of the world has become too big and too
indebted to fail. Neither the IMF, nor the development banks, nor the US and Japanese governments, can pay for
all the errors, mistakes and imprudent actions that people are inclined to undertake, particularly when they think
they will be bailed out.
          I would like to christen the overhead machine for one minute. Here is Mexican debt. You can see how,
crisis after crisis, the debt is increased. This is total external debt in 1996 dollars deflated. Here is the income of
the poor people in Mexico. The mistake that people make is to say "Mexico is a great success because the
Mexican loan was all repaid." But what happened to the Mexicans. The Mexicans are enjoying the same income
in 1996, if that's the right word, enjoy, as they were in 1974. Look what happened to Mexico in the good old
days before they started to have financial crises, and look what's happened to the since. All those crises have left



                                                                                                   44
the Mexican government and the Mexican taxpayers, people, more indebted and poorer. Is that a success? Is that
what we want for Asia? (Applause)

Ricardo Hausman: Thank you very much Alan Meltzer for reminding us of the glorious days before capital
account convertibility. (laughter) Let me turn the floor now to George Votja who is the Vice chairman of the
Board of Bankers Trust.

George Votja, Vice Chairman of the Board, Bankers Trust New York Corporation: Thank you very much.
I knew I was to blame for all this. (laughter) It's sort of painful to be reminded. I think you'll find that my
thoughts are more akin the formulation that Gerry just gave you. I want to make about five points which should
flesh some of these things out a little bit.
          I remember in the banking system in the early 80's, before we got to the beginning of the debt crisis,
many of the banks around the town here had a very serious set of thoughts about Latin American risk. Most of
them said, "Look, the US government is never going to let Mexico go down because we're on the border, strategic
and all that sort of thing, and their never going to let them renege on their debts." Most bankers said the same
thing about Brazil but for different reasons because it was the biggest economy in Latin America and so on.
Well, when the Brady plan emerged and everybody forgave to the extent to 30, 40 and 50%, and so much for that
type of thing. So now, if you're historically minded and you think about the recent experience where Mexico was
supported and so on, you had to sit and think with any kind of a time frame, "what's the reality?" In one case
there was no financial support, in another case there was.
          Let me remind you also that many serious analyses of the issues of a safety net, and I think I could add
to this serious conversations about this with senior people in the regulatory community. I think there continues to
be an informal consensus among the people that manage the world's financial system that it would be highly
unwise to advertise or put on a piece of paper a formula for support. And it basically seems to always come
down to the conclusion that everything that comes up needs to be handled on a case by case basis. Case by case
is another way of saying reinforcing the constructive ambiguity statement of Gerry, and that's the case. That will
continue to be the case for the foreseeable future. So, if you are an investor or a cross markets investor or a
lender, or whatever you are, in terms of taking risks in the global market place, you don't have a possible basis for
assuming in any market that there will be official support if there is a problem. If your risk management policies
rely on assumption that there will be official support, I think that is a seriously flawed point of view.
          The next point I want to make is when there is official support, as we've seen from time to time, there's
always a basis for the problem, serious macro policy deficiencies, as in the Thai case which kicked it off. The
capital markets reacted, we had a severe dose of market discipline, which means that if you don't like what's
going on there, you sell. You sell the currency, you sell the securities and you get out. That's what happened.
But the world is such that we have another problem which magnifies this and I think the formulation of Alan
Greenspan put on this in the time of the 1994 disturbances, he said to me it comes down to the fact that the spread
of information technology around the world has extended so far, so fast, so comprehensively that we have to
operate on the assumption that the players in the marketplace, however you want to define that, have access, as
we know, to the same information at the same time, no matter where their location or time zone. Consequently,
even risk, so to speak, often triggers a higher degree of market correlation than we've ever seen before. Your
market positions or exposures, whatever they are, are not as diversified as they used to be because of the
advances in information technology. That in turn magnifies the degree of illiquidity that sets in in some of these
markets during these periods of disturbance and finally amplifies the volatility of the change.
          Again, in the Asian crisis, most risk managers in the financial system found that their policies for
calibrating risk and stress testing risk going into the crisis, were seriously flawed by the experience. Typically
the risk management population calibrated a stress test type of thing on a portfolio 2.5 - 3 times standard
deviation type of thing. Again, like in 1994, we saw 10, 12, 15. This is a function of the way the financial
markets work. I don't think anybody's solved that problem yet. Because if you price your services to the degree
that you have to sustain 10 standard deviations, you're certainly not going to be competitive or do any business.
Yet on the other hand, as we move and move and move forward in the world, this correlation risk, as I like to
think of it, gets worse and worse.



                                                                                                 45
          Because of that, the consequences of event risk are such that systemic questions come into play. The
contagion affect is partially, and I think very importantly partially, determined by the fact that everybody's
reading the stress in one place, looks immediately for comparable situations in their own mind, starts taking the
same action. It presents the regulators and the participants with immediate problems of risk. Gerry is absolutely
right when the event take place, the next thing on the table is where am I in my gross exposures in who I owe. If
I'm a clearing bank for the Korean financial system in New York, I've got a billion dollar intraday overdraft
position to manage the next day. And if I have trade credit maturities coming in that are not paid, and then
hemorrhage of credit comes out of the Korean system by the billions, something like that, we've got a serious
problem of systemic consequence. Because as Gerry says, the interconnected of all of this. I would say that the
instances official support, the Tesebonos experience in Mexico, and now possibly the support for the Korean
short term credit position, some 38 billion dollars which is now under discussion among the banks, arises not
because the objective of the support is to pay off the bank, or pay off a certain class of creditors. The purpose
and the rational for doing that was, in the Tesebono case, I think the systemic risk perspective was that if this
problem was not handled, we were risking a free fall ***Tape 4/1 Ends*** Exposures had the same
functionality, if you will in the crisis. So, whether or not it's serious enough to be a crisis of this proportion
comes down to a judgment call. And who makes the judgment? The judgment is made, roughly speaking, by the
small number of senior financial in the regulatory and government and multinational agency communities around
the world consulting with a limited number of private sector financial institutions. And there is a collective
communications process that forms up immediately and the consensus is sort of formed, "this is serious." Or, in
the Bearrings case or Solomon, the Drexel Burnham case, we can let it go. The market can absorb it. And that's
the way the world works. I don't see much hope for change and I think it works basically about as well as it can
at this point. But we've got to keep working on better mechanisms and I think some of Gerry's solutions are
worth serious thought
          The next to last point I Want to make is that whether or not there is a bailout or a public sector support
in these circumstances, people lose money. And all classes of people at interest in this situation lose money. I
would hope that at some point we could get to the point where we disconnect the thinking of losses incurred to
the bailout. I've already lost a lot of money in Asia. And I'm going to lose more. And so is everybody else. And
the governments are going to lose more. And the owners of the institutions with distressed or overpriced assets
are going to lose more before its all over. So what happens is the problem has to be corrected in the first stage to
bring financial equilibrium, or the avoidance of a massive problem has to be contained.
          The second thing has to be that we proceed through the second stage but in the final stage it always
comes down to an analysis of the asset plays or asset exposures that have to be revalued and distributed. In the
Asian markets, for example, and Japan, all the way down the line there are still overpriced assets, there are
overpriced assets which have to be restructured, revalued at a realistic price and placed out. If you can do that,
and this will be the subject of all the restructurings of banks and corporates throughout the area for the next
several years, that's how the whole thing gets ultimately resolved. Realistic prices means prices at which
investment capital can be attracted. And there's a lot of capital around looking for this and that's the end of it.
The point is there are losses whether there is an official support program or not. The losses are ultimately
distributed after being recognized among the governments, the owners of the enterprises, and those who invest or
lend to the enterprises. And that's always going to be the case.
          So, when the country is back at equilibrium, reestablishes itself after one of these things, the ultimate
thing is that when it mounts a program of growth again, under hopefully better stable conditions, all risks on that
market improve as a result and the official sector gets paid back. I say that's the world we're living in and it's
probably as good as we can do at this point. Thanks.

Ricardo Hausman: Thank you very much. Let's move on now to Jose Barrionuevo who is Senior Vice
President and Director of Emerging Markets Strategy at Lehman Brothers.

JoseBarrionuevo, Senior Vice President and Director of Emerging Markets Strategy, Lehman Brothers:
Thank you, thank you Ricardo.




                                                                                                46
          What I would to discuss with you regarding moral hazard and systemic risk, though I see this really from
the perspective of the markets and recent financial developments. Essentially we have three moral hazard issues.
One is from the past, one is in the present, and one is for the near future and hopefully the very near future in the
agenda of the Asian authorities. I think the first moral hazard issue is really the standard opening up of the
financial sector that took place in a lot of these Asian countries in the late 1980's where the financial authorities
didn't provide enough incentives to ensure that market risk exposures reflected unbiased returns. In fact what
happened is you basically have a scheme of single sided bets where investors were having a market ***54 4/2
*** assigned to their game in any single investment but a ***55 4/2 *** which basically was reflecting an
implicit guarantee, or the idea that through some sort of scheme or political relation, the losses were not going to
be taken. That obviously led to the excessive lending and the financial equity and real estate asset price bubbles
that we're seeing today. I think at the end, this is what this crisis is all about.
          To exacerbate the crisis, and really the reason why it has been so protracted, you basically have
authorities that didn't have the market experience or focus to deal with some of these issues and certainly were
not addressing investor concerns. Specifically, at the end you have a lot of these institutions taking leverage by
ten to fifteen times. They were lending against real estate and equity as collateral. They were also were involved
in a lot of unhedged transactions. So again, the bottom line is you had fairly weak financial practices in weak
financial systems that led to an asset price bubble. I think that really from the past and really the answer to those
questions into resolving this crisis essentially means looking for the once and for all major bank loan
restructuring and bank recapitalization initiatives which obviously so far you still don't have. You are still
looking for the one, still roughly isolated solution.
          The second point, second moral hazard issue is really related to the IMF and the involvement of the
IMF. Here the moral hazard issue arises because by providing financing to these countries, the IMF essentially is
signaling the market that there are things that are going to change in the economy, in the financial sector of these
economies, and in that sense, with markets that have imperfect information and cannot really look at the ***77
4/2*** monitor, you know how these governments will fulfill, redress, the market concerns, basically rely on the
IMF to do that and basically having these countries being involved in a program essentially tells them I have to
invest more than I would otherwise because the IMF is a signal to be in the market. That explains the second
shock. The one that we've seen recently over the past few weeks when investors are learning that the programs
we have put together by the fund are not enough, or at least so far don't seem to be the final answer to the crisis.
          So the new dimension to this crisis, the first one is the standard moral hazard lending aspect of it. In the
second one you have a very important issue that is now in everybody's mind which is the issue of credibility.
That also involves the IMF credibility to a very significant extent because with the crisis continuing and the fact
that, despite the IMF intervention, a lot of these problems are just becoming worse to some extent. The market is
questioning now what were the things that we were missing? What would it take to solve this crisis? To what
extent does the fund have enough leverage, I'm talking about monitoring and surveillance authority to enforce
these programs and to monitor these programs to the satisfaction of the market and I think that that's the other, the
second significant aspect.
          What is critical here is the difference between this crisis and the early 1980's crisis in Latin America is
that at that point you had countries that were moving into IMF agreements and countries that had been, for a long
time, net borrowers from the Fund. This time around you have countries that typically had been, at least some of
the largest ones involved, net creditors to the Fund, and maybe that ability to enforce policies and programs by
the IMF could have been limited because of that previous relation to some extent.
          The bottom line is that it is very difficult to justify for the market, or market players, engaging in
agreements that a couple of months later you have targets being revised. That doesn't help creditability. You
also have agreements that were finalized, for example in the case of Thailand and Korea, when you have a very
difficult political situation and probably that basically led to the very rapid conclusion of agreement, but on the
other hand you were still missing key elements in those programs. The ***106 4/2 *** is the one that I found the
most interesting in terms of moral hazard that really involves breaking the link between the currencies and a weak
banking sector. I think that's very important because at the end, what you still lack in Asia to a very significant
extent, many of these countries except Japan, is a very strong monetary anchor. I think that the first, immediate,
and most significant answer to a crisis or to contain currency pressures should be focused on interest rate



                                                                                                  47
management. Increasing interest rates, getting the liquidity out of the system, is really one of the key things that
investors are going to be looking for. They are to believe that there has been a significant change in the current
situation and that we are going to be in a situation where there could be some prospects for a resumption of
capital inflows. At the end that's where you want to be and it won't be until you have the significantly attractive
interest rates and fixed income opportunities in those countries that you will start seeing that resumption of
capital inflows and the more definitive stabilization of the Asian crisis.
          If you look at Mexico, the Mexican crisis started in December, 1994. Despite the US package and
despite the IMF package, the crisis actually just worsened and it was not until March 30, 1995 that conditions
began changing more dramatically. That day was when the central bank decide that they were not going to move
from 30 to 40% interest rate but from 40 to 100% (*** 125 4/2 (I don't know if the previous is right***) and that
got the liquidity out of the market. I think it's very tough to see a currency crisis if you don't give the liquidity to
the market. And at the end the moral hazard arises because if you don't do that, if you don't pursue the monetary
anchor, the high interest rates in a clear way, what you're signaling to the market is that you're prepared to bail
out the banking sector sooner that later for monetary creation. That's really the main concern.
          It is also obvious that you can raise interest rates to whatever levels, what is important here is that the
one thing that we have to be focusing on is that the key issue about interest rates is not how high they get, but
how long they stay there. That's one thing that we're missing in Asia to a very significant extent.
          To make those interest rate policies credible you have to focus on the kind of bank restructuring
programs that Mexico announced in 1995. I am talking about the bank loan restructuring and recapitalization
programs, not the isolated, one on one type of initiatives that we've seen so far. At the end is to really be in a
position to attract capital inflows and in order to do that, again, the monetary anchor, there's no way you can do
without that.
          The second set of issues is systemic risk. From the market perspective there are two significant sources
for that systemic risk. The first one is related to basically investors trying to liquidate positions, essentially you
try to diversify your portfolios. When you have a country that is under a lot of pressure and you are moving into
significant losses, you also tend to liquidate positions in other countries that still provide you with significant
gains in order to still try to provide your shareholders with a significant return. So that gives you the first aspect
of the systemic risk. A significant aspect of that from the perspective of the market is during a crisis you stop
trading on a cash flow basis and essentially start on a stock basis, meaning, if we want to be paid, the issues that
are going to be relevant to us are the measures are level of debt, the stock of debt, the stock of international
reserves, and the stock of credit because at the end of the day I am going to be concerned about not only the
rollover, but whether you can pay me if I want to be paid if I want to be paid today.
          The other second issue has to do with countries in terms of the systemic risk evolving or moving
throughout the market, has to do countries that are in a similar position to the country that is under pressure, or
has the same perceived problems of that specific country. In this case we are talking about excessive bank
lending, financial weakness. We're talking about large external imbalances. We're talking about equity price
bubbles. Effectively, the reason for why we had on October 27, 1997, the worlds first asset price shock, was
because the chairman of the Federal Reserve quite some time ago had raised the concern about equity price
bubbles and clearly that was one of the main issues behind the Asian crisis. You also had investors immediately
turning around and say "What other countries have those kinds of problems?" and you look at Brazil, with equity
returns of 80% during a six month period when you had very little growth so that didn't really make a lot of
sense. You also have Russia with similar growth and other countries with lower growth but it's still significant.
          You also have these countries having significant debt rollover. Which are the countries that are more
vulnerable to that systemic risk outside Asia? In my view those are today Brazil and Russia. That's again
because, in the case of Russia you have the financial weakness, the bank excessive lending, equity concern, and
you also have the equity price bubble which obviously the market has been working out. The other one is Brazil
and that basically related to the fixed income, to the rollover of internal debt, a very large stock of internal debt of
about 30% of GDP, of which on February 2, you have to rollover another 14 billion during the whole month of
February 33 billion when you don't have very significant global liquidity. This is the second concern. The
bottom line in trying to reconcile the moral hazard monetary issue and the systemic risk is that you have to
provide investors with significant opportunities. If you lose your equity anchor, to put it that way, you have to



                                                                                                   48
provide them with a fixed income anchor. The reason why we don't have a large devaluation in Brazil today is
because the central bank reacted very aggressively to provide the market with that anchor.
          The final issue on the systemic risk that I would like to address is how you contain those systemic risks
and how you decouple from the systemic risk. Decoupling is the most significant issue at this time. It would be
too ambitious to hope for a prompt once and for all resolution of the Asian crisis, that solution will continue to be
fairly protracted. But I think what the market is looking for at this time is just basically a sense that we're
touching bottom, and obviously with Indonesia close to corporate defaults, concerns about similar situations in
Thailand and Malaysia, there is not a clear sense that that's already where we are. I would argue Indonesia and
Thailand and Malaysia don't really give you the systemic risk, systemic risks are obviously coming from Japan,
South Korea, and Hong Kong, but they are relevant to the extent that they raise issue of default and put in front
of every trader the word default and in that sense immediately leads to asset price corrections throughout.
          The things that we are missing today from Asia and what we have to address is systemic risk, from the
perspective of countries, in trying to differentiate themselves, is really addressing the stock problems, when you
have a large stock of debt, obviously you have to do debt buybacks. You can do that if you can do privatizations
so the things to focus on now is privatizations in countries that can move on that. Brazil is in a good position. To
the extent doesn't do that, the concern is that they'll be under significant pressure and their ability to hold the
currency is going to be questioned at that point even more.
          The second one is that you have to provide the strong monetary anchor. You have to focus on interest
rates. What is interesting here is that you are moving into a situation where in Asia everybody is focusing on
recessions, not only slowdowns, and very sharp recessions. But the fact is there will also be increasing inflation
and high inflation in Asian will cause the market place to start reassessing how much do we really need to see the
rupiah weaken, for example. That will start taking some of the pressure off. Interestingly, Asia is moving, to a
partial extent, but is really moving in line with the Latin economies in the 80's, in terms of high inflation, at least
for now, than some of the leading Latin American economies.
          Finally, it is clear that this is not a fiscal problem. It is also obviously that the bank addressing banking
issues in a creditable way means you have to come up with a stronger fiscal performance that leads to
capitalization of banks. You also have to focus on the market to help restructure those loans.
          My conclusion here is that what we are seeing now is that Asia, to a significant extent, is following the
Latin American path of the '80s in terms of the financial inflows and financial crisis. That is really not new at all.
And Latin America is not moving, as Mr. Meltzer suggested really, moving more into the Asian path of the
1980's in terms of relying more on foreign direct investment. But what I think is clear is that Asia has been
postponing for a long time the restructuring of their financial sector for at least seven years now, and I'm talking
about some of the leading economies, including Japan and Korea. I think it is time for them to address the
financial restructuring. I think markets are providing the best role in this restructuring, simply because now they
are telling the market that, in a credible way that the only way that they can get out of the crisis is through the
bank restructuring and obviously in a very costly way. So my bottom line is that I hope this time they'll get it.
Thanks.


Ricardo Hausman: Thank you very much. Now let's turn to Carlos Asilis, the Director of Emerging Markets
Strategy at CS First Boston.

Carlos Asilis, Director of Emerging Markets Strategy, CS First Boston: Thank you Ricardo. First I would
like to thank and commend Marc Uzan for organizing this very productive conference. I hope certainly that is the
first of several conferences on this issue that is certainly of crucial importance all of us here and the global
economy.
          I find myself very much in agreement with the articulation and also the conclusions given by my
immediate neighbor, Mr. Votja, from Bankers Trust. I would go a step further and say that indeed, there is much
we can do in terms of improving the system that is currently in place. I've organized my presentation in four
parts. First I'll briefly discuss what is the nature of the moral hazard problem in the context of international
lending, and the relationship with systemic risk. Secondly I'll briefly discuss, or address the issue of how



                                                                                                   49
prevalent, or real, the moral hazard problem is in the international capital markets. Thirdly, I'll address the issue
of should the moral hazard problem be the focus of policy discussions. In other words, is the problem, the moral
hazard problem in the international capital markets, of an order of magnitude to warrant the design of specific
policy action. Finally I will conclude with a discussion of what policy prescriptions, if any we can think of. And
on this issue I address this issue through the lens of rules verses discretion.
          So I will start of with a brief discussion of semantics. semantics are always very important in any
discussion, as has been my experience. If we look at the MIT dictionary definition for moral hazard, we see that
the dictionary defines moral hazard as the effect of certain type of insurance systems in causing a divergence
between the private marginal cost of some action, and the marginal social cost of that action, thus resulting in
allocation of resources that is not optimal. This is very much in line with what Professor Meltzer's definition has
been. The link in the international market context, of course, has to do with systemic risk. Risks to the global
payment system, an issue that Mr. Corrigan has discussed at length. However, before proceed to detail, in the
context of the moral hazard problem, I would argue that in the international lending context, and international
financial system context, the moral hazard problem is a foresighted problem, involving not only creditors,
debtors, domestic financial intermediaries, as well as international financial institutions as some of these
international financial institutions' performance is assessed, often times in terms of the size of the portfolio, the
size of the lending that is extended to the recipient countries. This is certainly not the case at the IMF where I
worked for a number of years, but it is the case in other international financial institutions. And this distinction is
key because of the implication that it has on terms of policy prescriptions, as we will see in the fourth part of the
discussion.
          Moving on to the second part of the discussion, in terms of how prevalent, or real, the moral hazard
problem is in the context of the international financial system, much has been said by previous participants in this
conference, particularly Mr. Lachman and Mr. Daza, about the case of Russian investors, investors in the Russian
DKO market. Their interpretation that action on the part of the IMF, and not only in the case of the Mexican
Peso crisis in 1994, but also in the very recent case of the Asian crisis, leads to the implication that Russia, being
a nuclear superpower, one of two in the world, certainly would deserve a lot of attention from the international
institutions and also the German government, not just the IMF. So, in terms of anecdotal evidence, I would argue
that indeed, the moral hazard problem is a real one, potentially, in the international financial market.
          Secondly, I'll just advance another anecdotal episode which essentially establishes the realism, the
reality of the moral hazard problem in the international context. The existence of the moral hazard problem in
the international financial markets has been fueled not only by implicit action and announcements, but also by
explicit action and announcements. For example, in a statement given by managing director, *** Michel
Camdessus *** in the aftermath of the IMF bailout of Mexico, he made reference to Article 1 of the Articles of
Agreement of the IMF which states that it is the IMF's mission "to give confidence to members by making the
general resources of the Fund temporarily available to them under adequate safeguards, thus providing them with
opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of
national or international prosperity." Mr. Camdessus went on to state his interpretation of Article 1 in the
Mexican context by stating "On January 31, 1995, this was the problem." If the IMF did not contribute quickly
and substantially to a major international financial package for Mexico," and the IMF was the institution in a
position to react promptly, was his inner reaction, "Mexico may have had no other solution than a moratorium on
foreign debt, or a reimposition of trade and exchange restrictions. Such steps would have met Article 1's
description of "measures destructive of national or international prosperity."" The issue of moral hazard is
certainly a real one, and it is certainly that has been inferred, I would argue correctly, by market participants, both
through implicit as well as explicit action and statements.
          In terms of point number three of our discussion, essentially should the moral hazard problem be the
focus of policy discussion, or in other words, is the order of magnitude of the moral hazard problem large enough
to warrant policy action, I'll be extremely brief. Here, of course, I alluded to in the beginning of the discussion to
the four dimensional nature of the moral hazard problem in the international context. I certainly do not have the
time to discuss all those issues. It is clear that what the focus of the moral hazard is in this discussion, that is to
say, primarily in terms of the moral hazard as it affects the creditor activity as well as the immediate borrowers'
or debtors' activity. But in terms of the costs, is it worth our wild to think about policy action? I think that's self



                                                                                                   50
evident. I certainly agree with a primary role of the IMF in the international financial context, I think that goes
without saying, and I would argue that almost all the panel participants, not just this afternoon but also this
morning, would concur with that view. I think that the issue of contagion, of course, is the first cost factor that
springs to mind. Contagion is certainly a reality. It really exists. Both because of the micro economic nature of
the investment industry, as well as because of the current account and capital account nexuses or linkages across
countries. I think that's pretty clear, the literature is very clear on this, the evidence is also quite clear. I will
defer allusions to evidence to the discussion section if need be, but I shouldn't elaborate much on this.
           I'll just move on to the fourth and final section where I devote the bulk of my time, which has to do with,
if indeed there is room for policy action, what form should this policy action take, i.e. rules versus discretion. On
this, I'll make again a quick comment paraphrasing a very well known member of the community, Mr. Larry
Summers, who has been a pivotal official in the trying to address the Asian crisis. Again, in the aftermath of the
Mexican peso crisis in 1995, Mr. Summers discussed the issue on moral hazard and he stated, "as with domestic
bank runs, any last resort lending also raises questions of moral hazard. Planning too well to deal with failures
may encourage countries to behave irresponsibly and also undermine market discipline as investors rely on the
international community rather than monitoring country risks." He went on to say, "On the other hand, not
planning in advance runs serious risks too." To minimize moral hazard, and this is his conclusion, "it remains
essential that these procedures should not be spelled out in detail, and that it be universally understood that any
financial assistance will come only with rigorous conditionality." This paraphrasing of Summers certainly seems
to indicate that he is very much on the side of discretion versus rules. On this, of course, I would generally favor
the adoption of rules versus discretion, of course, the key issue here in the context of the international financial
system is credibility, what economists call time consistency. Can we think of a set of rules that are time
consistent, or credible over time? And of course, this issue cannot be addressed solely within the confines of the
IMF, but also within the context of the instruments, of the various instruments that the global financial
community has, which not only includes the IMF, but also the OECD, the BIS etc. Because, if we were, just
think of a hypothetical, supposed we can think of a rules based solution to these problems we are discussing
today. Certainly, the rules based solution may be defined within a context of an institution, say the IMF or
maybe the OECD, but that solution would have best been a internal solution. When the crisis occurs, upon
occurrence of a crisis, there is always a prospect of a solution external to the IMF, external to the BIS, external to
the OECD. This is the crux of the issue, it is a time consistency issue, a credibility issue. As a result of this, my
own personal opinion on this is that I have to embrace, not fully but to a great extent, Larry Summer's conclusion
in which discretion, which sort of is a kin to a mixed strategy type solution in the context of game theory, is the
optimal solution. Discretion is the optimal solution. I do think however that we could inject a number of rules,
or a certain degree of rules, certainly an imperfect rules based system, or a soft type rules based system to the
IMF that would mitigate the extent of the moral hazard problem. And I'll further discuss this in a moment.
           First of all, I follow the motto that prevention is better than the cure. On this, on the issue of prevention
is always better than the cure, what can we do in terms of preventing a recurrence of a type of crisis that we've
seen or preventing the blowout of a moral hazard problem that may exist, or as we would all argue, that indeed
exists. I think that first we would all agree that sound market fundamentals are always key; fiscal, monetary,
structural, micro policy mix, and a strong independent central bank is very important. A unified foreign
exchange rate system is key. Broad private ownership of banks is very important. Transparency, free capital
markets, I think is very important as well. Secondly, the integrity of the payment system should be at the center
of any prevention, because in periods of market crisis, the market sees through the vale of actions on the part of
international financial institutions. The market realizes that the governments will always put precedence in terms
of preserving the payment system over preventing a blowout in inflation. And this is key. The deposit insurance
considerations are very important. Of course this is not a panacea, as Mr. Corrigan has said. The make-up of
various countries in terms of lacking deposit insurance and others that have a strong deposit insurance system is
still not quite clear.
           Finally, in terms what does the theory tell us about international lending under moral hazard and what
are the policy implication that can stem out of the theory? International lending certainly has various
distinguishing features from domestic lending. One of which is the ability of sovereigns to repudiate their debts.
The second is of course the issue of imperfect information, something that has been discussed throughout the



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day. These two issues lead to, in terms of the economic literature, that the second best contract in this type of
environment with imperfect information and with the ability of sovereigns to repudiate their debts, that the
second best contract prescribes default behavior for instances of repayment difficulties and a draw down in terms
of the extension of credit to sovereigns, to debtor countries, in periods in which the production output is low, or
in which terms of trade shocks are adverse, as was the case in Latin America in the early '80s when commodity
prices experienced a severe drop, and also the reversion in real interest rates, US dollar interest rates. This result,
of course, implies, this result was arrived at by Andrew Atkinson in 1991. I myself have a model that addresses
the nature, the market structure of the international financial system in which debt default behavior, or debt crisis,
occur recurrently as part of an equilibrium. But again, I will not expand further on this. But this has relevance in
terms of what the IMF has been doing in the last few months. And I'll conclude with this.
          These two feature which imply that the second best contract looks very different from the first best
contract, namely one in which credit extension is always ongoing, is always existing, even through periods in
which commodity prices drop, terms of trade shocks drop quite severely, have two implications. One, that to the
extent to which we can lessen the ability of sovereigns to default in their commitments, that would be key. And I
think transparency here is key. Mr. Cambassus, of course, has been talking about the moral suasion that Asian
countries could exert upon one another. I think this addresses the issue of imperfect information. The issue of
putting basic data on the web, on the part of the IMF, addresses the issue of imperfect information. Which again,
lessens one of the constraints that prevents the first best contract from occurring.
           Another action that we could think of in terms of improving the system is trying to complete these
markets, trying to address this market incompleteness problem by specifying property rights. Here we can think
of facilities that would impute a price on countries that create the negative, i.e. the contagion effect, the adverse
contagion effect that we've heard of so much throughout the day. I'll address this issue in the discussion if need
be.
          Thank you.

Ricardo Hausman: Thank you very much. We started about an hour late and we are about a half hour late now
so I am going to allow two comments/questions and then I'll decide how many answers I'll provide.

***470 4/2 Unknown Speaker ***: What is the probability of the contagion going as far as Brazil, and from
Brazil to Chile, or Peru and from Peru into Argentina?

Jim Nash, Nomura: I would like to ask if the probable of moral hazard could be reduced if the debt problem
there could be resolved by the adoption of a debt discounting solution that we reached in Latin America with the
Brady bonds in the 1980's. And specifically to Mr. Votja, as a banker, would he support the idea of a Brady plan
for Asia?

George Votja: I think there are better ways to do it. My point to you is that you're going to have losses incurred
by all players no matter what's done.

UriDadush: It seems to me, the reason we have systemic risk and moral hazard in the same title for the session
is, it seems to me what we are recognizing is that there is a real cost to moral hazard. One is trading off moral
hazard for systemic risk. I think that one of the questions which I would have liked see discussed but I haven't
heard from the panel so far, is what has happened to systemic risk in this new world of private capital flows and
very different structure of capital flows with a much higher share of equity financing and, indeed, a lot of the
bond financing that goes in in the form of high yield bonds is quasi equity financing, it has many of the properties
of equity. The contention would be that the big lesson learned from the debt crisis was that it is much easier to
manage this kind of systemic risk, or should be, if you have a lot more equity investment. One aspect of this
equity investment, which is very important, is that the people who own the equity are highly diversified investors,
or should be highly diversified investors if they are not stupid. So very simply, the question is do we really face
the same level of systemic risk today, given the fact that the bank lending to governments and bank lending in




                                                                                                   52
total, is a much smaller proportion and that the bulk of the investment that is going into these countries, is going
into the private sector and offered by highly diversified investors who understand that they are taking a risk?

Ricardo Hausman: Thank you very much. Since we are out of time, let me stop the question period there and
let me encourage our panelists to be very economical in their use of time. For example, we all know that nothing
else will happen in Latin America, so forget about it. (laughter) Concentrate on Asia. We have a very important
question as to whether the main thing we learned about the debt crisis is that it is very hard to learn about debt
crises. The issues are these investors adequately diversified and is a Brady bond solution a solution to this
problem.


George Votja: The last question is very important and shouldn't be neglected. I partly answered the question in
my remarks by saying that after Mexico there was much less financial flow and much more foreign direct
investment, that is people had seen what happens in stock markets and they didn't like it very much and that that
will probably happen, one hopes, in Asia, if they liberalize their institutions and permit it. So one way is to
equate those risks, the private and social risks, by having foreign direct investment. The other one, which is I
think for the banking side, we don't need the IMF. What we need is to change the rules of the game so that these
risks are again equated and internalized. How do you internalize the risk on bank lending? The older capital
market rules of, say, the end of the 19th century, was that the banks had branches all over the world so that they
internalized the risks of foreign exchange and other kinds of crises by mixing them and diversifying their
portfolio. In my judgment, the big problem in Asia is that countries like Thailand, Indonesia, South Korea, are
probably too small. Korea is the biggest of them and it's the size of Los Angeles County. Now we wouldn't think
of setting up a banking system for Los Angeles County. We would think that it's much if a banking system for
Los Angeles County was part of the banking system for California, or even better, the banking system for the
United States. That's what we need to do. We need to get foreign lenders in there, but in order to make that
work, they have to post a guarantee that they're not going at the last moment when there's a crisis to sort of say
we pick up our chips and go. My solution is we have to internalize the risk, which means that the banks have to
be multinational. We should have learned from the experience in the United States that regional banks don't
work very well because they are not diversified enough. We have to diversify the banking system over the world
by having banks that are branches and they will internalize the risk. But in order to keep them from running at
the moment of crisis, they have to post some kind of bond that will keep them from doing that.

Gerrald Corrigan: A couple of very quick remarks. One on the contagion thing. I actually think you can make
a case that markets are becoming somewhat more discriminating, not less. And if that observation is correct, it
works in the direction of arguing that maybe contagion is becoming somewhat less of a problem rather than
somewhat more. That of course doesn't mean that when you have a bunch of countries that all have real
problems that they're not going to be found out. But I do think that you can make a case that markets are getting
a bit more discriminating.
          On the debt discounting, forget it. Remember, in Latin America you had one debtor, the sovereign.
That is not the case in these countries. The overwhelming problem is in the private sector, not with the sovereign
itself.
          On rules and discretion, I would just observe just observe that discretion is kind of a kissing cousin of
what I call this constructive ambiguity. But I want to be clear that I do see a role for rules. For example, as I
mentioned, one rule is you never, never, never, never protect shareholders and managers, and I could cite a
number of others. So it's not quite black and white. But I do think, I'll just use an example that occurred in the
United States in the mid 80's, we had a controller of a currency who stood up in a room and said the ten largest
banks in the United States will not be allowed to fail. That to me is not a very good idea. ***Tape 4 Ends***
And it's hard to see any alternative.
          Since the debt is in the corporate sector in many of these countries and payments, repayments,
restructuring, debt to equity, and so on is probably just going to have to be worked on case by case with the
relationship banks. It's already started.



                                                                                                53
Ricardo Hausman: Let me bring this panel to a close and invite you over for a well deserved coffee break and
we'll have the next panel in fifteen minutes tops.

PANEL IV - BANKING RESTRUCTURING, AND BUILDING AN ORDERLY WORK OUT
PROCEDURES

Edward Altman, Vice Director, New York University Salomon Center: I'm Ed Altman from NYU and I too
would like to congratulate Marc Uzan for a really incredible effort in putting together this two day conference.
Perhaps the only criticism one could lay on him is the fact that with so many distinguished speakers, the day runs
very long and those of you who are with us for the last session we thank you very much because obviously, a
speaker always like to have an audience. That goes not only for myself but Lee Buchheit who is the last of the
last speakers and he's probably saying why do I have to be last, but then again, somebody has to be last.
          I'd like to say a few words in introduction to the session, which is on bank restructuring and orderly
procedures for work out. Before coming today I was unaware myself of the extent that this current crisis,
particularly in Asia, but recently in Latin America as well, is fundamentally a private sector crisis with, of course,
sovereign under and over tones, particularly in Korea. As a result, the question is what sort of work outs or
procedures are in place, or could be in place, to salvage this and to turn around these problems which are the type
of problems that we really haven't faced before on a global level? We've had the experience, and I think others
will talk about that at the sovereign level, but at the private sector level we have this real situation which is much
greater than even I had thought coming into today. One then thinks that perhaps what the world needs, it sounds
like a song, what the world needs is some sort of international bankruptcy convention so that creditors, equity
holders, in fact stake holders in general, can know where they stand, both when they put in capital, and when the
crisis occurs, rather than wondering whether or not they are going to be bailed out and the moral hazard and other
issues become problematic at that point in time.
          You have to look around as to what is available from a standpoint of private work out systems. The
United States, as many of you know, has what's called a Chapter 11 bankruptcy reorganization system for most
organizations, not banks and a few others, but most organizations and although that process is by no means
perfect, and could be abused by the various stakeholders, it is one model that needs to be looked at very carefully
in some sort of international forum. For one thing, the United States is known as a debtor friendly country. As a
matter of fact, people rush to file for bankruptcy first in the United States when they have the choice, should it be
in the United States, should it be Great Britain, should it be in Canada, I can think of some recent cases where
that was an issue. Debtor friendly. And yet, the empirical evidence shows that the senior creditors do very well
in the US bankruptcy process. That the senior creditors, the rest of the world, tend to force, when it's expedient,
and it usually is to them, at least in their eyes, a liquidation of the entity. Sell the assets of, pay off the most
senior creditors first, and nothing usually is left over for the subordinated creditors and the equity holders. And
yet, in the United States where that rarely happens in large companies, almost all large companies now get
reorganized successfully, I don't know the percentage but I would guess 65-70%, we're talking about large
companies, 100 million dollars in assets or more, and in those cases the most senior creditors get paid off close to
100 cents on the dollar, but also, if you would buy their securities at the time of default, and hold to the
extinction of the reorganization process, which on average takes about 18 months, your rate of return would be
20 to 30% per year. In other words, you buy at default, which has some implications which perhaps Richard
Gitlin is going to talk about, buying and selling assets in a distressed situation and what role that can play in the
economy.
          The last thing I would like to mention before turning to the panel is the banking system. One item that
has not been mentioned today about banking systems, or maybe its been touched upon, is that when there is a
crisis, the banking systems essentially close down to new lending. Everybody is worried about fixing the old
problems, and as a result the economies stagnate or, even worse, fall back further. So what can be done during a
crisis situation, and thereafter, to motivate the banks to lend, so that the economies will not suffer even greater
losses in the short run? I'm working with the Mexican banking commission now, not necessarily terribly



                                                                                                  54
successfully at this pint, in terms motivating the banks to lend, and of course that means rigorous, modern, credit
management systems are in place, or could be in place, to lend to those investors and those firms that are still
credit worthy. Because there are many of them that are credit worthy, the problem is refinancing, and everybody
gets tarred with the same brush.
          So we're worried about the Indonesian situation. I would wager that there are many very solid
Indonesian companies there. The problem is how are they going to manage over the next short run when the
country is paralyzed? The only way to do that is they have access to capital. So the panacea, and it's only a small
one compared to the bigger problems you've heard today, is motivate the banks to lend by having in place, maybe
not now but in the future when these problems come up again, risk management systems that you have some faith
in with respect to making the right lending decisions. And don't tar everybody with same brush.
          O.K. without further ado, let's go to the panel. And what I've asked is the panel keep their remarks to
ten minutes and so everybody will hopefully will be able to get out of here by six p.m., which is just slightly after
the expected end of the conference today.
          Our first speaker is Gerry Caprio who is with the World Bank and particularly in the financial sector
research and I would assume that he is going to be talking particularly about that sector.

Gerard Caprio, Manager, Financial Sector Research, The World Bank: Thank you. Since some of the
earlier speakers today who were economists were accused of speaking beyond their time limit, I'll try to uphold
the professions valor and faith by sticking to the time limit as closely as possible. This also suits my book since
I've got to leave at six o'clock to catch a plane.
           I'm also going to try to do it from an economist's perspective on the issue of bank restructuring and its
often precursor, bank recapitalization. Some of you, no doubt, have seen the book by the psychologist Elizabeth
Kubler Ross called On Death and Dying. She writes about how people deal when they're informed of their own
oncoming demise. And she talks about the stages that one deals with this, saying that first, one usually
experiences fear, then anger, than denial, than depression, and, at last, one accepts it. However, after she
apparently had her own bout with cancer and went through these stages, she finally admitted that you never
accept it. Well, so to it is with systemic banking problems in some developing countries, indeed, I think in all
countries. At some point in this process, usually when they get to accept it, but even often times before that,
government officials try to restructure the banking system.
           An early view in the last fifteen years has been that one has to recapitalize banks early on in this
process. The logic is not very complex. If there is a hole in the balance sheet, it's been argued that you have got
to fill it. This recapitalization is often justified because it is said that banks are special. There can be contagion.
Problems can become systemic, meaning that other banks, presumably even good ones, might be affected, though
it is very hard to document when that happens, and that then the payment system can collapse. This suggests that
it is very urgent to fill those holes.
           However, banks are special in other respects. Their scope for fraud and moral hazard, for looting, and
for the ability of bankers to shift the risk profiles that they take very quickly. A second view is that, in short,
banks that have a lot of bad loans should be regarded as machines that make bad loans, and if merely put in more
fuel, mainly inject new capital, you shouldn't be surprised if they continue to turn out bad loans. So this says that
you really want to restructure them first and make sure that new capital will not go to waste.
           Unfortunately, this is not always, or even usually the case. I would like to draw the contrast between
how banks are dealt with and how non bank firms are dealt with in times of trouble. Usually, insolvent firms find
it very difficult to raise new funds. They may have to sell important assets. Usually, if they are major firms they
don't cease operations, but they downsize themselves to a profitable core. They'll deal with the imbalance
between assets and liabilities not by getting new equity, certainly not early in the process, but by marking down
liabilities and equity to conform to the new lower value of their assets and their cash flows. Equity holders
usually see their claims wiped out, and debt holders usually often have a substantial portion of their position
converted to equity. At the same time, or before this, management gets replaced. A lot of the assets are sold.
Workers get laid off. All participants in this process get the message that poor performance is costly. The result
is that assets can continue to be used in the best way possible for society by transmitting this message strongly.




                                                                                                   55
          The imposition of losses on creditors plays a very important part in this process. creditors may not have
the best information on the firm, but they do have very good incentives to take action based on the information
that they have. They have the incentive to monitor the firm and when there is a serious downturn in its
performance, to step in and take action. The problem is that because banks are deemed to be special, restructuring
often involves government funded recapitalizations and as implemented in many countries, these programs either
mute or totally squelch the message that poor performance is costly. The recapitalization of a bank to support its
existing liabilities leaves creditors completely protected, forces no downsizing of the bank, no layoff of
employees, no reallocation of capital to better uses, and it reduces the accountability of regulators to the public.
Perhaps most importantly, it reduces the incentives to pursue delinquent borrowers. In many developing
countries, the typical collection rate on written off loans is five percent. Most of the people get off free. In
addition, the government has to use its scarce resources to fund wealth transfers.
          If governments are going to deal with these problems, how should they do it? A study by the late
Herbert Bear of the Chicago Fed and then the World Bank suggest that a comprehensive approach to resolving
systemic insolvency can minimize the risks involved and the costs to this process. He looked at five episodes
where countries took a very comprehensive approach to dealing with financial system distress. Each of the
approaches had a lot of different elements but there were a few common themes that he drew. First, uninsured
depositors of insolvent institutions lost money. This was an important part of the process because policy makers
sought to maintain that there needed to be strong market oversight. Secondly, and this is of key importance, all
insolvent institutions were dealt with more or less simultaneously in each of these five programs. On Sunday,
March 5, 1933, Franklin Roosevelt wrote in his diary when he returned from church that day, "Am increasingly
convinced that 48 separate solutions to a banking crisis cannot work." The next day he shut down the banking
system and reopened banks that were, at least the nation was told, were solvent. By moving against all insolvent
institutions simultaneously, the government can reduce depositors concerns that their deposits are going to be in
banks that are next on the list. Third, actions taken by regulators made it clear to depositors that a financial
institution would be allowed to remain in operation only if it's well capitalized. This policy can help reduce the
possibility of runs on solvent banks, and also enhance the efficiency, indeed not only the efficiency of the
payment system, but its ability to stay open. In all these episodes, shareholders were wiped out and bondholders
took a beating.
          What are the preconditions for injecting capital, once one gets to that step? I'll just do the thumbnail
sketch. One wants to halt the flow of funds to borrowers that are in default. If you haven't done this it is a waste
of time to inject new equity. Secondly, instituting oversight. One needs a rigorous program of performance
monitoring, including, I would argue, substantial monitoring by the market, in addition to improving the ability of
supervisors to monitor the institutions. One needs to limit lending by insolvent banks, which is often not done.
And, change management completely, and change the incentives of the new managers.
          I could talk, and indeed often do, talk at great length on what it takes to change incentives. Again, just a
quick sketch, Clearly making a serious attempt at collecting uneven written off loans, is important. Otherwise,
for the next crisis, people will have gotten the message that they don't need to repay. There are different ways to
improve the incentives of banks and of the market to oversee banks. Higher capital requirements, greater liability
limits on bank owners, limiting entry into banking to increase franchise value, higher liquidity requirements, you
can add to this list. One needs to identify non viable banks and shut them down. Privatization can play a role in
this process, but we've learned in some countries, certainly in Mexico, that it is not a panacea. If there are
significant losses in the enterprise sector, especially the state owned enterprise sector, you can't restructure the
banks, obviously, without dealing with those enterprises. As big and as messy a problem as it is, one has to do
that simultaneously.
          Lastly, there can be a role for new banks, especially those with foreign ownership. It's interesting, I just
returned over the weekend from Argentina, which has moved on several of these fronts following the Tequila
crisis. At that time there was a significant run on the system, though it actually weathered it, I would argue,
reasonably well. It did close down about 80 of about 220 banks, but those were all very small banks who were at
the top of the list of the supervisors of banks that needed to be closed, so the market actually worked reasonably
well. Over half of the banking system now in Argentina has foreign ownership by good foreign names, and that
may end up of improving the quality of financial services. Argentina has one of the highest minimum capital



                                                                                                  56
ratios in the world, 11.5%, and most of the banks have between 15 and 20% capital asset ratios. They also have
very high liquidity requirements, given their special arrangement with having a currency board. They also have a
tougher definition of non performing loans than even the United States has. So, although there were slight
tremors felt in October and November, and interest rates increased maybe 500 basis points to 13.5%, they're now
back down to where they were before the Asian crisis started and deposits grew continually throughout the last
six months. So the important part of the restructuring effort, namely instilling good incentives in the banking
system, I do think worked.
          Lastly, I can't resist ending without saying that in the debate about what the Bank and the Fund can or
should do, there may be various views in the World Bank, I'm quite happy to leave the crises, while they're crises,
to the IMF. But one role that the World Bank can play is trying to improve financial systems and how well they
function, which means working to improve infrastructure and the regulatory framework in developing countries,
and that is far more important than any type of financial systems that we provide.
          Thank you.

Edward Altman: Great, thanks Gerry. I fact he did keep to the ten minutes and that's a great start. Our next
speaker is Hal Scott, who is the Nomura Professor of International Financial Systems at Harvard Law School.
The nice thing about endowed chairs, we have, by the way, two Nomura Chairs at NYU, and we have even some
Yamaichi Fellows (laughter). The nice thing about endowed chairs is the money is in bank already (laughter) and
so you don't have to be on the creditor line when they file.
         Without further ado, the Nomura Professor from the Harvard Law School.

Hal Scott, Nomura Professor of International Financial Systems at Harvard Law School: I want to talk
about the dreaded "D" word, default, and what its role might be in dealing with the restructuring of foreign bank
debt in Asia, and particularly in Korea. This is going to cover some ground we've already been over but I think it
may be necessary.
          The US and the IMF have assumed that default on foreign bank loans, which is Korea's principle
external debt, is unacceptable for reasons we've already heard today, largely based on moral hazard. And I agree
that the moral hazard problem is basically focused on bank debt, the bank debt is the significant part of Korea's
external debt. The basis of this was that, although the US and IMF recognize that there is a moral hazard
problem, they concluded that the benefits of bailout, to put in short, exceeded the costs of moral hazard. So once
it was determined that there were not enough reserves in Korea to pay off this external debt, the IMF gave Korea
55 billion dollars to use to service this debt. But in cost benefit terms, I think one has to ask, did the use of these
resources really improve Korea's situation? Was it the best use that could be made of 55 billion dollars to pay off
foreign bank debt? Rubin says that it gave Korea breathing room. In fact we heard that it was done very quickly,
within seven days. Well this is true, if you assume that what the country needs is breathing room to pay off all of
its debt. But there was another solution which was that debt could have been suspended. And that could have
given the country breathing room to decide what to do with this foreign debt. The argument is that that was not
acceptable because of a number of arguments that have been put forward over the course of the day by various
speakers. Systemic risk, financial systemic risk, Gerry Corrigan spoke about that. I guess I think that was a very
significant problem in the Latin American debt crisis in the 80's because we know that the complete collapse of
the four largest country debtors in that situation would have bankrupted some of the largest US banks, indeed
some people thought they were bankrupt.
          But the problem in Korea is really quite different. The foreign banks, at least by my figures reading the
press, have about 100 billion dollars in foreign currency loans to Korea, mostly short term. Of this, US banks
have about 10 billion, which is barely 6% of the total capital of just the top ten largest US banks. That's what's at
risk. The Japanese, sometimes the argument is made, "well the Japanese have exposure and if there is a default
to the Japanese and they get in trouble it will all default on the US and we'll have a chain reaction of
bankruptcies. But the Japanese have about, in Korea, 25 billion which is about 9% of the capital of the top ten
Japanese banks, and we all know that Japanese banks have much more exposure from what goes on in Japan,
indeed, one day on the Nikkei could be worse than the Korea problem. So, I don't see, really, that the case has
been made that there is some systemic risk problem and we're going to trigger chain reactions of bankruptcies if



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certain banks are not repaid on all of their debt. Indeed, even if this is a problem, which I don't think it is, the
way to handle it is not to give Korea 55 billion dollars to pay off all the banks. The way to handle it is have the
US bail out particular banks that are exposed to the Korea crisis, that is US banks. And have Japan bail out the
Japanese banks that are exposed to the Korean crisis, not give Korea the money to bail out all banks whether or
not they are really exposed in the Korea crisis.
           The second argument, one that has been made in recent days at Georgetown by Secretary Rubin is
because of capital flight, we really have to bail out of Korea if we don't than everybody is going to pull out their
capital. Number one, I think a lot of capital has already been pulled out. Number two, the capital holders, I think
if I were a capital holder, if I were invested in some Korea company, either directly or through some institutional
investor, I wouldn't like to see 55 billion dollars go into Korea to pay off the foreign banks that lent money there.
That's not helping me much. What I would like to see is productive resources being used in Korea to do
something about Korea's problem and the general economy. Paying off all bank debtors, I do not see how this
particularly helps equity. Indeed, what one could do with a technique that is typically used in bankruptcies, and
talked a little bit about already, would be to create a system by which we could encourage more loans to be made
into the country by giving them preferences over the old lenders. So if you want to do something for equity, you
should tell the old lenders to take a hit and design incentives for new lenders. We didn't do that.
          The third justification for not having a default was the financial contagion argument, if Korea goes
down, all these other countries are going to go down. (By the way, I didn't give you the numbers of the total
exposure of banks in Asia as a whole, it's still a small a small percentage of their total capital, I just did it for
Korea, I could have done the same for all banks, this is essentially the same story.) But coming to the country
point, the idea is that there will be a irrational run on the countries here. If we don't rescue Korea, if we don't bail
out Korea, everybody is going to pull their money out of Thailand, or everybody is going to pull their money out
of the Philippines, etc., so we just got to put this money into Korea. I think that if you really do have a irrational
run on countries, as opposed to financial institutions, people are taking their money out, this is something that the
IMF should deal with, but not by giving money to Korea, but by giving money to the countries that people are
irrationally taking their money out of. I clearly don't think it was irrational in Korea. There was a real problem
there. That was not an irrational run on Korea. From what I can gather, in a number of these other countries, it
wasn't irrational either.
          What I think should have happened here is that public lenders in Korea should demand still, or should
have demanded if it is too late, that there should have been substantial bank concessions before injecting new
money. This is what we did in the 80's in the Latin America situation. We said we would only inject new
money, or public money, if the banks took a hit. What we've done here is we put the money in and then now we
talk about the banks doing something. What are the talking about? Not surprisingly, since all that money has
been put in to service their old debt, what there talking about is extending their debt from short term to three
years at some mid point interest rate between the current rates on interest and junk bonds with a sovereign
guarantee and probably an IMF implicit guarantee of the sovereign guarantee. This is hardly a hit.
          I guess what I think more generally is that we should think about using principles of bankruptcy to deal
with these kinds of situations. I'm not advocating international bankruptcy courts or any courts whatsoever, but
the IMF and the US, as it approaches these situations, should think about some traditional principles which we
use in bankruptcy. Number one, the automatic stay. If you can't service your debt, all debt is suspended. Then
we spend some time to figure out what to do about it. Now I'm prepared to say we should make an exception to
the automatic stay if you could really show there was a systemic risk problem, because then it's not acceptable
because you can trigger a chain reaction. but I don't think that case has been made out, in Korea or in Asia in
general, that we have a real chain reaction of bankruptcies of banks problem here. Number two, I think public
money, in the form of IMF contributions, should be minimized. What we should try to do is give countries the
ability to attract new money with priority, as I've already said. We should not generally, as the IMF and the US,
be looking to pay off old debt. But we should allow the country and their creditors to try to negotiate some
solution to this problem by themselves. And maybe, if we are going to use public money, it should be used as a
carrot, as it was in the 80's, to get some conclusion of these negotiations.              Indeed, we're talking about
recapitalizing banks, which I agree should be a tremendous, that is the domestic banks in these countries, should
be a tremendous objective in order to get these economies going. Why not take some of this 55 billion dollars



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and use it to recapitalize the domestic banking system, rather than to pay off old bank debt. In that case, I think
equity would like that, we would attract more capital, if we are using public resources to do something
productive.
          I think we need, we haven't talked about this much in the negotiations process, we probably need to
consider some kind of system where we could get hold out creditors to come in and agree, that has a problem in
the 80's. It would continue to be a problem if we were actually renegotiating debt.
          I think there is a tremendous problem of equity, in the sense of fairness, in the situation today. As
people have talked about. In the 80's, the problem was largely one of bank debt. Now what we've got is a much
more complicated situation, to a greater or lesser degree in a particular country. You've got equity, bank debt,
and bonds. The principle seems to be that equity takes a hit, bonds take a hit, banks take no hit. I don't think
that's acceptable. We want to encourage the capital markets, we don't want to discourage the capital markets.
Many people have said we'd like to get the banks out of the center of this. But is that going to happen when you
bail out the banks and you don't bail out the bond holders, what's the lesson of that one? Lend through banks,
don't lend through bonds. So I think there is a fairness problem here.
          I also think there is a tremendous political problem which is yet to materialize, it's just coming up now.
Koreans are questioning, as indeed the Mexicans questioned in the 80's, why are they paying off all this old bank
debt anyway? The US congress is questioning, why are we giving them money, to Korea to pay off all the old
bank debt, anyway? So I think political forces are now going to conspire probably to alter this situation.
          Finally, change in management. I was reading something as I was coming down here that said "you
can't apply normal bankruptcy principles because the key thing to do in reorganization is you may change the
management." We can change the management. Somebody was talking today, "We've got to get rid of Suharto."
I mean in a non democratic country, I guess can try to get some leverage to change the management. At the very
least of course you can talk about changing the policy makers, or talk about changing their domestic policy,
which is of course what the IMF has done. So I think, and the IMF, I think, has pursued this idea that it really
does have to get a change in policy management. That is a basic principle of reorganization and I think it should
be followed as well. Without the right management, nothing is going to happen that is good.
          Thank you.

Edward Altman: Thank you Hal. Earlier today, one of the speakers referred, I believe, to the vampire lender or
the vampire investor. But there is a much more benign investor out there called the vulture investor. Vultures
actually do a great deal of service on our globe, and Richard Gitlin, although he is not a vulture investor, he is an
attorney and founder of his firm, Hebb and Gitlin, deals with these folks all the time and perhaps can talk a little
bit about how vulture investors, the buying and selling of distressed assets, something that we chronicle and
document very carefully at New York University in a regular way, what role they can play, and have played, in
these sovereign banking and firm crises.

Richard Gitlin, Founding Member, Hebb and Gitlin: Ed talked about Chapter 11 in the United States. What
is so interesting is so many other parts of the world have come to recognize that having a system that can rescue
companies in trouble is a critical component of rehabilitating a troubled economy. Being able to take the core
business, isolate it, build a new capital structure around it, and distribute that to parties in interest. If you can do
that, you get your companies operating and growing and hiring new employees faster than if they sit there with
debt that everybody talks about what you do with it.
          What I would like to do is talk about that concept as it relates to a banking structure in rehabilitating a
troubled banking structure. What we find often is that in rehabilitating a troubled banking system, as they did in
Mexico recently, the government takes groups of bad assets, either from a whole bank that failed or taking bad
assets from other institutions, so they leave some good institutions. And that's the banking system. What
happens is in the process they accumulate an entity where they have a very large number of distressed loans and
distressed assets. In Mexico it's called Phobaproa. Phobaproa still has about 50 billion dollars of distressed
assets from the 1994 problem in Mexico. There is a remarkable amount of money available to purchase
distressed assets, particularly in the United States. And what I have found when our clients have a distressed
loan, if there is information available for people to evaluate it, we have far more buyers than we ever anticipate. I



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have talked to Ed about this, who knows much more abut it than I do, but I suspect these tens of billions of
dollars out there will grow to the product available. It's an important concept. Will grow to the product
available.
          So the question is, how do you create the product in these distressed economies to make this attractive?
Well let me first ask the question, what's the benefit or detriment of bringing in someone in the distress
community, Ed called them vulture investors, to buy an asset from a Phobaproa, or an entity in a country that is
set up to hold the assets. It's very interesting, there's really a double benefit to the economy, particularly if it
comes from what I would call intelligent capital, in the distressed community. Intelligent capital in the distressed
community, Ed does is very well and he could tell you what their returns are, which are actually higher than the
20-30% he was talking about, finds a company that is a good company, obviously with too much debt, buys the
debt, and then proceeds to use its talent to restructure the balance the sheet and then, sometimes, its talent and its
resources to get the company going again. Because what it does often is convert its debt into equity. So it has a
strong interest in the company growing.
          What's the effect of this? Let's assume you buy an asset for 50 cents on the dollar, from the entity, the
Phobaproa or whatever entity in the country, 50 cents in hard currency comes into the country that goes through
the banking system. Instead of like Mexico, which I think is a tragedy that still has 50 billions of dollars of assets
sitting there. Those assets could have been sold. Money could have flowed in. What happens with that money?
It could be loaned to other companies or to repay international emergency funds. That's one benefit. But the
second benefit, what you really want to do in these countries, is get your companies going. That's the key.
Bringing in distressed debt buyers who have a strong interest in getting companies going in the countries is of
enormous benefit, because they've done it all over the world and they're remarkably good at it.
          What do you have to do to make your distressed assets attractive to the distressed buyer? There are
really too things that have to be done in a process. One is have a proper purchase process, and have a proper
execution process. Both of which are huge value components in what someone will buy the piece of paper for.
On the purchase process, it's has to be fair, transparent, predictable, with available information. It sounds so
easy, but generally that isn't the case. To whatever extent that isn't present, take a discount of 10%, 15%, because
if you were out there buying a distressed asset without adequate information, you'd simply give it a big discount.
So that's one discount. But the other discount is the most important one. And that's where we start in on a rescue
process. If I'm Morgan Stanley and I'm out there and I want to buy a loan because I am going to rehabilitate the
company and make a lot of money when it grows again, I have to asses, once I buy the debt, how am I going to
convert that debt to equity. What can I anticipate. Is there a reorganization system? Is there a formal bankruptcy
system? Is there an informal bankruptcy system? What do I do to convert that to equity? If I have no way of
anticipating, as is in the case of Mexico and in many of the Asian countries today, what will happen once I
purchase the debt? I'm either not going to buy it, or I'm going to pay so low that I'm just taking a flyer. So the
ability to convert the debt into equity and anticipate what is going happen is a huge value component.
          Let me quickly give you three examples in developed countries. One of the tests is, if I'm dealing with a
totally insolvent company, and I buy the debt, how much am I going to have to leave shareholders in order to buy
their cooperation? If you do it in the United States, we have a strong out of court system and a strong court
system, we probably will leave them 5%. So when I convert into equity I'll own 95% of the company. If I do it
in the UK, where they have a strong informal system called the London Approach, but frankly an inadequate
system, I'm going to leave them 15%. and if I do it in France, Eurotunnel just did that, they have an informal
system and a formal system that sort of blend together but are quite debtor oriented, I'm going to leave between
35% and 51%. But you know it doesn't matter from the distressed debt buyers point of view, because the
distressed debt buyer can predict and purchase on price analysis.
          What do countries do to try and deal with the execution process? It's so interesting, the factors that enter
into creating predictability for the buyers are the control of the leadership of a leadership, both political and
financial, of a country. There are huge economic factors, and they make a significant difference in getting money
flowing through the system, and they are within the control of the governments and the financial system. And
there are two, just to summarize, there are two process that you can address, that can be addressed. One is the
informal system, which is just as important as the formal system. How do we create predictable rules of creditors
getting together to resolve problems? And if we have some time in questions we can talk about how the London



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approach works and how the bank of England tackled that so remarkably successfully. The second is the formal
system. The formal system being whether it is Chapter 11, administration in the UK, or the system Thailand is
trying to put in to affect, they have a law going through their system. But one of the keys of the formal system is
if you have an agreement outside of court in an informal system where you have 75% or so of your creditors in
the company agreeing, to be able to run it through court quickly in a formal system.
          So in sum, the rescue process, ironically, becomes a high value component in putting capital through a
system. And there are tangible ways that can be addressed, and its within the power of the countries to do it.

Edward Altman: Thank you Richard. Perhaps you will just say one quick thing about this United Nations,
international bankruptcy, I don't know if you call it reform or convention, that hasn't been signed by anyone but
maybe will, and what's the outlook for that.

Richard Gitlin: UNCITRAL just completed a project the model law for cross law for cross boarder insolvency,
which is the most significant development in world insolvency in the last 40 years. Basically the problem we had
is if a company in the United States did business in five countries and got in trouble, there is no law where, if the
company is in trouble, I can run to five courts and say we just keep this company on hold while we try and
reorganize it. There's no treaties, no laws. So we went to UNCITRAL and said we can't let companies fail
simply because they simply do business in more than one country and the commercial laws, internationally, are
so far behind the public laws. So there is a model law that is recommended to countries and it's really rapidly
being presented to Congress in the United States, which basically, if it's adopted by the countries, and I suspect it
will because countries of the United Nations approved it, will allow us to put a freeze on a multinational
company and allow us to have an opportunity to reorganize it. I recommend it to those interested, it really is a
very significant development.

Edward Altman: Thank you. Our next last speaker is Lee Buchheit from the firm of Cleary, Gottlieb, Steen
and Hamilton. Lee is one of the leading counselors to the governments that get into crises like Korea, etc.,
although I guess he is not on the Korea team, so he is going to talk from that perspective.

Lee Buchheit, Cleary, Gottlieb, Steen and Hamilton: Thanks very much Ed. What I'd like to do is spend my
time to survey for you, in a comparative way, the techniques that have been used over the last seventeen years to
deal with this kind of crisis and perhaps draw some lessons from the development of those techniques. If you
turn the clock back all way, August 22, 1982, when Mexico declared its moratorium the last time around, the
technique that was developed, very quickly, to deal with that problem is hauntingly familiar to the one you are
reading about in the newspapers with Korea this morning. The technique was identify an advisory or steering
committee of your largest creditors, twelve or fourteen largest creditors. Sit down and negotiate a voluntary, I
stress that word, a voluntary rollover of maturing principle. And in order to induce banks to accept such a
rollover of principle, in fact the spreads on that debt increased, increased quite dramatically over the ones that
had prevailed when it was incurred, get the country to adopt a country to adopt an IMF program and reform its
economy. And finally, to the extent it is necessary to build up the country's reserves, the banks were prepared to
talk about, again I stress the word voluntary, new money. That is, in those days a proportionate participation in a
new syndicated credit facility, proportionate to the bank's exposure in the country on the day that the balloon
went up.
         That technique, which was repeated throughout the 80's, right up until Mr. Brady, it was repeated again
and again in countries, I think Brazil went through four installments and Mexico went through three and so forth,
that technique was predicated on certain things. First, that you had an identifiable creditor group. In those days,
the commercial banks. Even in the largest of sovereign debt reschedulings of the 80's you were talking about 500
or 600 banks, still an identifiable group. They had to be reasonably tractable, when you asked them to pony up
new money they had to do it, even though they didn't like it. When you asked them to rollover, by and large they
had to do it. Which is another way of saying they had to be susceptible to the kinds of pressure that a sovereign
debtor can bring to bear. Moral persuasion, get your fellow creditors to talk to you, and, in the final analysis, get
Paul Volker to pick up the phone and say that your Uncle would very much like you to go along with this



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package because it has geopolitical implications to the United States. The theory however, the propaganda if you
go back and read it, was really quite clear. The propaganda was that this was a short term liquidity problem, it
was not going to last long, it would be resolved by a realignment of the country's debt profile to move away from
this enormous spike of short term debts, iron it out for a few years, the money would start to flow back in and by
flowing back in the debt crisis would disappear like a marshmallow on sidewalk on a summer's afternoon. Of
course it didn't happen that way. And as the 80's moved along, you had what came to be known as creditor
fatigue, in which individual creditors began dropping out of the system, refusing to pony up new money, refusing
to reschedule. And you also had, frankly, debtor fatigue, in which it no longer was supportable for politicians to
go back to their citizenry and say that we are simply going to continue to have an economy that's contracting
while our creditors are getting paid out, as Hal said, in full. That changed of course when Mr. Brady came along
and gave the creditors a haircut, for the first time, for the first time. His speech was on March 10, 1989. Only
then did you have commercial banks taking haircuts.
          Now, what's changed between then and now? The principle thing that's changed in terms of technique
was Mexico in December, 1994. The Mexican bailout was quite different from what happened in 1982. In the
Mexican bailout the theory was this: If you can mobilize enough money at the multilateral and bilateral level,
mobilize enough money to put a safety net under the country, voluntary, private capital, truly voluntary, private
capital, will start to come in. And that money will allow the debtors to refinance what's owed and than no one
will have to take any kind of discount. And the theory was, do that quickly enough and you will not blot the
country's debt record by having forced any creditor to do anything, either roll over, much less take a haircut al la
Mr. Brady. That was the technique.
          Now you come to Asia. What seemed to attract the US government and the multilaterals when the
Asian crisis broke was the theory that you could simply repeat Mexico. Put the safety net there. And by the way,
the understanding with these safety nets is of course that they'll never be drawn down, and the whole point of
them is that you would never allow them to be drawn down, and no multilateral ever commits to these safety nets
on an unconditional basis. The last thing a multilateral wants is to wake up one day and find it's the only
remaining creditor in this country. The whole theory of them is that they will not have to be drawn down because
the psychological fact of their being there will induce private capital to flow in. That's how the early days of
Asia started. Regrettably, it proved not to be as efficient or as quick as it was in Mexico in early 1995, the
market's perception of the underlying structural problems seem to be deeper, and the private capital wasn't
coming back in, forcing, forcing a gradual drawing down on these lines, which I think alarmed the multilaterals
and the bilaterals who were providing.
          The circumstances in the Asian crisis are, in many material respects, quite different from those that
prevailed in 1982. This has been mentioned and it can't be stressed enough. In 1982, the debtors were
principally the sovereigns themselves in their state owned enterprises. This time we have, in most of these
countries, a disproportionate amount of private sector debt. There was a theory, a myth really, that any country
can view with complete equanimity the borrowing of money by its private sector because, after all, there is no
state guarantee. That is a dangerous fallacy. Every dollar borrowed by the private sector represents a claim on
the country's foreign exchange reserves going forward and, in a pinch, that claim either has to be suppressed or
rescheduled, or you have to make available the foreign currency to satisfy it at the cost of further depleting the
country's reserves. A second aspect of the private sector nature of this is that there is a horror by the policy
makers of bailing out the private sector. You can probably come up with a pretty good argument why you should
bail out a financial sector, because of the importance of the financial sector to the country's overall economy. It
gets a lot diceyer when you are talking about bailing out individual companies making widgets. And the policy
gurus in Washington have an absolute horror of that.
          Finally and one of, in my view, the principle aggravating factors in dealing with a crisis that has private
sector borrowers is you need a legal infrastructure. I think this is what Hal and Richard were talking about. You
need a legal infrastructure to permit those private sector borrowers to work out their affairs with their creditors in
an orderly way and a predictable way if you are going to avoid a situation in which the state has to come in and,
in affect, prescribe the rules of how it's going to be done after the fact. These countries do not have bankruptcy
codes as we understand them, and accordingly, the option of simply saying, "well, go into Chapter 11 and work
out your affairs," is not really there. Another difference is you have a much more diverse group of creditors. As



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was mentioned you've got large bond holders and so forth, not nearly as tractable, not nearly as subject to
suasion, and people who will simply not care very much if Mr. Rubin calls them on the phone and asks them to
do something. Finally, what's happened in the last fifteen years is people no longer believe the propaganda of the
word voluntary. What does it mean to say that a rollover is voluntary? Does it mean to say if you don't rollover
you get paid out in full? I can promise you that was not the meaning given to the term in 1982. Every creditor
was told, or hinted, that if they did not roll over the consequences would be that they would not get paid out.
They would simply drift in some legal limbo. That has changed. There haven't been many lawsuits brought in
which creditors have insisted on getting paid, but there have been some and, from the borrowers side of the table,
the law is really rather pedestrian. I'm afraid it says when you borrow money and promise to pay it back, that you
really have an obligation to do it. And if a creditor pushes it far enough they'll get a judgment.
         If you then look at what is going on, Korea is a situation in which there is the closest replication of
techniques of what happened in 1982. Pick up the newspaper. Bank advisory committee. Short term rollover,
voluntary, voluntary rollover. Perhaps a contribution to new money, to bolster reserves and so forth. The other
countries are, frankly, searching for a technique. They haven't found it and they can study the history books if
they wish, but the 1980's will not provide very good models for how to work out debt crises in countries like
Indonesia today. It's something they have to develop.
         Thank you.

Edward Altman: Great. Well we have time for a few questions so why don't we start with the gentleman right
here in the first row.

*David Hale*: The question is first for Lee and than for Richard, the lawyers here. To speculate on what advice
you would give to Indonesia right now with this debt problem. In contrast to Korea, the debt is very diffuse, it's
not focused on the commercial banks. Secondly, in the case of Indonesia, it's also very broadly distributed in
terms of bank by nationality. There are Korean banks, Japanese banks, American, European, there is no
dominant intermediary. In the case of Thailand, the ministry of finance was able to have great moral suasion
powers over half the loans. The same is true of Korea, because of the concentration. Plus the Americans, by
definition through their relationship, can influence things in Korea. Just speculate for us what advice you'd give
to the Korean government, the Indonesian government, or even to the commercial banks themselves who, frankly,
by not doing something imaginative have created this rupiah crisis. If they had volunteered some kind of
program a month ago we might have kept the rupiah at 5 or 6 thousand.

Richard Gitlin: If it were my call, I would not encourage the Indonesian government to guarantee the private
sector debt, in whole or in part. The one step that they might take that I think would be enormously helpful, is to
say that the government is prepared to extend some support. If you wanted to take the analogy back to what was
done in the 80's, that support was in the form of foreign exchange protection. You see the problem with many of
these companies is not that they are insolvent or that they don't have the prospect of returning to the export
markets, they're in the export markets. The problem is with a crashing local currency they simply cannot
generate enough local currency to buy the dollars to satisfy their external debt. It was done in the 80's by a
number of countries, the Philippines, the only country in Asia that went through this process did it. The
government said, as an inducement, as a carrot to the debtors and their creditors, "look, we will give you a
foreign exchange risk protection. If you stretch out for a certain period of time, we will assure you you can buy
the foreign exchange at the current market, let's say, or at some reasonably advantageous rate." That takes away
from the creditors and the debtors the risk that the loans will not be paid on their rescheduled terms simply
because of the devaluation risk and, with that in hand, I think a number of these creditors will stay with their
debtors. But my point is you don't try to prescribe it at the level of the state. The state simply indicates what it is
prepared to do, short of guarantees, that will assist debtors and creditors in a one-on-one negotiated solution, and
then you put in place that mechanism. That is, I think, what I would advise them.

Lee Buchheit: I would add to that, I agree absolutely, you need to do something with exchange. They did it in
Mexico in '82 with De Corca. It's a floor. But what Indonesia does not have is any legal system that allows you



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to rehabilitate a company. Now you can't, all of a sudden, adopt a formal legal system, change all the judges, and
expect it to work in time to resolve the crisis. But what you can do, is you can adopt rules that the government
and others can enforce for an informal, out of court system. And there is much power to that. And there are
models that. So what I would do is, I would of course focus on the formal rescue system, but I would deal with
both the exchange, and a predictable government enforced, to some degree, informal out of court system so there
is a framework for organization.

***Unknown Speaker***: Are we making these bankruptcy procedures seem far too easy in the sense that, in
Indonesia itself, there have been histories of many companies going through informal bankruptcy processes and
banks taking over assets, and even in those circumstances, it has taken years to unravel one conglomerate? Now
we are talking about an economy that potentially has a thousand times bigger problems. I just wanted yours
sense, are we making this much too easy?

Lee Buchheit: It's certainly not easy, even in the United States, where we've been doing it for a long time. On
the other hand, it's remarkable how people act in their self interest if you put them in the right forum. And one of
the tricks is how you create the right forum. And that's really the trick. What I have found with creditors groups
is, they generally act rationally if they are in the right forum. And people who own companies generally act
rationally if they are in the right forum. So, I don't care whether you call it a formal system or an informal
system, the trick is, how do you create an environment where business people can make business decisions in a
rational manner. And if you do that effectively, they usually come through for you.

Edward Altman: O.K., we have time for one more question.

***Unknown Speaker***: This is a question just about going through negotiations with companies in Asia
because I'm from Goldman Sachs and it's clear that there's going a lot of venture set up to commit capital to
restructuring companies there. But the question is how you go about doing that with these companies. A lot of
the people that are involved in that are Americans, there are huge differences in culture between Asians and
Americans. Does it make sense to hire a bunch of Asians, teach them the techniques of not causing loss of face
when dealing with these companies? What kinds of things, five, six years from now will have be mistakes that
we would have made going about in this process that, if we know what they are today, we might be able to
actually make money from this.

Hal Scott: I don't know that there is an easy or quick answer to that question. I think it's very difficult to expect
to be able to walk in and start restructuring companies in a culture that has never really done it before and doesn't
have any experience with it. Especially when you bring in investors that have strong positions and strong ideas
as to how to do it. But we've dealt with this in countries around the world, and it is remarkable, even in the UK
where there is a strong aversion to distressed debt buyers coming in, because the banks have the London
approach and they think a distressed debt buyer will be disruptive of the approach, and they really want no part of
them. So, even if you are taking a developed economy, they say how do I deal with this stranger coming into my
midst, it's going to interfere my clubby atmosphere with banks and restructuring companies. And if you asked
that question five years ago in London they would have said we want no part of these people, absolutely. They're
awful people, we've dealt with them before and we know all about them. But the reality is, in the last companies
that have been reorganized in the UK, the ones that have been most successful are the ones that had distressed
debt buyers involved, because those have been the only restructurings where they really created a sensible capital
structure, instead of just pasting the company together again. And when you create a sensible capital structure,
you end up with a company that thrives better than other companies. So, there's no easy answer to it and it's very
difficult and you just have to hope the economics will control the day and culture will fit within it.

Unknown 210 5/2***: The only thing I would add to that is I think it's almost presumptuous for us to answer
that question. What you really need to do is ask the folks in those countries how they would attempt to
incorporate the principles, rather than the exact way of doing it, but the principles of a reorganization system that



                                                                                                 64
would work in their environment. And maybe sit down and work it out that way because you're quite right, for
us to pontificate what works here, given the cultural differences, is extremely difficult. But crisis has a way of
galvanizing as Richard was saying, concessions and manipulating the ideas so that it would be palatable. It's a
very good question and probably a behavioral scientist would have something to say about it as well.

Lee Buchheit: I'll offer you one little glimmer of hope. Next to yawning, there is nothing so infectious as debt
rescheduling techniques. (laughter) And your salvation, my friend, your glory, is going to be to lead the first of
these large companies through a negotiation and you will find it will become a model, assuming that it works
reasonably well, this is what happened in the 80's, where Mexico was constantly the flagship for all of these
techniques. It will be replicated again and again and again. And, in affect, you'll make the practice, and the law,
together as you go along, and it looks like an enormously daunting task in prospect. In reality I think you'll find it
won't be quite as bad as you think. And your photograph will be on the cover of Euromoney. (laughter)

Edward Altman: With that exotic reference, thank you speakers, thank you audience for sticking with us, and
thank you Marc.




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                  THE INTERNATIONAL FINANCIAL SYSTEM UNDER STRESS
                                       DAY 2


PANEL I - AFTER THE CRISIS: PROSPECTS OF PRIVATE FLOWS IN EMERGING ECONOMIES
AND CONTAGION EFFECTS

Stuart Brown: The title of this session is After the Crisis, Prospects of Private Flows in Emerging Economies
and Contagion Effects. The key word, I would argue, is the first word in the title - After. Leaving aside for the
time being how we would define "After the Crisis," or how the crisis would end exactly. I suspect that based on
yesterday's discussion, during which I at least detected a fair degree of anxiety and skepticism about how exactly
we will get out of this crisis. I suspect that many people in this room will find it a bit premature to be holding
this particular session which deals with the post crisis scenario. However, I think it's fair to point out that we are
already seeing the beginnings of the process of differentiation by investors within Asia. That is to say, investors
who are differentiating across different countries in terms of the perception of the credibility of the programs in
those particular countries and the commitment of the policy makers to carrying them out, which is a sign that
there is some degree of stabilization taking place. It's also the case that an increasing number of investors are
looking for value, and have discovered value in segments of the markets in Asia. That is to say their overriding
feeling is that the swings in currencies and the swings in equity markets, and perhaps in the fixed income market,
to some extent have been over done, and that there is value to be found and therefore the crisis is not so deep that
one cannot dip one's toes into certain parts of Asia. That's another sign that we may be beginning to work
ourselves out of this crisis.
           And finally I would say, as was stressed yesterday, there is some historical precedent to which we can
look to get some idea of how this crisis might end and the prospects of it ending - namely the LDC debt crisis 80's
and Mexico's Tequila Crisis of the 90's. These are not, of course, perfect analogies. Nonetheless they do tell us
something about the ability of the various actors to bring a crisis to a close. It will be an extremely important
issue for the panel here to assess which of the two historical precedents is closer to the current situation. Because
if it's the former, if it's the 1980's, than I think we are in for a very prolonged and protracted adjustment period
where private capital flows will not materialize very rapidly. This could be an extremely difficult situation,
obviously for the countries involved, but for investors as well.
           However, we can be a bit more sanguine if we can argue that the current crisis resembles, much more,
the '94 - '95 Mexican crisis. And if it's possible to say as a third alternative that the international economy and
the investment climate has changed so fundamentally since '95 that we may see a much more rapid return of
private capital to the emerging markets than even during '94 - '95, than obviously we will want to hear that point
of view.
           We have a very distinguished panel here to speak and represent the private sector, two segments of the
private sector and the investment community, as well as one speaker from the multilateral community, to
hopefully shed some light on these questions. The format will be about twenty minutes per speaker, after which
we will begin the question and answer period, and that will be about a half hour to forty minutes.
           With no further ado, let me introduce the first speaker who is Mr. Uri Dadush, whose title is Director of
the International Economics Department at the World Bank.

Uri Dadush, Director, International Economics Department, The World Bank: Thank you very much.
Good morning ladies and gentlemen. Although I complained yesterday that people were not standing up, given
the fact that we have about half as many people in the room, and that you can see, I think, and if you cannot see
you are most welcome to move up, I will stay sitting down, in part because we don't have an adequate
microphone facility there.
          In any event, I wanted to begin, first of all, by joining in the chorus of congratulations to Marc Uzan for
having organized what I think is really an exceptional event in terms of the subject matter of the questions that
are asked, and also the speakers.



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          I'm going to make three main points and I don't think I am going to be able to do justice to any one of
them, but let me just state them as assertions and then try and fill in the rest of the time. The first point is that
we are clearly dealing with a very new situation, and the old reflexes can be the wrong ones. The second point is
that, assuming that we are somewhere near the bottom of the bottom of the crisis in the EA5, the East Asian five,
that is Korea, Malaysia, Indonesia, Thailand and the Philippines which are the countries most affected.
Assuming that we are somewhere the bottom, our analyses suggest that the affects on the world economy are
adverse and significant, but they are certainly not disastrous affects. Affects on the developing countries are
larger than those on the industrial countries. But again, they are not huge and the projections for the developing
countries are that they will continue to grow near the handsome rates that they have in the 1990s so far. That's
the second point. The third point is that again, assuming early stabilization in the EA5, the likelihood is that the
decline in private capital flows from the record that was achieved in 1997, despite the crisis in East Asia will be
only moderate in 1998. I will try and document each of these points.
          The first point is that this is a new situation. This is the first example of a large international crisis
where the capital flows are private to private. In 1982, which the exception of Chile where the crisis was
especially severe, the flows were private to public. In 1994, private borrowers in Mexico, of course, played an
important role in the crisis. But the restructuring which took place centered on government debt. The fact that
the problems arise out of the private to private flows has injected a number of imponderables or even errors. I
just want to highlight a few of these because I think they are important in terms of understanding our projections
and our forward looking view.
          The first point is that for all intents and purposes, we failed to anticipate this crisis. A lot of people say,
"we knew, we warned, we did, we said," but the bottom line is that the capital flows were at a record, the spreads
were at a record low, and the credit ratings were the highest that they had every been. We focused on low
inflation, small government deficits, modest external debt and high rates of growth and investment and concluded
that private capital flow is equal to 10% or even 15% of GDP per year in Thailand, according to our estimates, in
the last three years they received 15% of GDP capital inflows each year. We concluded that these huge flows
were sustainable. We now appreciate, with the benefit of hindsight, that the sustainability of private to private
flows is affected by a much broader set of factors. If you like, not just perceptions of sovereign risk, but business
risk. These factors include the quality of the banking system, open currency and maturity exposures, the extent
of macroeconomic overheating and asset price inflation, the quality of the investment, and confidence in the level
of the exchange rate. All these were known to be significant in the 1980's, but when the flows took the form of
long term commercial bank loans in foreign currency to governments, these factors may have been significant but
they were much less important. They were not critical. Today we understand that they are critical. That's one
thing we have learned, I think.
          The second point is that the private to private nature of the crisis also leaves us with many open
questions with respect to how to deal with them. Many of these questions were talked about yesterday and I will
not go into them in detail. I think one is reassured by the IMF position that, in fact, physical construction and
monetary tightening in a situation where the government sector was in good shape, is not some kind of knee jerk,
immediate reaction to these problems, but is something that is applied very selectively, that lasts a relatively short
period of time, and whose objective it is to reestablish confidence. I think it is difficult to disagree with that
overall position.
          The second question is: How do you manage systemic risk in this new world of private to private flows?
Again, we discussed this yesterday. It's important to note that in the 1980's a few dozen large banks accounted
for the bulk of the flows, and these flows, in turn, represented a large part of the banks capital. For example, the
exposure of BIS banks to the top ten borrowers today, represent 34% of their capital. In 1982, it represented 82%
of their capital. The bulk of the flows today take the form of foreign debt investment, equity, and high yield
bonds. And the investor base in enormously diversified. These investors have already taken big hits. But the hit
that they take is typically on their capital, it is not on borrowed funds that would have repercussions on the rest of
the system. And furthermore, most of the investors, if they have been wise, only have a small part of their capital
invested in these markets. So, in a sense, the system is less subject to systemic risk today by virtue of the nature
of these flows. In fact, that is one of the lessons that was learned as a result of the debt crisis, is that you needed
a different type of capital flow, a different type of financial structure.



                                                                                                    67
          The third question that is raised by the structural shift toward private flows is: Do the bailouts of these
private to private flows create the seeds of the next crisis? We talked a lot about that, which is the moral hazard
argument. In the 1980's most borrowers and lenders, the lenders were the commercial banks, went through about
ten very tough years, and most lost quite a bit of money. Today, the bailouts help predominantly one group,
which is the banks, which actually represent a relatively small part of the total lending, and in fact within that
category, it's largely the short term lenders, at least so far, that are being bailed out. Since we know that the short
term lending was a central part of the problem, and since we know the systemic risk involved may not be zero,
and I want to underline that, but less than it used to be, the question is: Is this right, is this necessary, how do you
deal with this problem? These are very basic questions which are being asked now. And the forth issue that the
shift of the structure to private to private flows raises is that we know how to do workouts of public to public
debts, there is the Paris Club instrument, it's been there for a long time. We know how to do workouts of public
to private debts, the Bradys, etc. But how do you deal with private to private workouts? Is the alternative to
socializing the debt, which is what Korea seems set to do, and Indonesia meltdown, or is there something in
between? How long will these private to private workouts take? This is a critical question in trying to
understand and forecast the effects of the crisis. In the next few months I don't have answers to these questions.
In the next few months, much work and research will be done to come up with a better answer than we have at
the moment.
          Let me move to the second point of my presentation, which is let's now assume that the crisis in the EA5
sort of abates or moderates in the next six months, we reach a kind of bottom. Then it is useful to ask; what is the
effect on the world economy? What is the affect on the other developing countries. Now here we are moving
into a much better known territory because, basically, what we are talking about is a large share change in trade
patterns and various other variables which we can analyze the implications of using fairly standard modeling and
econometric techniques. And it is useful to ask the question.
          Now in answer to the question, there are three basic points to bear in mind. First of all, in the last six
months since the crisis erupted in Thailand, there have been many positive surprises in the world economy, as
well as negative ones. Most important, the momentum of the European recovery and that of growth in the United
States is quite a bit stronger than we thought. These economies represent about 60% of world GDP, and a more
rapid recovery helped world trade grow at near 8% in 1997, much faster than the average of the last 20 years,
faster than the projections that we had, and indeed one of the fastest rates in post war history. The strength in
Europe and the United States is more than enough to upset the weakness in Japan, which was one of the
unfavorable surprises. The second point to bear in mind in understanding the implications of the crisis, is that the
most affected economies, the East Asia 5, represented only about 7% of world trade. Instead of growing at 7-8%,
as believed before the crisis, the best guess is that they will not grow at all as a group in 1998. Furthermore, they
will have devaluations in the range of 30-90%. The affect of the trade adjustment, less imports / more exports, in
these countries on the rest of the world is significant. It's an adjustment of 40 to 50 billion dollars in 1998, but is
nevertheless is unlikely to exceed about 1.5% of the world exports at a time when world trade has quite a strong
momentum because of the recovery in Europe and the strong performance of United States and also the strong
dollar in other countries. The affect of this adjustment will be largest on the close trading partners such as Japan
and the ***193 6/1***, as well as oil and metal exporters. The third point to bear in mind is that as far as the
industrial countries are concerned, the effect of the adjustment in the EA5 will have two important offsetting
benefits. The first is lower interest rates. Long term interest rates have come down by over 50 basis points since
the crisis began on average in the EU, Japan, and the United States. And also, one affect of the crisis is lower oil
and other commodity prices. There will be substantial terms of terms of trade gains for the industrial countries,
in particular for the United States, which will be the biggest beneficiary, with a terms of trade gain estimated in
excess of 2% in 1998, reflecting, in part, the high dollar.
          The net affect of all this is that we have reduced the 1998 world GDP growth rate by .5%, compared to
what we had in the middle of last year, leaving it near 2.6%, which is above the average growth rate of the 1990's.
However, growth of developing countries is cut by nearly twice that amount, that is instead of 0.5%, growth of
developing countries is cut by 0.9% in 1998. This growth for developing countries remains at 4% above the
average rate in the 1990's, impart reflecting the recovery in Eastern Europe and the former Soviet Union. There
are three reasons that the affects of the crisis on the growth in developing countries is bigger than on the



                                                                                                   68
Industrial countries. First, many developing countries are small economies, highly dependent on trade and credit
constraint. Therefore the volume adjustment affects in East Asia will have a larger affect on them. Second, the
terms of trade moves strongly against the developing countries in the projections, -3.3%, reflecting the falling oil
prices and most primary commodities, while at the same the prices of manufactures rise. And third, last but not
least, is that new capital flows to emerging markets have declined by about 1/3 in the November-December
period, compared to the first ten months, and spreads have risen by 300 basis points or more. Brazil is the
clearest example of a country that has avoided the worst of the crisis, but at a cost of large hikes in interest rates
and fiscal consolidation, which will distress growth. So these are the three factors then, that explain why the
effect on developing countries will be larger than on the industrial countries, but nevertheless, our estimates are
the developing countries will grow at a rate near 4%, assuming that the crisis, as I said, abates in the first half of
the year.
          This takes me to the third and last part of my presentation, I see from watch I have about tree minutes,
which is about private capital flows. Our estimate is that private capital flows will fall, but only moderately, in
1998. Again, assuming that the crisis is contained in the first half of this year. In 1997, private capital flows to
developing countries again hit near 250 billion dollars, about equaling the 1996 record, slightly above. I don't
actually remember the precise figure. This is despite a big slowdown in the flow, starting in October, about three
months after July, not much happened on the capital flows. But starting when the crisis began to spread
northwards to Hong Kong, then we really saw a change in those capital flows, and there substantial net outflows
out of developing countries when you take into account basically flight capital and also long renewal of short
term credit lines. It seems to us almost inevitable that flows will decline from these levels in 1998, in part
because of the 40 or 50 billion dollar current account adjustment in the EA5, although bear in mind that our
figure do not include Korea as a developing country, and a lot of the adjustment is in Korea. And also in part
because of the adjustment measures in Brazil and others. However, out estimate is that the overall current
account deficit of developing countries and the financing requirements will not decline significantly in 1998,
since many developing countries should see somewhat larger current account deficits as exports volumes and
commodity fall. Part of these current account deficits and refinancing requirements will come from drawing
down reserves, which are ample in many cases. But much will still be needed to draw on private and official
capital flows.
          If the crisis is contained, we feel that the private flows to finance these current account and refinancing
requirements will be forthcoming and, here again, for three reasons. There are always three reasons for
everything. The first reason is that we feel that the market will continue to discriminate, as it always has,
between the problem countries, and those where things are in decent shape. Now, I don't have time to go into
each of the regions, but there is a good story that has been developed in each of the regions as to why the crisis
has not spread to them so far. But the point is that much of Latin America, South Asia, China, Eastern Europe,
have avoided the worst affects of the crisis. And in each case the reason differs. But the reasons range from not
having the same level of capital flows, not having the same size of current account deficit, not having the same
overheating problems and credit growth that has occurred in the East Asian countries. Not having the same open
currency exposures, this appears to be much less of a feature in countries which have learned the hard way,
through devaluation and so on, the problems of this. And of course in many of these countries it is more difficult
to speculate against the currency because of a very tightly controlled banking system and capital flows.
Furthermore, we feel, I don't want to give you the same story again, but we feel that, in general, the policy stance
is moving in the right direction. That there is a lot more confidence, if we really want to compare '82 with 'is this
Mexico?', 'is this post Mexico?', 'is this post 1982?' Then you have to simply recognize that we are dealing with a
totally different policy environment in these developing countries. We're not dealing with import substituting
policies, we're dealing with what looks like a much more sustainable picture. So, the markets will discriminate.
The second reason we think that capital flows will be broadly sustained, although lower than they were in 1997,
is whatever a dimension which is that the external environment remains strong. And if you look at each of the
statistics as we project them, world trade, interest rates, inflation, growth, they compare very favorably with the
average of the last 20 years, and they certainly bear no comparison at all to the post 1982 world. And last but not
least, the nature of capital flows has changed, I think, as the chairman has already indicated. We are not talking
about capital flows that are primarily coming from banks that need to be restructured and that will take five to ten



                                                                                                  69
years in order to workout. We know that much. We are dealing with a tremendous amount of equity capital debt.
Foreign direct investment represents half of the flows. This foreign direct investment will, if Mexico is any
guide, react to currency devaluations in a favorable way and it will react to high growth potential. Similarly,
equities and bonds, will react to price variables. These are the three reasons why, provided that the crisis is
contained in the course of the first six months, we think that private capital flows will remain somewhere near
recent levels in 1998.
         Thank you.

Stuart Brown: Thank you very much Uri. Our next speaker is Joyce Chang who is a Managing Director with
Merril Lynch. Joyce -

Joyce Chang, Managing Director, Merril Lynch: Thank you very much Stuart, and thank you Marc for
organizing this seminar, which I think is very timely to reflect on all of these issues.
          I have a handout that I am going to be going through but just to maybe touch on a few points that Uri
made and also Stuart's questions at the beginning. First of all, was this crisis something that's more similar to the
1980's debt crisis or does it resemble 1994-'95? Well I think it is hard to answer that across the board. And we
do think, for example, in Korea and in Thailand, that you may very well be reaching the bottom right now. That
you are seeing a fairly strong turn around in some of the external accounts and export growth and that also the
outflows at this point seem to be more rolloff rather than capital flight. However, in the case of Indonesia I think
that you do have a situation that looks more like Latin America and, just to go over recent events in Indonesia for
those of you who haven't had a chance to actually look at all the wire stories this morning, the Indonesians have
announced that they may have to temporarily freeze payments on some of their private sector debt and, secondly,
that they will be guaranteeing some of their banking sector debt and setting up an agency basically to buy back
the bad debt. And I think this is a situation which is increasingly more looking like Latin America, where the
Indonesians are talking more and more about instituting some type of currency board which would be put in and
set at a rate which we have heard could be anywhere from 4,000 to 6,000 rupiah and this is the way in which they
would run out of alternatives that would work. This is a way in which they would try to save the majority of the
corporate sector, but also this is really with the currency free fall they haven't been able to do much else. So I
think that there is a process of direct differentiation occurring amongst the depth of the crisis in the Asian
countries.
          And I would like to say before I start my presentation that I would agree with Uri that this is sort of a
new situation. That the old reflexes can be the wrong ones. And what we've really seen is that in an era of
capital and of global mobility, that all of the lessons that we have learned from the devaluations have really sort
of been blown apart. Any lessons from the 1970's and the late 1980's have sort of been blown apart and that's
partly because in a period of global mobility I think that it has been hard to anticipate how quickly the crisis can
spread. And I would say that I do think that we are at a point where you may be very near the psychological
bottom of this market in that nobody's really kidding themselves. Alan Greenspan is using the "D" word.
Commercial banks in the US are taking 600 million dollar hits on their Asia portfolio. European banks are being
downgraded for their Asian exposure.
          But what we haven't reached yet is: How do you fix the situation, how do you actually stabilize the
foreign exchange market? How do you answer this question? I think there are two things. First of all that the
foreign debt problem has to be solved. Korea is now going through this process. Indonesia announced yesterday
that they have appointed their committee being led by standard charter and UBS. And the second thing is that
these countries need to develop real debt markets. That most of their financing had been occurring through just
bank lending and had not been occurring through the creation of any debt markets. There has been very little
volume in these markets, maybe 50 million dollars where the central bank is the only offer of dollars and the
currency has been going through a free fall and basically no volume. So, even though I think we may be near the
psychological bottom of this market, the mechanisms for fixing this really haven't been developed yet. I think
we're very contingent on coming up to some kind of resolution with the whole foreign debt problem.
          I would also agree with Uri that we think that the impact on private capital flows is going to be one that
is not a complete disaster for developing countries. And one thing that I would point out is that when you look at



                                                                                                 70
why have the Latin American countries not been impacted as badly as the Asian countries, you see that in Latin
America, in Mexico, Argentina, and Venezuela, the banking sectors are basically more than 50% foreign owned.
And I think what you will see in Asia is more of an opening and foreign capital going into the banking system
that, as we look at some of these questions that have come up yesterday about transparency and accounting
standards and the kind of numbers that are being reported, one reason the Latin countries have been less impacted
is because of the foreign involvement in the banking sector. And I think that you will see strategic stakes being
taking by foreign investors that you will have more rigorous banking standards being set up in the region. But I
think what you will see also in private capital flows to emerging markets is that the composition of private capital
flows may change, and that the regions that receive capital flows may change as well. And that's what I will go
through in some of the data that I am presenting.
           But just to follow up on Uri's presentation, the numbers that we've used from the multilateral
development banks and from the IMF do show that private capital flows increase slightly to about 255 billion
dollars from 235 billion dollars in 1996 with almost half of this going to Asia, then secondly going to Latin
America and a very small percentage going to Africa and less to the Central and Eastern European countries
which is not a total disaster because what the charts that I am going to show demonstrate is that much of the
private capital flows have been debt financing and the Central and Eastern European countries just have not had
as much of a need to have access to debt financing given the lower debt servicing burdens. But I think there has
been a lot of debate: Is Latin America a safe haven from this whole crisis? And I think what we are looking at is
a more difficult environment for all regions, including Latin America. I think the notion that Latin America is a
safe haven is going to be challenged since almost half of their flows are debt financing and debt issuance has
slowed down dramatically, whereas we were at, last August, 11 billion dollars of debt issuance issued in the
month of August. This went down to 1 billion dollars in December. At the same time, the current account deficit
is increasing in Latin America. We estimate that the current account deficit for Latin America is going to
increase to about 3.6% of GDP, or almost 70 billion dollars this year. So that is more than double what the
current account deficit was in 1996, for example, when it was about 2% of GDP. At the same time, economic
growth, which was 5% in Latin America, is slowing and we think it will be sort of in the 3 - 3.5% range. So you
do have increased financing needs for the current account deficit as consumption has picked up in these
countries. Half of the financing has been debt and the debt issuance has really slowed down quite dramatically.
           I think that also the volatility has led to some postponement of investment decisions. And in Asia we
have also seen that exporters are having difficulty obtaining finance. So while we don't see this as a disaster
scenario for what's happening with private capital flows, we would caution that this is going to be a more difficult
environment and that the reliance on debt financing, which developing countries still have, is still going to hurt
them.
           Just to turn to what have we learned from the Asia crisis, and I think a lot of these lessons have already
been discussed. But just to highlight some of the points that may have not been touched upon as much, I think it's
very questionable, in a period of global mobility, whether the value weight ratios really can occur from a position
of strength. I think time and time again we see that if Brazil had devalued last year, the currency would have
appreciated. Two years ago, if Thailand had done the same thing, the currency would have appreciated. What
we've really seen is that these crises very rarely occur at times where the devaluations can occur from a position
of strength, the way that they have actually worked. And what we have seen is that the peg exchange rates have
been very dangerous, really lethal many of these countries. I think the other thing is that the traditional IMF
prescriptions are really being challenged because rightly or wrongly, the IMF looks at the first sequence of events
that has to occur is that the exchange rate has to be stabilized. When you are looking at a private to private debt
crisis, this has become much more difficult to ascertain how you do this when even the central banks themselves
haven't been tracking some of these numbers and the figures that were released into the system. So I think that
the lessons that remain from Mexico are still very valid, but a few new ones have also come up. That is really
that the private sector debt and the banking system, in many case, just were not being monitored by either the
multilaterals or even the central banks themselves. This has really left something that is more difficult to address
than past crises we've had with Mexico, or even in the 1980's for that matter. It is important to point out that in
the debt markets there is 300 basis points of spread widening that we've seen. Well, after the Mexico
devaluations, spreads widened by as much as 1500 basis points. But if you look at where spreads are at for the



                                                                                                 71
Brady bond index, in the mid 500 basis point range, you have for the first three quarters of 1996, the spreads in
the market were over 600 basis points when there was no crisis and the market was actually seen as improving
and going through a recovery. So I would say that the sell off in this market this time has been much less
dramatic because very few people are really contemplating that a sovereign debt default is going to occur at this
point in time.
          We've also not seen many of the crossover investors exit the market. In the last two years you've have
more than 170 billion dollars of emerging markets debt placed. And I think in 1995 what we saw was a real exit
by the crossover investors where it took them until 1996 - 97 to come back into the market. And I think that
investors at this point are much more inclined to look at the situation more constructively. And that's for a couple
of reasons. Mexico is really the follow on of having five Fed hikes and then the Mexico devaluation. I don't
think that we are in period where global liquidity has completely dried up that's really comparable to what we
saw in Mexico. I think that global liquidity is still there. As you look at treasuries below 6%. Spreads, for
example, the Merrill Lynch High Yield Index, which has a lot of single B and below rate US junk bonds in it
trading at 250 basis points. Spreads at 550 basis points for instruments that most people feel comfortable will be
serviced, don't look that bad. So I think that you still will see financing going into these countries, but it's
definitely slowed down quite dramatically, and definitely the cost of borrowing for these countries is increasing.
          So what we've grasped is that really you've seen the growth of this market increase dramatically with
debt insurance in '97 hitting about 90 billion dollars for non investment grade countries. This exceeded what was
raised in the US high yield market and it brings the total size of the emerging markets debt universe to something
that is close to 1.3 trillion dollars by our estimation. Now this seems like a very big number and there is a
question of whether the market has become saturated and has grown too quickly, but we would point out that this
is only 5% of the world bond market, the emerging markets debt universe. And I think that's one reason why it
has been so susceptible to vulnerabilities, during periods of global mobility of capital. Even though this number
is very big, it's still a very small number over all when you put it in the scheme of things in the industrialized debt
markets, even though the growth of this market has been tremendous. In 1990, by our calculations, this emerging
markets debt universe was about 90 billion dollars after the first restructurings were coming out. So there has
been a tremendous growth when you look at this 1.3 trillion dollar number but it is still relatively small in the
scheme of things. Debt issuance has slowed down quite dramatically, but when we take Latin America for
example, which still has the highest sovereign debt servicing debt burden, more debt financing than foreign direct
investment has been going into the region. Equity has been a relatively small part of this equation. You can see
that in 1997, equity issuance was only about 7 billion dollars, that this is still something that is occurring, the
banking has had more foreign, that equity financing, compared to debt financing, has not occurred nearly as
rapidly.
          You can also see that from the mutual funds that we track, and we track about 101 debt funds, that there
were net outflows in 1997. So the picture going into the debt issuance cycle in 1998 is once that looks
considerably more difficult at the same time that current account deficits are increasing quite dramatically in
Latin America, although they will be moving in the other direction in Asia. I would say that we do think that the
composition of flows is going to change quite dramatically. If you look at what Mexico has issued since the
devaluation in just sovereign debt instruments, it's issued about 45 billion dollars of debt. In many of these Asian
countries that have to pay back 100 billion dollars of bailout packages, I think that you will see much more
competition for capital for Latin America as the Asian countries begin to come to market, reliquifying their
banking systems, and at repaying these bailout packages. So if you look at what Korea, Indonesia, and Thailand
may have to raise over the next several years, you do see that there is going to be much greater competition for
capital compared to Latin America being two thirds of the total debt issuance sum right now.
          I think that the point that Uri brought up that the current account deficits seem manageable, we would
concur. When you look at the current account deficits in Latin America, you don't see the depth of the current
account deficits being nearly as severe as they were in Asia where they were nearly double the size of 8% of
GDP. These are numbers though that at 3% of GDP seem manageable, but I think it is a more difficult operating
environment. Whereas in Asia you will be seeing surpluses turn around actually quite quickly by our estimation.
          As far as our own projections for economic growth in the emerging markets region, we may be looking
at something a little bit less than 4%, given that we think Asia is going to slow down quite significantly. Even



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some of the numbers that we have in this chart are being revised downwards to less than 2%. Latin America
could be closer to 3% rather than 3.5%. And in Central and Eastern Europe, given how high interest rates are in
Russia, it's hard to see how they might be the leader of growth this year. In Russia, 1997 was the first year that
Russia has positive growth since 1989. Growth was .4%. But this is still a very modest number, so I would not
say that we see this as being a year where the developing countries are going to really be spared from a fairly
significant slowdown in growth. But I would also say that the policy stance has been the correct one. And if you
turn to the final page, when you look at what has happened in the Asian markets you are seeing that exports are
already beginning to turn around. In Thailand, for example, they went into the position of having really the
highest export growth rate in the world after being, just in the fourth quarter of 96, at negative export growth
rates. And I think that this is going to continue to look like quite a turnaround for some of the Asian countries
going into 1998.
          I still think that you are stuck with the more difficult question that in Mexico, much of this track on the
US economy that there is the whole issue of when domestic demand will pick up in Japan and whether there will
be a destination for many of these exports, even if your numbers are able to turn around quite significantly.
          I think the other issue that is worthy of mentioning is just the concerns about whether China will
devalue. And even though we view this as an unlikely scenario, you can see from the export numbers that if you
look at the point where China last devalued you could say that this is really what caused many of the South East
Asian countries to slow their export growth. I think this will remain as a concern in the market, particularly as
we anticipate that export growth in China can slow to maybe only 6%. It was as high as 26% in the second
quarter of 1997. So we are looking at a real reversal of some of the South East Asian numbers. I think lingering
concerns about China, as we look at the export potential with the larger question being will domestic demand in
Japan pick up? Will they come up with a package that makes sense?
          So I think that just the prospects for capital flows, just to summarize, global liquidity has not dried up. I
think there continues to be good interest in emerging markets and people who are looking at it opportunistically.
But I would not downplay just how significant some of the challenges will be for some of these countries this
year. With a combination of very high interest rates, still relatively high debt burdens, and higher current account
deficits in Latin America in 1998.
          I see that one issue that had been raised yesterday that I would actually like to touch on was the whole
issue of are capital controls something that reduce external vulnerability? Are they something that developing
countries should encourage at time like this when global mobility is so volatile and when the countries still such a
relatively small part of overall GDP. And I would say that I think it really is a myth that capital controls reduce
external vulnerability, although they may buy time. I think that what we've seen is that time and time again, the
countries that have had capital controls can still have a currency crisis, and this happened to Chile in the 1980's.
And I think that while controls may buy time, they also create huge distortions and really jack up interest rates
tremendously. So I would not necessarily say that we see the situation of capital controls being a solution that is
going to work over the longer term for what adjustment some of these countries are going to have to make. And I
think that is a debate that has been ongoing when one looks at Brazil and at China as well, but Brazil most
significantly. Our conclusion is that ***6/1 Ends*** bottom but that in Indonesia a more Latin type solution,
where you look at some type of currency board as the solution to stabilization. Perhaps some type of *** 2
6/2*** restructuring, and they have already temporarily announced that they will have to freeze some of the
corporate payments, is probably more in order.

Stuart Brown: Thank you very much Joyce. our next and final speaker is Ronald Johnson, who is vice
president and fixed income director of fixed income research for Templeton.

Ronald Johnson, Vice President and Co-Director of Fixed Income Research, Templeton: Thank you Stuart.
         I would like to address the issue of prospects for private capital flows in terms of time frames. But
before I do that I would like to make a couple of observations. First, we are in a tight globalist liquidity situation.
Liquidity is tight in the United States. It's tight in Europe. It's obviously tight despite the comments yesterday,
even though we can't measure it. As long as the countries in East Asia are following IMF programs, it's got to be




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tight there. The only major place where liquidity is not tight is in Japan. So we are currently in a tight global
liquidity situation.
          And the second observation that I would like to present before I go into my main discussion is that we
have to remember that credit is allocated both by price rationing and by quantity rationing. And in the current
environment the rationing that's taking place is in terms of quantity. And that's one of the reasons why I could
say that liquidity is tight. If we take a look at US term structure, flat to inverted, and we recognize that people
talk about a flight to quality. What a flight to quality means is that people are not willing to lend to credit risk. It
has nothing to do with the interest rates itself, or the spreads even, that they can't borrow in the primary market.
So the only thing that we should make a distinction, in terms of our own understanding, is that there is a primary
market, new issues, and then there is a secondary market, which is trading the old stuff, and we can't look at the
secondary market right now to get a sense of what's going on in the primary market because there is a
discontinuity or better known as a credit crunch. Now I happen to be a person who wrote the first non anecdotal
piece on the US credit crunch when I was at the New York Fed in 1990 so I know a little about credit crunches
and I can tell you that we are in a global credit crunch.
          To begin in terms of time frames, let's talk about the short term. In terms of short term flows I am going
to focus primarily on Asia. I doubt that we will actually have any clarification of whether we're seeing a bottom
or not, at least as an investment manager I have to make the distinction between risk and uncertainty and right
now we are still in an uncertain environment and so I would rather leave money on the table rather than getting
blown apart. And so I say that in the short term we don't have a sense for any of the countries in Asia whether
we've hit bottom yet until we cross March 31. Now March 31 is a very, very important date. And the reason for
that is because that is the end of the Japanese fiscal year. We don't know what bodies are going to fall between
now and then and if big bodies fall then I guarantee you that Korea and the rest of the countries that may look
like they are in good shape right now will be in serious trouble. Now the reason why the fiscal year end is
important is because again, having served in the Federal Reserve system both at the Board of Governors and at
the New York Fed, I've seen institution after institution not make it through the fiscal year. And clearly in the
United States, we're sitting in New York, we can think back to the bank of New England, they couldn't make it to
the end of the calendar year because no auditor would sign on on the audit statement. And so the point is that we
have to look to the end of the fiscal year in Japan before we can get some sense of when things are going to
clarify. If they clarify before, well, we've left some money on the table. But the point is that if something bad
happens you're dead.
          And the next point I want to make is that in terms of medium term, I think 1982 is a relevant
comparison. Obviously there are some differences. Clearly one of the things that's the same is that the real
sector of the economies have been damaged. In 1982, Mexico, Argentina, Brazil, all the Latins were hit in the
real sector of the economy, and that's what's happened in Asia. And as a result this is not 1994. But in addition,
what does real sector affects mean? It means that we have excess capacity. And we actually had excess capacity
before we even had this crisis. When we look at the auto sector in Korea, they added an additional automobile
manufacturer, added excess capacity, so we had excess capacity, the real sector is affected. In the polyester
industry that is significant. In Indonesia we have excess capacity globally. The next point I want to make in
terms of 1982, in terms of being a relevant comparison, is that I think it is a bit misleading to focus on the private
to private debt arrangements today. As I sit back and I say "hymph, what is private about Korean debt?" Korean
corporate bonds are guaranteed on guaranteed by Korean banks. And the banks have a lender of last resort as the
government of Korea. What is private to private about Suharto corporations in Indonesia? I think that's a totally
bogus comparison. In fact, I think it's no different than Mexico or Argentina or Brazil in the 1980's. It's just
different names, things have been moved around. Now there are some differences between 1982 and the current
environment. One of the differences is that in 1982 there were limited channels through which financial flows
passed into emerging economies. Primarily through banks, and of course, official institutions. And the
borrowers were clearly government aparastaitals, but usually it was owned by some general anyway. The other
differences between now and 1982 is that in 1982 we were in a disinflationary environment. I know, I was at the
Federal Reserve at that time and I left in 1982 to join the team of people fighting the first debt crisis at the IMF.
And so we were in a disinflationary environment in 1982 and in 1998 we are in an environment where there is a
tendency toward deflation. Now the simple minded destination between disinflation and deflation is that



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disinflation is where you are trying to slow the rate of acceleration, or slow the rate of inflation, whereas
deflation means that there is a tendency for prices to fall. I know in my lifetime I've not lived through a period of
deflation, thank goodness, or otherwise I'd really be in bad shape right now, given my physical condition, but the
world did live through something like and that was in the 1930's. And so we do have a tendency right now for
global deflation and that makes a big, big, big difference between now and in 1982.
          Another difference is in terms of the way in which the agents that are involved in the can respond to the
crisis and so let me talk about all three of those. First, I will talk about the channels, the different channel for
funding. And this again is under my medium term perspective. When I think about the channels for lending right
now, in a medium term sense, the guys who make out the best in lending in Asia are guys who are secured
lenders. Guys who come with a full package where they can lend to finance distribution, say distribution of autos
in the United States, they can finance the inventories of the cars. They can also finance the leasing or sales of the
cars to final consumers. So secured lenders, guys who are involved in financing shipping, warehousing, they are
all going to do quite well going into Asia. There are additional guys who will do all right if they choose viable
companies that focus on working capital financing, rollover financing and also equity. Right now, in terms of
targeted financing, I can not believe that it's not happening right now. Places and companies like GE Capital, I'm
sure are swarming all over Asia at this moment, providing a full menu of financing, but secured. So Asia has
now become sort of like a middle market lending environment.
          In terms of the ability for Agents to respond, I remember several years ago, first time, I can't remember
how many years ago it was, watching TV, and I'm sure you've all seen the commercial, guy sitting up there with
the Ginsu knife and he's chopping stuff and he's chopping and I'm watching this commercial, usually I hit the
remote, and at the end I say, "Ah, this is a trick." The trick is it said no COD, you know, credit cards, money
orders, blah, blah, blah, blah, allow 6-8 weeks for delivery. So these guys don't have any inventory at all. So
companies that can actually do just in time production in Asia are going to be attractive companies from an
investment standpoint and they can line up in a vertically integrated way, not necessarily selling their equity, but
a vertically integrated way with other companies that can use just in time production where there is no need to
fund working capital.
          Now as I mentioned that there is a tendency toward deflation and, as we said, most major corporations
have already made decisions with respect to deflation, and they've recognized that there is deflation. In fact, I
think that the evidence, in my mind, that there was a sea change in expectations, was the 22nd of October. The
22nd of October, last year, was a point in which the markets actually dropped to zero, and then on the 23rd
jumped to infinity and then came back to a resting point. In economic models those jumps happen. And in real
life we've seen those, at least I've seen those several times. 1987 was an example when I worked at the fund and I
worked on New Zealand, before New Zealand became the modern New Zealand, and the night that we landed
they floated the currency after having gotten rid of reserve requirements and the overnight rates went to 800%
before the market just froze. But then the next day it started up and worked and we began the process of building
what people now see as the modern New Zealand, that was 1985. And so we have these sea changes, regime
switches, and they take place, and I think that in the corporate world the regime switch has taken place and these
guys recognize that we are in a world in which there is a tendency toward global deflation and that has led these
guys to do two things. One, they've changed their procurement practices, procurement arrangements, and second,
they've shifted to cutting direct and indirect labor costs.
          I now focus on firms in the United States and firms in Europe. This is not necessarily the case with
Japanese companies, largely because Japanese companies get the benefit of reduced world material input prices,
reduced intermediate input prices, lower interest cost, and on top of that they get the devaluation which cuts their
labor cost. US companies don't have that luxury in terms of labor cost and as a result they have to change
procurement procedures with a vengeance and they also have to start to cut into their labor cost. And all of that
means that there is going to be a change in terms of flows related to trade, in some cases in terms of the absolute
level, but most cases in terms of the growth rates. And so I just wanted to just give you an example. Korean
steel was already relatively attractive in terms of flat steel products. Now with the significant devaluation of the
won, Korean steel is a super bargain relative to Brazilian steel. Now where Brazilian steel has an advantage is in
Brazil, because there are still tariffs and all sorts of costs and so manufacturers who are producing autos in Brazil
are not likely to shift to Korean steel in their plants in Brazil. But, those guys are not likely to be using Brazilian



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steel outside of Brazil. And so when people give these calculations of the effects of the Asian crisis they don't
really get into the micro, they sit up there at the macro level and the macro level misses the point. This is a whole
micro problem. Indonesia could actually be a tremendous beneficiary in the steel industry. But the problem is
that Indonesian steel is of low quality. So now if they get some technical experts in there and bring some
additional technology to bear to improve the quality of Indonesian steel, then Indonesia could become a
powerhouse in exporting flat steel. Right now Indonesian pig iron is bought by Japanese firms and by Korean
firms, but Indonesia, all they need is additional technology and they can actually move forward. So again, the
tendency toward global deflation is changing the way in which economic agents are operating and that means that
we won't have precisely a return to the 1980's in terms of the crisis, but the crisis has in its character a 1982
flavor and not a 1994 flavor.
          Now let me move on to the long term. What I would say is that in the long term I think of Arnold
Schwarzzeneger and he say, "I'll be back." In the long term we'll be sitting here again, talking in the next time
about Yabadabado Land and about the fact that those guys lied to us and they cheated us and all the rest of that
stuff, a lot of it is because we failed to learn the lessons from the past. And lessons from the past are really
related to our own behavior, or the things that we allow to happen to us. When we look at banks, banks are
relationship driven. And as a result, if you were to take a look, I haven't looked at it in a couple of weeks, but if
you were to take a look the spreads in the syndicated loan market they didn't reflect anything in reality. Those
spreads were related to the need for the banks to either continue to maintain, as Joyce pointed out, their
relationships, they own 50% of the banking sector in Latin America, their relationships in those countries, or, as I
found right after the Gulf War and I looked at the spreads on Kuwait, at that time the largest jumbo loan was 5
billion dollars, I looked at the spread on the Kuwait loan and I said, "Wow, it's the same as Saudi!" But if Saudi
Arabia is a party to the GAB, General Agreement to Borrow, which then means that under the Basal capital
standards, Saudi Arabia is treated as if it's an industrial country and a zero risk weight. But Kuwait wasn't. And I
tried to figure out, how could banks afford to do this? And when I looked through and looked at costs of capital
of the banks, I found only the Japanese banks made money at that time and British banks were flat and US banks
were under water. And the question was why? And of course when you look at who is managing the Kuwaiti
money, then you saw that there was cross subsidization. So relationships for banks can actually lead to lost
leaders and we'll find ourselves having excessive lending just because they are making money somewhere else or
they feel that they can make money later if they get in good with these guys. I know I've spent some time in the
fall in Hong Kong and I talked to Hong Kong institutions and they told me that they pay 20 basis points for
managing fixed income money and I said "Good-bye."
          And the next thing is that the sell side is deal oriented. And that creates a big problem, because those
guys get paid by the piece, there is a piece work system and so as Mark Mobius pointed out, he gets a call and
some guy says, "Hey, we're going to market tomorrow and it's oversold but we're going to cut a good deal for you
and here it is, we faxed you the stuff last night but we have to move now." The sell side is deal oriented and
they're not going to change their behavior, they're going to continue to do the same old thing, and therefore
they're going to be selling junk the way that they did in the past. I use the example of Kia Motors Corp. They
had a bond issue in February of last year. And when I was in Korea in the fall I showed our guys in Korea how
in 15 minutes I could tell you that the company was bankrupt. That was in February when I looked at it and I
said that the company was bankrupt. So, one of the problems then is on the buy side that my colleague Umeron
Demorois points out that on the buy side we typically have what he calls, "Half baked potato analysis," and part
of it is because the sell side guys call us in the middle of the night and tell us, "Hey, we've got a deal," and then
we jump. (laughter)
          The next thing is that the rating houses, you know we point the finger of blame the rating houses and
we have to realize that the rating houses are not into valuation. That's first. And second they are really into
trying to still recover from being caught with their pants down literally with the Penn Central deal. The Penn
Central was the first triple A that went bankrupt on them and so as soon as they start to smell that they've missed
it, then they start to drop their rating and that's a problem. You cannot depend on the rating houses to do your
own do diligence.
          The international financial institutions have a credibility gap. You cannot tell me in one sense the Thais
and the Koreans lied to you and then but in seven days you can give them the money, you become an expert. I sat



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in Korea in the month of November, I was there long before the crisis hit. I sat there for almost the entire month.
And I could tell you, because I'm an ex-IMF guy, that those guys who went to Korea could not have understood
as much as I understood in seven days.
          The last point I would like to make, because I've been given notice, that the solution, really, if we don't
be here again, is that we have to have a forward orientation to the way in which we look at investing in the world
markets. And so in 1995, as we were coming out of the Tequila crisis, I told my guys "look, we need really now
get geared up and go into local currency." By the summer of 1996 I said, "huh, local currency in Asia is a
disaster, because I know where the money is coming from and I know it's going to pop at some point." So I got
out. But by the summer of 1996, every house in the street had a book out on local currency investing and every
dog and their mother was jumping in and buying local currency. So the point is that we all have a forward
orientation, then we are going to be sitting here again. And as I said, as long as we don't learn from the lessons
from the past, we are going to wind up right back here.

Stuart Brown: Thanks very much Ron. We have about a half-hour for questions and answers. Thanks to some
very provocative comments, I am sure there will be a whole series of questions. Why don't we just collect a few
questions and then have the panelists respond.

***Unknown Speaker 240 6/2*** This is a question for the group. There has been a lot of discussion here and
everywhere else about the fact that the IMF policies of restrictive fiscal and monetary policy with high interest
rates is the right strategy. Can you take me through the rational of that given that a lot of the problems in the
region were caused by excess investment, too many buildings, too many things built and is it possible when you
think as investors that we are just turning all these countries into countries that can't grow for a number of years
because there are no growth engine and how do you invest in that type of environment. It is question number 1.
Question number2: most of the people that are involved in emerging markets investments have tended to focus on
Latin America, and I 've noticed a lot of the people who are focused on Latin America suddenly looking at Asia.
There are a lot of differences in the countries and these regions have not been through restructurings again. A
number of people *** even know what to do or very very few. Latin American philosophy is different. Can you
talk about some little things that should lead to delays *** and any comments of the two of these things together?
Thank you.

Further questions?

- For those of you who are somewhat optimistic about Asia's prospects, I'd be curious of what your operating
assumptions are for the Japanese government's ability to work out the problems, not only the banking system, but
also the life insurance side.

- One question and then a couple of remarks. there is only one country in Latin America, Argentina, which has
something that approximates a currency board. Nobody else does, and even what Argentina has is not a fully-
fledged currency board. The private capital flows to Latin America over the last few years, the overwhelming
bulk of them, have gone only to four countries, Argentina, Brazil, Mexico and Chile, of which only one has an
investment grade rating. The other countries in Latin America, Colombia, El Salvador, and Uruguay, who do
have investment grade ratings have not been as blessed, if that is the correct term, in the private capital flows as
have the other countries, where size seems to be the driving force rather than too diligence investment grade
ratings, and all sorts of other positive signs which should be read. I agree with Mr. Johnson, most emphatically,
that 1982 is indeed a relevant comparison and the question is, I see indeed Merrill Lynch hand out and an
interesting page that says what have we learned from the Asian crisis, and it's got nine points. I've been an
international citizen for 25 years and my question is is there anything new here? If there isn't anything new, then,
why is it presented in this way. I am very curious. Thank you.

- My question is about the kind of partnership for the solution. How can we incorporate the wisdom of the private
sectors investors in the think tanks, for a kind of public solution to the crisis?



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Uri Dadush: These are very big and complex questions. What is the logic of the IMF policies? The logic is that
in a situation where there is a loss of confidence and where there is substantial capital flight, and speculation
against the currency, it makes sense to make it more expensive, to speculate against the currency by raising
interest rates. In some instances, even though overall there was not a fiscal deficit or a large fiscal problem in the
countries involved, there continuous to be a lot of concerns about the size of the projects, and the nature of some
of these projects whether you call them white elephants, or whatever you call them, that were being implemented.
So, in those cases, policies which impose a greater fiscal discipline on the government can also help to restore
confidence. There is also concern about the cost of the bailouts, and support to the private sector is going to be in
the course of these workout arrangements, which have to be taken into account when one is making the fiscal
projections. So, that is the logic of the IMF position. I think that in general as a short term device to reestablish
confidence, there is a lot of merit to these arguments, and in some cases, indeed it is inevitable, for various
reasons that that is the way one should proceed.

The concern of course is that if you have a very highly leveraged private sector, and furthermore, that private
sector high leverage and investment plans are predicated on very high growth rates, that very high interest rates
even in the short term could actually the opposite effect on confidence. There really is no easy way out of that
particular dilemma. Other than not getting into the dilemma in the first place, or simply a massive injection of
external official capital on which there are limits and on which there are all sorts of constraints and concerns,
many of which have been discussed in the course of the last few days.

So, one has to recognize that our colleagues in the IMF do have a very very difficult job on their hands, that they
are trying to do it in a very short period of time and that in many cases, they find themselves between the lock
and the hard place, so to speak. These are the sort of issues one is trying to deal with, and if anybody has dealt
this, many of us have, with real life problems on the ground, be it in business or in government, you have to
realize that in those situations, you have to deal with the specifics of the situation, as it arises, and have to be
careful not to approach the problem in a kind of preconceived or ideological fashion. And I think that, broadly
speaking, that is the direction in which we are going. And, I'll leave the other questions to the other panelists.

Joyce Chang: Just to begin with Bob's question on the merit of high interest rates, I think you are right, the
traditional IMF formulas have started with the whole sequence of stabilizing the exchange rate, rightly or
wrongly, and I think what many of these countries need is to reliquify the domestic banking system, to have the
creation of debt markets. It does seem to me that you have a sort of a set of solutions that the IMF has
traditionally used which perhaps is not as applicable to the current crisis. It is the dilemma of having sort of three
thousands trained macro economists having to look at things like leverage in the system, and banking equity in
the system as well, which may not be their specialty. I would point out, as far as the history with Latin America,
what is different with Asia. And the question how do you incorporate solutions into this crisis. In Latin America,
before the Mexico devaluation, willingness to disclose information, I think, was much worse. Mexico, as far as
the way it reported measures, even the stands that it took at many meetings, was much different that the stands
than the Mexicans currently take. For many of the Latin American countries, you are actually able to pull up your
web sites, internet, and get very comprehensive information that is reported daily in the system, that was not
reported in 1994. So, if you look at the history of Latin America, it is only within the couple of years that
disclosure has actually gotten better. And, these are the kind of solutions that can be incorporated using the
multilateral development banks. As far as the question on lessons learned, and capital flows to Latin America,
capital flows going to the four major Latin American countries, as the chart shows, actually make a lot of sense
when half of the flows are debt financing. They went to the countries that needed to raise debt. If you look at the
four major Latin American countries, it is like 90 % of GDP for Latin America. I don't really see anything not
logical about it when you look at the composition of flows, and the countries with higher debt services ratios that
needed to finance that debt. Chile did not want to raise debt, Uruguay did not want to raise debt, El Salvador may
want to have one benchmark, but they don't want debt. So why hasn't it gone to some of the better countries? We




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have more of the opportunities in privatization, given that half of the flows are debt, which have been presented
in the four major Latin American countries.

As far as the lessons that we have learned from this, I think you are absolutely right. These are some of the same
lessons, and whether it is 1980s or rather it is 1994-95, it is kind of irrelevant because there are elements from all
of it. It has just been speeded up by the volatility and the speed of mobility, but I don't know if you are going to
point to any of these things, as far as bankers making mistakes, investors making mistakes, making mistakes
without you having adequate information. There are not necessarily new lessons. I think the difference is the
speed and the magnitude, and the contagion effect which was not just in Asia, but which really has affected
emerging markets.

There are all difficult questions to answer and very very valid questions, I would also just say that I would not
take the most doomsday scenario in looking at emerging markets, because I think there is, for anyone investing,
quite a lot of money to be made, and quite a lot of opportunities to be had. When you look at emerging markets
debt returns last year, it very solidly outperformed the US high yield market, and US Treasury which had a fairly
amazing year, and if you look at US fixed income market and the US high yield funds are the only areas where
you continue to get new money in flows and emerging markets solidly outperformed that. I also think that in the
first quarter of 1995 it was possible to hear the most doomsday scenario about what happened to Mexico. And
Mexico in 1997 was the top performing equity market, with a 52% return, fixed income market, with a 23%
return in local currency, 21 % return in the external debt instrument. So, I don't see this as a situation where, you
know, there are lessons that are the same lessons that will repeat themselves again I am sure in another crisis. But
I think the difference has been with this one the speed with which this has happened, which had made very hard
for official creditors to respond, made it very difficult to stand the contagion.

Ron Johnson: As to the question of the logic of IMF policies, basically when we look at the Asian situation, we
get a clear picture. The explosion that took place in those economies essentially meant that the money supply was
undefined, that we are no idea the banking sector had huge hole in it. How do you fill that hole? You either work
this out and get financing so you can stretch out the filling of that hole over time, or the monetary authorities start
to print money. From the market standpoint, the immediate assumption has got to be that the monetary authorities
are going to print money, but no one knows the size of the problem. As a result, the money supplies are not
defined. Same thing happened in 1982 in Mexico. Mexico had a system where they had what was called
financieras and the financieras could buy *** and issue cash. No one really knew in Mexico in 1982 what the
money supply was because it was not in the hands of the central bank. Anybody who was a financiera could print
the money. When you have that kind of situation, you need to do a number of things, as Uri pointed out. It is not
a question of IMF uses a very strong term restore confidence, you have to halt the falling confidence.

The way that you do that typically is to move the currency, which seems to be counter intuitive, but you move the
currency or you let the currency float. Why is it counter intuitive? Imagine yourself driving on a road and you
hit a patch of ice. Your natural tendency is to steer away from the skid and people who do that often don't come
out alive. But the tendency is that you need to steer into the skid. So, one of the things that is necessary is to let
the currency go, and that will help bolster confidence. And the reason for that is because the government is
making an announcement that they are not going to try to print the money. The second thing that you have to do
is that you have to make sure that the world knows that monetary policy is independent. The best way to do that
is to have an identifiable target, that people can see and they can measure, because if they don't have that target
and there is no transparency, then there is no way they are going to be confident, because they know there is a big
hole and you have to finance it somehow. And the fear is that you are going to print your way out of it . The third
element which is a thing that typically lags, that is when the World Bank comes in, but it typically lags in the
process, and that is that you have to insure people that this madness is not going to happen again. The way that
you do that is to enhance supervision and regulatory activity in the financial sector, not just the banks, the
financial sector. So that is the first stage. The second stage is stabilization, and the third stage of course involves
restructuring.



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So the IMF programs have a particular reason for the way that they are set up. The question is the staging of it,
how good the analysis is, whether, as in the case of Korea, the motivation for putting the deal together was purely
political versus economic. there are a lot of other factors that will dictate whether or not the policies are credible.
The last point is that I just want to mention, in terms of the public/private partnership, there are many ways in
which those arrangements could be put together, and in fact, the IIF has meetings periodically with senior
management at the Fund and the World Bank, US Treasury, and the G-10 Deputies, but the reason why that
doesn't necessarily solve the problem, or even come close to solving the problem. For one, the IMF in particular
is a place that is full of clienteles, these guys they try to protect the other guys. Second, the role of the Fund is
undefined. When we go back to the original mandate for the Fund and we look at the history, countries that had
the same problems that the countries in Asia had after WW2 in Europe, they could not qualify for IMF funding,
none of them. They had to go to the World Bank. So the IMF's role has been sort of dirtied. it is undefined and so
we have a problem there. And then the other, there is a giant externality that is caused because of global politics
and global security issues. And those externalities lead to effectively moral hazard, because if I know that Korea
is important, if I know that the US has had a long standing policy of fighting two wars in the Pacific, one in the
Korean peninsula, and one elsewhere in the Pacific, then I know that Korea is going to be safe. there is no way
that this is not going to happen. So, we have these externalities that we are not addressing because we don't really
get a chance to do plain talk, or engage in plain speaking.

Stuart Brown: I think one of the questions that has not been answered is the one on Japan, Japanese banking
system, and insurance sector. Anyone wants to address that problem?

Uri Dadush: Just a couple of points. I think obviously , I am not an expert in this area, the Japanese bank
problem is a very real and a very large problem. I think that in the course of the last six months there has been
tremendous progress in terms of beginning to deal with the issue. In the first place, we have had an official
recognition of the magnitude of the problem, which officially now is set at 77trillion yen. Although estimates that
we heard yesterday by others are even somewhat higher than that. And second, for the first time, Japanese
government, or the Ministry of Finance, has moved officially to a position of recognizing that substantial
amounts of public money are necessary in order to deal with the problem. So I think this is a very big step
forward. The amounts of money are very large, but, on the other hand, I think few doubt that the Japanese
economy and the size of the assets are available both externally and internally, are sufficient to deal with the
problem over time. That is all I have.

There are some people who believe that the problems in the life insurance sector in Japan are more substantial
than those in the banking sector, but I don't know about those, so maybe somebody else.

Joyce Chang: Just sort of going back to both Ron and Uri's points about the significance of Japan, you finally
are seeing that some institutions are being allowed to go under in Japan. That is new. It is constructive, but I'd
also say that a major risk in this market is that you have a major Japanese institution go under, and liquidity for
emerging markets dries up quite considerable as a result. Even if you see some of the right steps being taken,
what impact is it going to have on emerging markets? there is two folds. There is the fact that Japan needs to go
through a recovery if you are to see Asia recover as far as just be the real economy export growth. Secondly, I
think, the immediate impact of Japanese sale of emerging market assets is going to have, as well as what impact
it could have on liquidity in emerging markets, if you were to have a major institution, that is a major market
player face difficulties.

New Question: I would like to challenge the proposition that the Fund's arrangements in these countries are a
standard application of the Fund's policies. From my perspective, what we have done in these countries is in fact
very different. In each case, some of the pieces of the programs are efforts to deal with the financial sector. This
is not a standard feature of Fund programs. In each case, there has been the closure of a large number of
institutions, and they are working in various ways. In the case of Thailand, of the 56 finance companies that were



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initially suspended 54 have now been closed. For the remaining banks, what we have is a policy trying to
recapitalize them and until that capital is full back in place to leave them gambling for redemption having
intensive supervision in interest of transparency we are, for the first time, going to have in Korea balance sheets
drawn up according to international standards. So for the first time there will be a serious attempt to evaluate
their assets. And I see this as a centerpiece of the programs, not the financial policies. But on the financial
policies, while I agree fully with the point made by Uri, may I just make one additional point? It is tempting when
you look at these countries to say policies are too tight, let's relax them and if we take a hit on the exchange rate,
so be it. I am not totally unattracted to that. But practical problem we face however is that the banks, and the
banks' borrowers have such large on edge foreign exchange exposure that every time the exchange rate falls, the
quality of banks assets deteriorate further. And you are in a vicious circle. Now the judgment may be wrong, but
the judgment is it is better to stabilize the exchange rate, with that cost of high interest rates which we certainly
hope can come down when things stabilize, it is better to do that than to force more and more borrowers into
bankruptcy which will inevitably destroy the banking system. Thank you.

- Reference was made here by a couple of people that there is a similarity between the current Asian crisis and
the 1982 debt crisis in Latin America. the question that follows from it is: we know that after the Latin American
debt crisis, it took the region ten years to recover, is Asia going to take an equal amount of time to recover?

- I would like to follow up on the comment by the gentleman with the very distinguished looking tie and ask the
panel to talk about the lessons discussions in terms of the countries we haven't talk a great deal about which is
Russia. I would just ask the panel to comment on Russia, and if you sir, could comment on your thoughts, Russia
has this question of do you leave interest rates high and protect the banking system, or let them fall a bit and hope
that you can stabilize it with a little bit of growth.

Ron Johnson: I would like to, if you don't mind, make a comment on all three of these issues very briefly. As I
mentioned to you, the IMF's role is undefined, but it is not out of the question that the IMF has been involved
where there has been a closure of large financial institutions. Again, we look at Mexico 1982, we look at
Argentina 1985-86, the governments basically nationalized the banks and that was under IMF programs. So, the
IMF has been away from its mandate for many ,many years, so that is a problem.

One of the reasons for the long period of adjustment in the 1980s is that the global policy makers and the
governments were following wrong headed policies . The point is that the policies then were just wrong headed,
and we didn't finally get a breakthrough until Nicholas Brady came up with a bright idea: let's just forget about
this crap. The point is that we are going to see real growth slow for at least a couple of years in Asia, if the
Indonesians continue to follow crazy policies which are the wrong headed type of policies of the 80s, then that
country is going to continue to see a protracted problem.

Lessons for Russia. I gave an example to a former colleague yesterday, and I think she just totally missed it. I
talked about Albania, and I said that the thing about Albania is that the Albanians got involved in the pyramid
skim. everybody got involved in pyramid skim. And the pyramid skim went bust. Now, the question is what are
the lessons to learn from that pyramid skim going bust. I like the point with the two-handed economist answer.
One lesson that you can learn is that never mess around with pyramid skim. The other lesson that you can learn is
that the key to pyramid skim is the stardom and get out first. Now the thing is that Russia to be honest is really a
pyramid skim. You look at the GKO market. I know because we were the first mutual fund operating in Russia,
so I can tell you: how can a country pay interest rates of a hundred or so % and GDP growth is falling? It is
falling. So, how do you continue to pay? The way that you pay is that you essentially build up debt. So the GKO
market goes from 0 to 54 billion dollars in two years and people don't really blink an eye. So Russia is the place
where we haven't learnt the lesson. Interest rates, I think are not high enough, at this moment to reflect the reality
in that country, independent of what is going on in the rest of the world.




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Joyce Chang: Just a point of the official creditors agencies and many of the points made that the offical
creditors brought into used to bring confidence back into the system. I think it is very important to say that
without the official creditors some of the private money follow would be much more difficult, and certainly, the
IMF has helped in some of the closure and the reform of the banking system, which has then enabled foreign
banks to go back in there. But the trade off against stabilizing the exchange rate and keeping that as a goal, I think
Indonesia was one case where many people in the market could not understand exactly what the IMF was doing ,
like why try to stabilize at 3200 to 3500 when the market was clearly going to take it somewhere else? Why use
resources in that manner? So I don't know if there is a blanket statement that can be made about every single
program, but I think that many people in the Asian markets felt that, first of all, interest rates were not high
enough, and trying to intervene to stabilize the exchange rate was going to be a losing proposition. All of those
things said, I think the official creditors have been used to bring back confidence to the countries, and it has
become very fashionable to debate moral hazard but very hard to do something about it in the middle of a crisis.
In the case of Asia, the whole model of stabilizing the exchange rate, when you basically have with every
revision of numbers a foreign debt wall that was growing by 30 or 50 billion dollars, was not something that
many people in the market could see as a very valuable proposition, and at the same time, it seemed like rates
would probably need to be significantly higher than they were just given what the situation was.

About the question: will Asia will take ten years to recover, I really don't see that as necessarily being the case. I
don't know if it necessarily recovers to what it was before, but whether or not it can't be unattractive in a recovery
mode. Whether it goes back to what it was in the same patterns, let's hope that it does, but whether or not, this
can go through a recovery that in certain countries resembles what Mexico went through a couple of years ago.
Absolutely in Asia there are cases like that. Korea seems to me like it can actually recover in that mode. And
even in Thailand, although many more reforms in the banking system need to be made, you can see that the
external macro recovery is looking more like Mexico a few years ago, although the corporate and banking
recovery may be quite different. I am not sure that it is going to take ten years, probably because the market has
changed so much as far as the type of financing that is going to emerging market countries.

On Russia, just to add to Ron's point about increasing the debt burden and whether the lessons have been learned,
I think you look at Russia's numbers and the fiscal deficit is larger than Brazil. If you look at what they need to
raise, domestically, just to finance themselves, it is about a billion a week. It seems to me that Brazil had a scare
and learned some of the right lessons and incorporated thing very quickly, whereas it has been harder to make the
case that Russia has actually done that. Still in the case of Brazil, you have a situation where the currency is
overvalued, that some adjustments will need to be taken at some point in time.

Stuart Brown: Before we bring the session to a close, let me add my opinion on Russia. I think it is obviously a
very complicated case. I would agree with Joyce and Ron that the interest rates need to go up, the currency is
more vulnerable that it has been even though it is not as overvalued as many argue, and certainly not as much as
the Brazilian real. therefore, given the fiscal situation and given the dynamics of the external debt situation, that
value in debt the debt market has shifted from ruble denominated to dollar denominated Russian assets, I do think
at 800 or 850 over, that spreads for dollar denominated debt grossly over discount the risk of the fall in Russia.
And if we look at the numbers in terms of at least the total debt stock, we have a much better debt situation than
we have in Latin America. I do believe there is some basis for using the phrase "too big to fail". I think it has
some meaning . In terms of political risk, in Russia the succession following a disaster vis-a-vis has been
exaggerated by the market. We are in a very different situation politically in 98 than we were in 96 when the
issue was yuganov versus Eltsine. To put some things in perspective vis a vis the fiscal deficit, we are talking
about I sorted the external debt of GKOs, we are talking about 15% of GDP, although as I said the dynamics are
not great and we don't get enough sense in terns of pulsy action in the midst of the Asian crisis. But 15 % of GDP
is not an inordinarily high internal debt figure when we compare to some of the other Latins. With that, I want to
bring the session to a close by thanking the panelists and thanking the audience for their active participation.
Thank you very much.




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PANEL II: DEBT AND RISK MANAGEMENT IN EMERGING ECONOMIES


Marc Uzan: A minor change in the program. Amy Falls was not able to attend our session, so Michael and Dr.
Pyung Joo Kim will have more time available. Without delay, I would like to ask Michael Pettis, Managing
Director at Bear Stearns, and I think he is teaching as well at Columbia University, to take the floor on debt and
risk management in emerging economies.

Michael Pettis:           Thank you very much. Just to introduce myself a little bit, I am at Bear Stearns
responsible for the fixed income capital market sector in emerging markets, and I have spent most of my career in
emerging markets. In fact, I was trading what used to be called LDC Debt back in the days before we were
emerging markets experts. My orientation is sort of a finance ***, that is really my background, I have been in
derivative structural products, that sort of things. But about 4-5 years ago, I became very interested in, perhaps
because I felt all the economists knew so much more than I did about the economic history, particularly of Latin
America, and expanding that to the so-called emerging markets region. It seems to me that there were a number
of patterns that regularly assorted themselves in the history of external debt in Latin America. What I wanted to
know is talk a little bit about these patterns and see if there is such a thing as a model of financial crisis, and
model is perhaps a very big word for it, but really, a number of things that are occur regularly, that we can point
to, and that are issues that may or may not be addressed.

Certainly, the last three years have been a period of currency crises beginning, I won't say beginning, there have
been currency crises quite continuously, but the big one that we all remember was Mexico in 94-95, and of
course last year and this year have been completely dominated by Asian currency crises. And I think one of the
results of this continued series of financial crises which continuously run the risk of becoming solvency crises,
there has been more focus, or refocus, on liability management issues. Now the title of this presentation is risk
management. I want to apologize a little bit, I think that risk management is really what providers of capital do,
and liability management is what users of capital do. What I want to focus a bit on is the latter, the users of
capital, liability management.

 My thesis is that historically there are really two risks, or two extremely important risks, faced by borrowers in
LDCs, or, let's use a more neutral term, middle-income countries rather than emerging markets. Those two major
risks have being currency mismatch and refinancing risk. What do I mean by that? I mean essentially for much of
the history of middle income countries borrowing, the borrowing has been in the currency of the major providers
of capital, European countries, US countries, Japan. So much of the borrowing has been in the form of external
currency, in the form of hard currency, but of course the economy itself is indexed to something quite different,
not the hard or external currency, but rather to a bunch of things for which the local currency is a proxy. So what
we have seen is typically one of the major ways that capital goes from the saving countries into the investing
countries, the rich countries to the poor countries, has been in the form of a major currency mismatch.

The other big risk is the refinancing risk. from time to time, for whatever reasons, and I would like to talk of
somehow what I think have been the reasons in the past, but for whatever reasons, the ability to refinance has
completely dried out. When that happens of course, if there is massive maturities coming due in the short term
which is a problem that Korea, Indonesia and a number of other countries have faced, Mexico faced in 94, and of
course the LDC countries have faced in 82-83, but when there is an inability to refinance a large amount of
maturities coming due that is when we have debt crises.

I said two major risks, as someone who has spent a lot of time helping sovereigns and corporates in Latin
America and other countries access the international markets, there is a lot of talk about risk management, and
much of that risk management is focused on timing your interest rates, deciding whether you should go fixed or
floating, deciding what percentage of your total borrowing should be in yen versus DM, versus dollars. I have to



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say initially I thought these were very important considerations, I went to the same sort of business schools that
most of these people went to and learnt the same sort of risk management techniques. But increasingly, I really
don't see that as a useful exercise or as a very useful practice. Whether a Mexico or a Korea gets its interest rates
right by 10-15-20 basis points is pretty irrelevant in the context of things, and pretty irrelevant given the rate of
growth that is possible in these countries. It seems to me that the focus needs to me on those two primary risks.
Now, why are they the primary risks? Well, first of all, and this is all very simple I think, growing countries don't
generate sufficient savings to finance their own investment. So they need to attract foreign savings. there is
nothing particularly new about that. England developed with Dutch savings, the United States developed with
English savings, Germany developed with English savings, and on and on. it is a pretty common pattern. But
what id does mean is that countries that depend on foreign savings for growth are of course extremely sensitive to
changes in the flow of foreign savings. The other issue that is really important is that most of these middle
income countries still are extremely sensitive to commodity prices, and that is something that, when I went to
business school during the 1970s, one of the things that we talked a lot about was the commodity orientation of
Latin American countries. In my experience, that sort of been forgotten for much of the boom period of the
emerging markets, particularly in the early 90s, we stopped talking about commodity concentration. And when
we did , it was generally to suggest that these countries for various reasons were becoming less and less
dependent on primary commodities for their export earnings. I don;'t think that is true. Certainly in cases of
miracle countries like Chile, it seems to me, that if you extend the definition of primary commodities away from
copper and include *** and seafood, the Chilean economy is more concentrated today on primary commodities
than it was 10, 15 years ago. I think that is true of a lot of other countries. If you expand the definition of
commodity to include very low tech manufacturing products whose prices behave very much like commodities,
then it seems that there really hasn't been much of a diversification away from primary commodity production.
I'll get in to why I make such a big issue of that, why I think it is fairly important.

I want to step back and talk about what causes capital to flow to emerging market countries, middle-income
countries. there is a myth and I have to take some blame for it. I think we, investment bankers have been very
active in promoting this myth, that capital is flowing into countries like Latin America for good fundamental
reasons : it is growth or the perception of growth, the expected growth that drives in or brings in foreign capital. I
am not sure that I really agree with that anymore. I think it is really the other way around. It is foreign capital
inflows that drive growth, and the reason I say that is because there have been a whole series of cycles of capital
going into. I want to talk about Latin America, by the way this is true of most of the so-called emerging markets
region. There have been a whole cycle of huge increases in capital and then sudden reduction of capital going to
these countries. And it is not clear that there was any one particular economic policy or set of reasons, or
whatever, that caused this foreign capital to come to these countries. In fact, going back in a very very simple
and simplistic pattern of history, the first really lending boom in Latin America was in the 1820s, and the reason
for money going in was because Latin America was in the midst of war with Spain, Latin America was becoming
independent with the exception I think of Mexico. That created a huge amount of enthusiasm, or at least
theoretically, it created enthusiasm which led to money going into Latin America. It is pretty ironic, or pretty
surprising that money would flow in such huge amount into countries that are essentially in civil war, but
nonetheless, there was a big boom of lending in the 1820s, and I think it was in 1826 when the first Latin
American debt crisis began.

The second big flow of capital was in the 1860s when again contrary to I think, a lot of what we have heard in the
last 10 years, when Latin America was probably the most free market in may ways part of the world. Certainly
countries like Chile and Colombia, by almost any standards, and almost any definition for capitalism, were far
more free markets than the European or US counterpart. But the whole region was experimenting with very open
markets, very free markets , various currencies, etc. perhaps confirming a pretty old pattern that a friend of mine
who either was or is a speaker here essentially he told me: we, Latin Americans will follow any economic
policies that are very fashionable in Europe and in the United States. Well, in the 1860s, capitalism was
extremely fashionable, just like it is now, and there was tremendous experimentation with it. In the 1880s, there
was again another huge inflow into Latin America. By the way, each of these periods that I mentioned are



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followed by debt defaults. In the 1880s, there was another huge inflow into Latin America. that was a period that
looked a little bit like it does today. There was a lot of talk about globalization, etc. they didn't use that ugly
word, but they used equivalent words. It was a gold standard period. In the 1920s where most Latin American
countries were experimenting with European influenced political systems, including initial stages of corporatism,
and a lot of protectionism by the way, there was another huge flow, the so-called 'dance of the millions'. And then
we could go on in the 1970s, we all remember the bad words of import substitution, which actually have a fairly
good track*** in many countries including Korea for the last four decades. And then finally the latest series, and
I hope this series that doesn't end in massive defaults like almost everyone of the other ones did, is the open
markets *** liberalism of the 1990s .

The reason I think that money went into these countries is not because of the economic systems in place, is partly
because the economic systems were so radically different from period to period -- we remember in the 1970s, for
example, Brazil which was experiencing a miracle had a very different economic system than it does today,
corporatist, militaristic, etc. That is part of the evidence, but the bulk of the evidence to me is when there were
huge flows of money going into Latin America in each of these periods, there were huge flows going into a whole
range of risky investments. money was going into Eastern Europe, into parts of Africa, particularly North Africa,
money was going into United States in the 19th century, which was most certainly a risky economy. By the way,
almost every period of default in Latin America in the century was matched by a period of default in the United
States in the same period. The only difference is that the US government never defaulted largely because I think
it had no foreign debt. If it had, it would have defaulted.

Are we seeing a capital boom today? Well, some of the evidence, some of the secondary evidence seems fairly
reasonable. we are seeing huge amount of investments in a wide range of assets, including fairly risky assets. I
think it is no coincidence that the junk bond market is really a market of the 80s and the 90s, and we see money
race to a whole bunch of countries, some countries that many of us would not have been able to point to on a map
not so long ago, other countries that don't even really have a history, they only became countries 4 or 5 years ago.
There certainly is a lowering of risk appetite. Why is that? Is there something that happens that causes money to
flow into high risk assets? the easy answer is yes, it is called global liquidity. the harder answer is we don't know
exactly what that means, but there is a sense of high liquidity during certain times. I have tried to get my arms
around what it means to say that there is a lot of liquidity, there is global liquidity, an expansion of global
liquidity in the last few years beginning roughly around the mid 80s. working with the economists at Bear Stearns
and a few of the professors at Columbia University, I have to say that we don't all agree. This is still fairly
controversial. But I think there are two or three things that may explain the huge expansion of liquidity. I wish I
brought some graphs because I think there are pretty startling. But one thing that I ask our economists to do was
to get the total amount of residential mortgages in the US, index it, and then compare it as a ratio with the total
value of residential real estate in the US, starting in the early 60s all the way up to the present. they showed me
very interesting graphs. From the beginning of the graph until roughly around 82-83, the ratio was pretty
constant. it was increasing during certain periods but very very slightly, almost not noticeable. But around 83, the
ratio went up really significantly, very sharply. And it is continuing at that rate. How do I interpret that? it seems
to me that total residential mortgages as a percentage of total real estate is going up, therefore by definition, the
equity portion of residential real estate, that is what people actually own out of mortgages, must be going down in
percentage terms. What is happening to the total amount? The total amount follows inflation pretty closely, so the
value of real estate has stayed more or less constant in real terms. But the equity portion of US household
investment in real estate has gone down pretty dramatically since around 82-83. Now since total savings rates in
the US have been more or less constant over that period, and we know that the biggest portion of most
Americans' wealth is the equity and their home, it seems to me that that huge transfer of savings, of accumulated
wealth out of real estate without a net change in savings must be counterbalanced by something else. And if you
ask anyone most people will say: obviously stocks and bond portfolios. Those things have showed up. And they
have showed up pretty dramatically. So, what does that mean? Well it seems to me that Americans are taking
their savings out of the real economy, out of their home, out of illiquid stuff, into very liquid stuff. Even to the
extent that there is investment in homes, in the form of an increase in mortgages. Mortgages are extremely liquid



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securities. Savings have become much more liquid, and I am not sure I can prove that suggests there is an
increase in this thing called liquidity. we use the same word for two different things unfortunately, but intuitively,
it seems to me that assets become far more liquid. It has to slide into our conception of high powered money. We
define it pretty statically, but very very liquid assets seem to me more like money than less liquid assets, and as
our total savings become more and more liquid some way or the other, there is more money in the system, or
more proxies for money in the system.

Let me hold out for a second, and talk about the other thing that I found very interesting. I have always heard
about the huge Japanese trade surplus, and I sort of assumed the Japanese trade surplus was an infinite thing that
had always existed. But actually it didn't. The Japanese trade surplus was fairly reasonable, it was nothing
spectacular, until around, again, the same period: 81-83. I don't know if there is a relationship for its changing at
the same time as mortgages, if they were both caused by similar things, or if it is merely coincidental, but around
82-83, if you draw a graph of the Japanese trade surplus, you see that, like the mortgage graph, it starts shooting
up very suddenly. why is that important? Because the Japanese trade surplus has to be recycled, it is a huge
number. Whatever affects the Japanese trade surplus is almost by definition important, because it is such a big
number and it has to be recycled. What did the Japanese do typically when they recycling capital? Well, they
bought, for the most part, US Treasuries, high cap stocks in the US, and relatively liquid assets. So it seems to me
that there has been a huge transfer, I am not sure exactly how to model it, but there has been a huge transfer again
of a form of savings or a form of income out of the real economy into very very liquid assets via the Japanese
trade surplus. that is my reason for thinking that there are reasons for liquidity boom, but you don't really need to
come with reasons, because most of us looking around the market have noticed the huge pressure of capital. A lot
of us, I think, on the investment banking side are sometimes a little bit surprised even bemused by the periods in
which the eagerness for spreads has driven spreads to levels which I think frankly were very very low. It seems
that that is really being driven by the need for investment.

In my class in Columbia, I have been teaching there for five years, I try to be bring outside speakers to speak in
the class, and about four years ago, something like that, I brought in a former boss of mine when I was in Manny
Anny who is a woman who is very senior at *** and she is been involved in emerging markets for most of her
career. And we had a huge discussion in class about whether banks would ever land to Latin America again. Me
being a complete liquidity guy, I said the lending to Latin America is going to boom, and the reason I said that is
because bank capital is increasing, the reason why banks were not lending in the late 80s was probably because
they had no capital, but with the excess capital in the banking system, it was inevitable that banks would become
big lenders once again ton Latin America. And my former boss said: absolutely no, you are crazy. After what we
went through, we will never lend to Latin America again, not in your lifetime. I am glad to say I won that one.
But my model is very very simple. In a way, she was right, but essentially banks lend because they are forced to
lend, they have excess capital. Funds have a lot of capital. And that I think has been driving the process more
than anything else.

What are some of the conclusions from looking back at the process of lending, and I am sorry if this is so
superficial and simple, I will be teaching a course in this next year, and I welcome anyone of you as speaker or
anything else, but what are some of the conclusions? First of all, I think capital flows into emerging market
countries are driven primarily by exogenous factors. That has important consequences. It has been very
personally frustrating very often arguing, and of course as an investment banker, very dangerous making this
argument, but a lot of the good stuff that has happened to Latin America, the growth, including the Chilean
miracle, I don't think, is necessarily driven by the economic policies that have been in place, and trying telling
this to a finance minister, and then asking him if he can do the next bondio*** is very difficult. Because,
essentially what I am saying to them is you are growing, and things are looking very good in your pictures in
Euromoney magazine, largely because there has been a huge amount of capital flows into your country, and you
could do anything you want and you will get rewarded. If you look back in the 70s, all those guys were again in
Euromoney magazine, right? that hasn't really change that much.




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The second thing, this is really quite the same thing: global liquidity seems to be more important than the
economic regime in attracting money, at least in the short term.

And the third conclusion is that the sector rises and falls together. There was a lot of talk during the restructuring
days on whether certain countries would be penalized because they defaulted on their payments, whereas other
countries continued to maintain interest payments. It was a very strong moral persuasion argument. But the truth
is: I think it was all bunk. Essentially, the entire region was able to reaccess the capital markets more or less at
the same time, and the difference in spreads are not really huge. When you think that Argentina defaulted on his
debt. It stopped paying interests for quite a long time. My colleague at First Boston who is now at *** Enrique
Bolini, I think has the honor of having purchased the largest block of cheapest Argentinean assets. He bought
Argentine debt at 9 cents on the dollar in 1991. So Argentina defaulted. It was not that long ago that Argentina
was able to borrow at spreads that quite frankly, I hope there is no one from the Argentine Government in this
room, were a little tight. So, the whole market goes up and down together, and I am not sure that there is a lot of
distinction among the markets. What does that mean? It means that first of all that financial crises are not
avoidable. It is not even worth thinking about avoiding financial crises. One of the things that I find very useful to
look at is the history of the United States in the 19th century. A real classic emerging market country: huge
booms followed by huge busts, US defaults dwarfed anything that Latin America could do -- In fact US defaults
caused, with the exception of Argentina and Barings, probably caused more damage to the British financial
system than Latin America did -- tons of corruption, etc. But what is really interesting to me about the United
States versus, say, Brazil is that when the United States had a debt crisis, it usually was very short term and
recovered within six or 12 months. When I say recovered, it doesn't mean that the economy necessarily
recovered, but money came pouring back into the US fairly quickly, whereas in Latin America, money has not
come pouring back every time. Some crises have been very short lived. The Mexican crisis in 95 for example.
The speed with which money returned to Mexico was pretty astounding. Other crises such as the 31 crisis or the
82 crisis lasted almost 10 years before money came back into the economy. And I have tried to figure out and
understand, and I would welcome any suggestions, why that is the case, why does money comes back into certain
cases, and so slowly into other cases. I want to stress that I consider that the major issue, does money comes back
into the country, because it is foreign money coming back into the country that drives growth, not the other way
around, I am convinced of that. One reason the United States is very different than Brazil is that the US never
defaulted on sovereign debt. I don't think it is because of any inherited virtue. we defaulted on state debts, left,
right, and center. I think Mississippi is still technically in default. But I think the real reason we didn't default on
foreign debt is we never had foreign debt, except in the revolutionary war, we borrowed francs and we defaulted
on that. But since then, we have never borrowed in foreign currency, so we never had the problem of access in
foreign currency to repay debt. That is a little simple-minded because of course, in the last 30 years of the
century, the US was on a gold standard, and it is not clear that a gold standard is anything different than foreign
currency borrowings, but I do think that is very important. And why is that important? I think when there is a
crash in a country, like Mexico, like we are seeing in Asia, we see investors really eager to sniff around and find
cheap assets. There is some level in which investors will come back and buy cheap assets, but investors require
one thing that is very important. they are willing to take the risk of buying cheap assets, but they have to know
they can get their money out again. And I think one of the consequences of sovereign default is capital control
and an inability to take money out of the country. I would say that maybe one of the differences, and I know this
is simple, because there are probably thousands of differences, but maybe one of the differences between
countries that get out of financial crises relatively quickly -- they are terrible crises but within twelve months or
eighteen months they are out and capital is flowing back in again -- and countries that take an awful long time to
get out of a financial crisis is the sovereign default problem.

Another point that I would want to make, and this is pretty much what I said in the beginning, sovereign liability
management is not about optimizing the cost of debt, or matching foreign exchange currencies to your
borrowings or your revenues or anything like that. It is really about bridging the next crisis. That is something
that has become a little bit of an obsession with me and some of my team at Bear Stearns. We are really thinking
about how does a sovereign, particularly a sovereign because of the importance of sovereign default, but also



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corporates, how should they think about liability management? And I think liability management is about
assuming that there will be a crisis and bridging it. What does that mean? A simple-minded solution, and the
wrong solution is capital control, making it difficult for the capital to come into the country. I think sometimes
there is too much money that comes into a country, and they do cause problems, particularly with the currency,
but middle-income countries need capital. They need foreign capital. It seems to me probably smarter that
borrowings be indexed to the state of the economy. There are numbers of ways of doing that. A country like
Venezuela should not borrow unless its borrowings is somehow indexed to the price of oil. 85% of their exports
are oil or oil-related. Essentially, we know when oil prices are high, Venezuela can pay back anything. When oil
prices are low, they can't. It would be great to have borrowings that are indexed that way, and it is not that
difficult to do that. Borrowings should also be indexed to earnings. Direct investment is a form of that, equity of
course is a form of that. As a guy that makes money selling bond deals, I am nervous about saying that, but I
think equity's clearly a much safer way of accessing foreign savings. Finally, I think what is extremely important
is to develop a local currency market for accessing foreign savings. And, why is that? I think local currency is
probably the closest proxy to an underlying value for the economy. By that I mean that it is hard to imagine the
currency's strength anymore when the economy is doing poorly, and, remember, middle-income countries are
very different from the advanced countries in the credibility issue. The Japanese yen could theoretically
strengthen with weakness in the Japanese economy, the US dollar could theoretically strengthen with weakness
in the US economy, but in Mexico that is not likely. When there is a fundamental deterioration in the underlying
economy, it is almost certain that there will be pressures on the currency. So, to the extent that borrowings are
indexed to local currencies, and I don't mean short term debt, I'll talk about short term debt, but medium term,
long term fixed rate debt, you have an opposite indexation which is perfect from the liability management point
of view, and that is when things are bad for you, the real cost of your debt actually declines. It doesn't increase,
unlike the US dollar debt which has the opposite effect: when things are bad, the real cost of your debt increases,
it does not decline. I just want briefly to talk about short term debt because most of these countries have a one-
year-market. the problem with short term debt is that interest rates, if they are indexed to interest rates, tend to act
the same way the currency does. During a currency break, interest rates shoot up. real rates become extremely
high, so if you borrow short term in your local currency, you still have the same problem, and that is that, in the
case of a crisis, the real cost of your debt is going up at exactly the wrong time. You want to have the opposite
indexation.

Maturities are a very important issue. I don't think it would be controversial to suggest, and I use Mexico as an
example for the whole world, that for a Mexican the real interest rate, the real cost of interest in dollars is
probably lower on average than it is in pesos. And that has been one of the great discourages of local currency
borrowing, because the assumption is : if I borrow in pesos it is expensive, whereas if I borrow in dollars it is
cheap. It drives me wild when I hear that, because that is simply not true. In order to say that, you have to make
explicit an assumption about foreign interest rates, about future interest rates. The cost of pesos is only higher in
the case of when the economy is doing well, when presumably you, the borrower, are also doing the well. If there
is a break in the currency, the cost of borrowing dollars, of course, is much higher than borrowing pesos. So the
on average you are better off borrowing dollars, but that average only holds true over very long periods of time.
maybe all I am doing here, in a very complicated way, is backing my way into what is perfectly obvious , but
short term dollar borrowing almost always exacerbates the crisis. Not because of George Soros, or any of those
nasty guys, but because corporates that have short term borrowings have to hedge their borrowings if there is a
threat of crisis. That is why, frankly, we were discussing Brazil earlier in the back there. that is why I am so
terrified of Brazil. Brazilian corporations are short dollars and they have massive amounts of cash sitting in ray
ice. And when they become worried about the currency, they will buy huge amounts of dollars to hedge their debt
positions, and that will break the currency, not nasty New York speculators. It never works that way. So we are
trying to develop a model that sort of suggests at what point, what maturity the range of your borrowing costs
within two or three centered distribution gets close enough to the mean, remembering that dollars are generally
cheaper than pesos, that it becomes safe to borrow in dollars. we think that it is beyond ten years. what I mean by
that is that if you are borrowing dollars versus pesos, you save a certain number of percent every year on an
average year. But that average hides a lot of sin. In good years, you are saving an awful lot, in bad years, you are



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losing an awful lot. How long does that period have to be with the total amount of savings is more than enough to
compensate for the possibility of loss. We think it is beyond ten years, but that is pretty intuitive. we haven't
really got the data yet, and we are working on trying to develop some sense of it. And even when we do, it will be
sort of bogus, because it will be for twenty different countries which is not necessarily explanatory for one
country. But I do think long term borrowing is safer because you don't have the principal maturities coming due
so, for no other reasons, that makes sense. Remember, I don't think there has ever been the case of a country
defaulting on its debt because it couldn't make interest payments. It has always been the principal payments. So
we want to stretch those as long as possible.

On the case of a crisis, and I will conclude here, we can expect a couple of things that happen at the same time. If
crises are driven exogenously, it's no point hoping that you will have a crisis when things are going well. it is no
point hoping when world aggregate demand is pretty strong and commodity prices are reasonably high, and you
are earning as much as you expect to earn on your trade account. Because generally when those crises happen,
there is a drop in aggregate demand worldwide, so you are going to be exporting less. And there is usually a fall
in commodity prices, which Chile is finding out and is obviously very nervous about. So the assumption has to be
that there will be financial crises, that financial crises can only at the worst possible time, when all of your
earnings and your reserves have been depleted, or near depleted. So, I would argue that liability management, to
go back to an earlier point, really is all about bridging the next financial crisis, and anything else is a fairly
uninteresting and unimportant strategic target. Thank you very much.

Marc Uzan: Thank you Michael. I am going to ask Dr. Pyung Joo Kim, Professor of Economics at Sogang
University, and as well Vice-Chairman of the presidential commission for financial reform.

Pyung Joo Kim: Thank you. I found out yesterday that I was on this panel, but I am not an expert on risk
management. So I want to share with you my experience of working for the presidential commission for financial
reform in Korea.

Marc Uzan: Thank you Professor. We are going to have a couple of questions before breaking for lunch.

John West: Thank you. I have two questions to Mr. Pettis. Why in your experience do you think developing
countries borrowers don't hedge their borrowings. The second point I would like to mention is I guess one policy
implication of your work is that to shorten the crisis in East Asia, East Asian countries should quickly allow their
insolvent companies to be sold off to foreign investors so to revive capital flows and to get the real sector moving
again.

Michael Pettis: To answer the second first which I think is the easier one, I would agree with you. I think
bringing capital back into Korea, Indonesia, etc. is key. And I think one of the ways of doing that is selling off
cheap companies. As a side effect of that, there is also a restructuring of the local companies, local balance
sheets, etc.,

The first question is a little bit more difficult: why don't they hedge their borrowings? I think, part of the reason,
well it depends what you mean by hedge, you can hedge your borrowings against commodity prices, sometimes
as in the case of Mexico, that presents political problems, because if you sell oil forward, first of all the market is
in deep very fall out, and secondly, there is sometimes issues about selling out the patrimony of the country the
first question is a technical issue which I think can be addressed. Perhaps borrowings should have implicit oil
options in them. I don't think that is very difficult, and I think investors would be very interested in doing so. I
think very often the bigger problem why they are not hedging, for example into their local currencies, is that
implicitly hedging in local borrowing dollar and hedging in local currency means borrowing in local currency.
And you can't escape the perception of higher cost, of a higher real rate. So that is my suspicion. I have also
heard comments such as, from certain corporates, this makes a lot of sense to borrow in pesos, but we know what
is going to happen: either things get better in which case our competitors who are borrowing dollars are going to



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beat us, or things get worse in which case we are all going to get into trouble and, and I promise you I have heard
this, the government will take us out of it. So there may be a disincentive, there is sort of a weird break in the pay
off schedule that makes it perfectly rational not to be hedged. I think it is probably more of a sovereign issue to
deal with than it is a corporate issue. Sovereign also don't have long dated *** local currency borrowings.
Mexico goes up to a year, most of the countries that we deal with go up to a year, and borrowing for one year
doesn't make a lot of sense, it doesn't get around the problems.

James Powell : Just one comment on Mr. Pettis' presentation. I guess something that sort of links your theme
with yesterday morning or yesterday afternoon theme of moral hazard, was a paper by Michael Duly. Its title is:
our capital flows, a vote of confidence in favor of policy in developing countries. It came out a few years ago and
essentially, he was looking at chance of guarantees that the stock market ***, one of them being exchange rate,
which could be the answer to the question just posed that there is no reason to hedge. Because governments out
there were providing at least a partial guarantee to their exchange reserve set about this specific fixed exchange
rate would be held. You don't have to, you probably don't need to hedge until the last moment, and also there is
no need for *** markets to develop.

Michael Pettis: I agree. There certainly is a perception that hedging is a fools' game, because the governments
are going to guarantee the exchange rates or they are going to guarantee the rate of depreciation of the exchange
rate. We have seen that in Brazil, in Mexico, and on and on. Mexico before the crisis. The only answer to that is
that it is true. The government will guarantee the rate of exchange, that your borrowing costs are going to be
lower if you borrow in dollars until they stop guaranteeing. The problem is the stop. It is totally unpredictable.
There may have been cases when it was done for policy reasons, but I think in almost every case, when they stop
guaranteeing, which is another way of saying there is a currency break, it has always been because there were no
alternatives. Mexico broke the peso because they were down to 3 billion dollars of reserves. Almost every
currency break has been for the same reason. So, there is a problem, and I don't know if it is a moral hazard
problem, or what, but there certainly is a problem with the perception that the government will step in and
guarantee the difference between your borrowing costs, and that you can trust that claim. Because once you have
stopped trusting, the consequences are pretty bad.

Susumu Awanohara: I guess in the earlier sessions, we were asking whether capital would return fairly soon to
Asia after the crisis or not. Given your idea that this is global liquidity driven and movement of capital, what is
your sense? Will capital return to Asia soon or not?

Michael Pettis: I wish I knew. I have of course a theory. Two things. First of all, I would say that if you are
going to have a financial crisis, be smart enough to have it during a period of great liquidity, like Mexico did,
because it recovers fairly quickly. Is this a period of great liquidity? We were discussing that a little earlier. I
think, and I publish a newsletter every week for borrowers, and in November I said by the end of the first quarter,
we are going to be back in a bubble in Latin America. And the reason I think that is because looking at capital
flows into the US, right now that is the only thing that interests me: how much liquidity is there in the US system.
It looks pretty good. High yield funds have been receiving a huge amount of money, emerging market funds have
been losing money, but that is not surprising, but they have been losing far less than high yield funds have been
receiving. Is that likely to continue? I think it is going to actually increase in the near future, and the reason I say
this is precisely because of the Asian troubles. I think no one would consider me crazy for suggesting that
aggregate demand in Asia is going down pretty significantly, and that of course, Asian products are now far more
competitive in the world from a price point of view, and they are more desperate to sell. And it is very difficult to
sell products into Asia. Luxury good producers have been really whacked. That suggests to me that the net trade
balance for Asia is probably going to improve pretty dramatically during 1998. If that is the case, that money all
has to be recycled. The question is how does it get recycled. In the past, that money has gone to US Treasuries,
and large cap stocks, and highly liquid assets, etc. the question for me is really is it likely to be any different in
the near future. I don't think it is. I think we are going to continue to see money coming in to ** investment. And
when they do, that means increased demand for US assets, including US Treasuries, possibly a reduction of



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supply of US Treasuries. So the money is going to show up somewhere. It is going to show up in high yield
market which I think is going to do very well in 98, and in a number of other places, including Latin America. It
is more difficult to say what will happen in Asia, because investors are not totally rational. I think they are
pushed into investing in high yield assets, into yielding assets, but they are unlikely to go into areas where there
is a perception of zero stability. I think countries like Indonesia may have a problem. But I am not horribly
worried about the financial markets in Korea. I think they will recover pretty strongly. I think we saw having hit
the second leg of the Korean crisis, which is the economic leg of the crisis, we have had the financial panic, and
we are in the process of resolving that I think. So I think things will be tough for Korea in the next year or so, but
I do think that the markets will come back there. Always subject to no major event that drives equity out of the
market, and almost by definition, I couldn't even tell you what that is likely to be. But I am reasonably optimistic
about the markets, even though I am a terrible bearer over the medium term.

Matthew Fisher: May I just offer a couple of footnotes to the Pettis' presentation which was a great one. The
first one is not only have a lot of people been borrowing very short term, but when people have been borrowing
medium or long term debt, they have done it in a way where it turns into short term debt just when the
government gets tough. Last year, the Korean Development bank floated 2-3 hundred million dollars, floating
rate ***, three year money that should have matured in the year 2000. They both had put options on them, which
were triggered by the downgrading of the credit rating agencies, and they were both paid out in December. So
what should have been three year money was in one case six month money, and in the other 90 day money. This
is exactly the sort of behavior which is the antithesis of what you people should be doing. It is difficult for us to
do much about it, because we don't deal with private borrowers, but I do hope that the NY investment banks will
be in the business of explaining some of these risks to their borrowers.

Michael Pettis: Don't count on that.

Matthew Fisher: No, and that is why I don't think I am going to be offered a job for some reason. The other
thing is the off balance sheet items. What we have seen I think in a number of Asian countries, is banks have
been using these tools to generate the income. Now, in the case of Indonesia, they were gambling that there
wouldn't be an exchange rate regime change. They sold large numbers of options when they started to get
frightened that the rate was moving in late September, they covered themselves, and the rate sort of took off and
the rest is history. But, we have also seen these banks gambling in other markets. And this is perhaps when we
are better placed to do something about it, but I do think that across all emerging markets, there is an urgent need
for central banks to strengthen their capacity to supervise off balance sheet items.

Michael Pettis: The only thing I would add to that is that I agree with you about portable bonds and all sorts of
credit sensitive notes that are inversely indexed, that have what we call a negative delta. I think in an insanely
optimistic world, it always makes sense to index the wrong way, because things are only getting better. From a
liability management point of view. it is a disaster.

Speaker: If we take your liquidity paradigm as given, the theory to the extent that it is one, are we not wasting
our time worrying about moral hazard? We discussed all of yesterday afternoon moral hazard, it has been widely
discussed for the last couple of months, if you are right, then could one not argue and say it doesn't really matter,
because it is all going to be in function of liquidity whether or not people return, and it really has very little to do
with moral hazard?

Michael Pettis: That is a tough one. I don;t want to sound cynical. I wish I could say that of course we should be
concerned about issues that bring rationality and a proper sense of risks to the market. Maybe in the short term it
doesn't matter, but in the longer term it does. Maybe the difference between countries that are able to extricate
themselves from that liquidity cycle and countries that are not, maybe such issues as moral hazard ... For one
thing, I didn't want to suggest early on that economic policies don't matter. Obviously, they do matter.
Unfortunately, they only matter over the long term, and over the short term, it is not clear that they do. I would



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put moral hazard in that same category. I think from a policy point of view, you don't want to be in a position
where there is no distinguishing among different types of risks. I think in the long term, that can lead to an awful
lot of damage. And I think Korea is showing that. But if the moral hazard problem is not addressed or resolved,
does that mean that lending to Korea stops? Not at all. It will continue.

Speaker: It is a question of point, I suppose. I am not sure whether you need a complicated term like liquidity
model to explain the flows of capital to emerging markets in the 1990s. I think two words are all that is necessary
to explain these flows, and the G word is one of them: Greed, and the F word: Fear is the other. It is the trade off
between greed, the love of game, and fear, the fear of loss. And what has explained the move of capital into the
emerging markets in the 1990s, as opposed to the 1980s, is that the love of game has overtaken the fear of loss. I
think that is largely a function of the time that has passed since the crisis in Latin America in the early 1980s. By
large, the people who were involved in making the loans to Latin American governments in the 1970s, by the
1980s had retired. They had been overtaken by younger people who took a rather more optimistic view of the
world, and they thought well, spreads of 1500 basis points on Latin American debt securities are ridiculous. Let's
push them all the way down to 250. So, I think you don't need to explain flows in these complicated terms of
liquidity models, let's think that greed and fear are what motivates securities prices. As far as the future is
concerned, on that basis, I fear about capital flows into Asian capital markets, equities and the local bond
markets. people who have invested in those markets have lost a huge amount, and the scars which have been
inflicted by those losses will be there for a long time. I wonder how quickly it will be before portfolio capital
flows into South East Asia will resume.

Michael Pettis: I am less optimistic than you are about the scars. I think that changes fairly pretty quickly, but I
am always happy to join anyone in bashing people who are a lot younger than me.



PANEL III: ANTICIPATING & RESOLVING FINANCIAL CRISES: REGIONAL OR GLOBAL
PROCEDURES?

Marc Uzan: My idea here was to bring a set of views about the best way to manage and resolve financial crises
with some distinguished speakers coming from international organizations, as well as from the GAO who will
provide their thinking on that. They wrote a couple of reports and will give their background on that. I am pleased
to introduce Mr.. Kumiharu Shigehara, Deputy Secretary General of the OECD who will make the first
presentation of this panel.

Kumiharu Shigehara, Deputy Secretary General, OECD:
tape 8-B, beginning

Marc Uzan: thank you I will ask now Susan Westin, Associate Director of the GAO, to make her presentation.

Susan Westin, Associate Director, General Accounting Office: Thank you Marc. GAO, by way of
introduction, is a congressional agency. We report to Congress, we have audit authority over almost executive
branch agencies with just a few exceptions. We evaluate programs, provide analysis. Currently, about 80% of the
work of the GAO is done in response to requests from Committee Chairmen in Congress. In fact, if we get a
request from a Committee Chair or ** minority, we do have to undertake that work. Yes, it is true that on
occasion, we go into an agency, and say we are from the government and we are here to help. (laughs) And we
get about the same reaction.

I am going to talk today about efforts to anticipate, avoid and resolve financial crises. A work that is based on a
report of ours that came out last July. The work was in response to a request from Jim Leach, who is chairman of
the House Banking Committee. In fact, he gave us a request in January of 95 to look at the Mexican financial



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crisis. We decided to split the work into looking at the financial crisis in Mexico, getting that report out, and then
undertake to look at efforts that the international financial institutions and G-10 was undertaking to better
anticipate and resolve these crises. In the work on Mexico, we focused on a few things, specifically whether it
was legal to use the exchange stabilization fund the way the Treasury did, and also what did US government
officials know about the crisis and when did they know it. that report, like almost all our reports in GAO, is
available to the public. And as well, you can visit our web site at www. gao. gov, and get a listing of reports, and
you can have one free copy of any report that we do.

So, I want to talk about first, initiatives to anticipate and avoid the crises. In our report, we really focused on
three things: improving information, and I am going to talk quite a bit more about the IMF data standards in a
minute. The other initiative we looked at strengthening supervision of commercial banks in emerging market
countries. Actually, this is probably the next job we will undertake in this area, particularly if we can get
somebody on the Hill to request it. We have heard yesterday and today as well, that a common element in each
country seems to be a weak banking system with inadequate supervision, where issues include things like weak
accounting systems or directed lending that analyses borrower credit on a political basis rather than on a
creditworthy basis, etc. It is a job that has been on our plan to do for a couple of years, and we think that it will be
the next that we undertake, looking at the implementation of the BIS standards in different countries. The third
initiative that we looked at in this area was looking at improved IMF surveillance of member countries, economic
and financial situations. When we talked at the IMF, mostly what we heard is that this was really a resource
issue, that with the amount of resources and people that the IMF had, it was going to be difficult to increase their
surveillance, and whether they would be keeping as close an eye on all countries at the same time, partly it is a
matter of whether the country is actively borrowing from IMF at the time. Also, there was the issue of making
public the confidential discussions that were going on under the consultations, and we have heard about that in
this conference as well.

Back to the data standards, their purpose is to encourage dissemination of timely reliable economic and financial
statistics from the countries to the capital markets. As of September 1997, 43 countries including all the G-10
countries had subscribed to the special data standard, which is the tougher of the two standards. There is a
general standard which is not quite as tough. There are ideas to have a bulletin board on the internet, which there
is, but there is no actual data on the bulletin board. What there are are links to country data. Of those 43 countries
that have subscribed to the standards, 21 of them are developing countries, including Indonesia, Hong Kong,
Malaysia, Singapore, Korea, Thailand and the Philippines. But there are only 12 countries so far on the bulletin
board who actually have links to the data, and only 3 of the Asian countries Hong Kong, Singapore, and Japan. It
is really a market-based effort top address the information problem. One of the things we found in analyzing the
Mexican crisis, in talking to investment bankers, and commercial bankers, was that they didn't have enough
information about the real situation in Mexico, particularly about the foreign currency reserves position. in fact,
when we looked at the real situation, Mexico had been disclosing their reserve position in the same way for
years, two to three times a year at set times of the year. But, that turned out that, in those gaps, there could be a
lot that had happened to the reserve position. And, now I understand that Mexico is widely regarded as the best of
the developing countries in getting its data available. I think since the crisis, it has announced its reserve position
on a weekly basis. With our analysis of looking at the IMF data standards and what that is likely to do in helping
to better anticipate and perhaps avoid these crises, I think it is important to know that there are no IMF plans to
verify the data. This is not a disclosure issue. On the bulletin board, when you head to the hyper link, there is a
big disclaimer for each country, saying that IMF has not verified this data, is not standing behind the data at all,
and that it is simply what the country has chosen to put on. There is no IMF plans to monitor Countries'
compliance. In fact, one of the things that we asked when we were talking to IMF officials was what would you
do if in the course of your consultations, you found out that what you learned was different from the data that was
being put on the bulletin board. And, they pretty much said that it was unlikely that they would take any action.
The plan was that market participants should be the one to monitor this. Well, in our analysis, it seemed unlikely
to us that they were going to hear back from investment bakers and commercial bankers telling them when they
found instances of where the data was not very good. I don't see why any market participant would have an



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incentive to point out poor data, and one other thing we encouraged IMF officials to do informally was to at least
set up some kind of system where they could be collecting information on how many instances there were, say,
over a year where market participants actually reported poor data to them. It is not meant to solve the problem of
bad data, but to help. It is not meant to solve the problem of poor investor analysis, that is up to investors to
conduct their analysis. I think one of the interesting things that rose in the Asian financial crisis is that lent some
insight into how useful these data standards might be. Is the issue about the hidden data? Supposedly Korea hid
foreign debt by about one half. Thailand allegedly hid its central bank huge foreign currency exposure. But these
may not be examples of violation of the data standard, because it is not provided to countries exactly how they
have to calculate the data. One other thing that is supposed to be on the bulletin board, and then when you hyper
link to a country's data, you are supposed to have a sense of what the methodology is in calculating these
different figures. But it is not going to be uniform from country to country. So, our bottom line on that what that
it may help the information problem somewhat, but it is definitely not a case where anybody is going to be able to
verify that theses really are good data, so we are not clear on how much it would really help investors make better
decisions.

Turning to the proposals to resolve crises, I wanted to talk about three of these including our analysis of them. the
three of them are : expanding the general arrangements to borrow to the new arrangements to borrow, the
emergency financing mechanism in IMF, and the concept of an international bankruptcy court.

Before I talk about those three, let me give you just a little bit of the conceptual framework that we developed for
analysis. I would say the 3 most important elements out of the ten were first of all the effect on contagion, and/or
systemic risk. What would the initiative or proposal, what would the effect be on moral hazard, and we definitely
found there was a trade off between moral hazard and the effect on contagion, or systemic risk in almost every
case. And, then, because we are a congressional agency reporting to Congress, a big element in this framework
was looking at the effect on burden sharing. And frankly, I think that relates to the topic of this panel. it is
important when GAO does its work that it looks at its impact on the US. In the Mexico crisis of 94-95, the United
States took the lead, coming up with the first package lent to Mexico, and then the IMF. It has been very different
in the Asian countries. We had a briefing at the Treasury Department in early December about what they were
doing in Asia, and one of the things they pointed out is whereas they took the lead in Mexico, all the money
going into the Asian countries would be coming from IMF first, and the US would only providing back up funds
which would have extra conditions attached to it, over and above the IMF conditions. they would not get specific
at that point on what the conditions were going to be, because they didn't expect that that money would be drawn
on. It may be something that we get as to look at, in another six months or so, exactly what were the conditions of
the money that the US has lent. As you probably know, the exchange stabilization fund is where they use their
money. That means that Congress does not get to vote on it, GAO does not have any audit authority over that
fund, which is a sore point with some of us. So Congress approval was not needed when they lent the money to
Mexico, so the issue before Congress is not looking to whether they have to approve these loans, but as we'll see,
the issue is much more on whether they are going to support an increase quota to IMF, and also the money to put
into new arrangements to borrow. The rest of the elements in our framework are listed in the report.

So, for the General Arrangements to Borrow, as probably most of you know, it is meant to supplement ordinary
IMF resources. the US share is about 25%. The rules are that you need to get countries representing 60% of the
credits in the general arrangements to borrow before you can activate it. And, there are two main conditions to
activate use of the general arrangements to borrow. First of all, the IMF must have impaired resources, and that is
one reason why the general arrangements to borrow were not used in the Mexican financial crisis. IMF had
plenty of liquidity and had no reason to turn to the GAB. From what we understand now, and from remarks I
have seen by Stanley Fisher in the Press, the IMF is getting closer to where their resources may be considered
impaired. The second condition to activate the GAB is that there has to be threat to the international monetary
system. Being good auditors, we asked officials at the IMF well, how do you determine if there is a threat to the
international monetary system. There are no rules or set criteria written down. In fact, one of the things they told
us is that having rules that laid out what would constitute a threat to the financial system would mean that it



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would increase the moral hazard problem. So to try to keep some ambiguity, some vagueness into whether the
GAB would be used, they don't have any set of formula for what constitutes a threat to the system. Another thing
about the GAB, it hasn't been used since 1978. In fact, the United States was the last country to draw on it.

For the new arrangements to borrow, on the handout there are a couple of charts that come out of our report so
that you could see how this will be structured. The new arrangements to borrow doubles the resources to almost
50 billion dollars. As you can see from the charts, it includes many more participants, including some from the
Pacific Rim, like Korea, Malaysia, Singapore, and Thailand. The US share would drop to about 19.7%, and
actually, this is an important figure because, for the new arrangements to borrow you need to have 80 % of
countries representing the credits have to agree to activate the new arrangements to borrow. So with the US share
just under 20%, it means that the United States plus one other participant would be able to block activation. And
unlike use of the ESF, in order for the new arrangements to borrow to take place, the Congress does have to ratify
this, and it would require both congressional authorization, and appropriation of the money to provide the support
for the New Arrangements to Borrow. Some people have asked me at this conference what is Congress likely to
do. I think there is a good chance that Congress is going take up this issue again, I know there is a lot of interest
about the Asian financial crisis on the Hill. I think one clue I would be looking for is to see if the President
mentions, and in what way, the Asian financial crisis in the State of the Union address tonight, and see if he talks
about the importance of getting more resources to the IMF. With our analysis of the NAB, we thought that it
would ease the relative US burden of crises resolution, that IMF would more take the lead on this. We also noted
though that activation could be more complicated with more members. it definitely could help stage stem
contagion effects, but it , as we have all heard, could increase moral hazard as well. So again, we have that trade
off between increasing moral hazard and stemming contagion. With the Emergency Financing Mechanism, that
is an expedited decision making process. The IMF Executive Board agrees that extraordinary circumstances
exist. the agreement is to be reached between the borrowing country and IMF. there are just 5 days giving them to
circulate the documents, and the Board agrees to meet within 48 to 72 hours. I think we have seen in countries in
the Asian crisis that the IMF can move much more quickly than its reputation was just a few years ago. definitely,
the EFM can stem contagion, and it reduces pressure on the US to act quickly unilaterally. the effect on moral
hazard we thought was unclear. In fact, it may be that the availability of support, like IMF resources or the GAB,
or the NAB, is the factor in the moral hazard issue. Not so much the speed with which the funds can be made
available to the country.

The last thing I wanted to mention was the international bankruptcy court. In fact, this is where the team got to
know Marc coming up and talking with him about the work that he had done on this. Mr. Leach is particularly
interested and intrigued with the idea of an international bankruptcy court. We agreed that it may not pose the
risk of moral hazard that the rescue packages do. But, we were also concerned that it may not limit contagion
effects, which is a concern to many people. And the implementation challenges are pretty great right now. I will
let you read the details in the report if you are interested.

Marc Uzan:      Thank you Susan. I am going to ask Mr. Yoshimura, Japanese ED at the IMF, to make his
presentation.

Yukio Yoshimura, Executive Director for Japan at the IMF: Thank you Marc. I would like today to
comment on the regional approach for the stabilization of the Asian currencies. IMF covers not only the regional
issue but also the global problems. previous speaker, Ms. Westin, covered a considerable part of the role of the
IMF in the global context. On the other hand, Mr. Shigehara mentioned ** a lot on the regional surveillance
issue, which is according to him explained by me. Well, I am not foolish. I can respond, because he referred to
many aspects of the regional surveillance, but I will reply.

There are two types of regional approaches that have been discussed since last fall. One is independent of the
global approach, the other is complimentary to the global approach. Of course, I strongly support the latter. Not




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only because I am an Executive Director of the IMF, the central institution in the global effort towards currency
stabilization, but also because I do not support regionalism if it inclines toward isolationism.

Let me begin by recalling how the independent regional approach emerged in Asia. After the Thai currency crisis
which occurred in July last year, some countries in the Asian regional informally floated the idea of independent
regional cooperation for defending their currencies. The proposal to create an Asian monetary Fund was
discussed, of course informally, during the Annual Meeting of the IMF last October in Hong Kong. but the
discussion there was inconclusive. The original proposal, again informally made, by Japan included the
possibility of having conditionality imposed by the regional fund, independent of the IMF. This caused
controversy. I can see why such a proposal was made and why it got support from some Asian countries. Asian
academics had noted the discrepancy between orthodox IMF and World Bank policy prescription for economic
adjustment and the way economic management is actually carried out in Asian countries. Since Asian countries
had achieved rapid economic growth, they were skeptical about the policy recommendations of the IMF and
World Bank. these differences in view are sometimes referred to as differences between Washington consensus
and Tokyo skepticism. Because of this different way of thinking that many Asians have about economic
management, it is not easy for Asian countries to accept the terms offered by the IMF. They therefore hoped to
find their regional prescription different from that of the IMF. This kind of argument is still seen in many of the
recent articles in the media. For example, Professor Jeffrey Sachs insists that IMF conditionality is too harsh for
Asian countries
especially when the IMF has to tackle new problems in an economy. For example, there were some who thought
the recent IMF program for Thailand emphasized the tightening of fiscal and monetary policies without
sufficiently addressing structural problems. I would point out, however, that financial sector reform is one of the
main pillar of the Thai program. In addition, the programs for Indonesia and Korea that followed the Thai
program covered broad and substantial structural reform, including such new issues as governance and labor
markets. In fact, the structural element sometimes crucially affects market sentiment.

As for macroeconomic policies, the contends of an IMF program are gradually modified to reflect the changing
environment. The new Indonesian program allowed some fiscal deficit for fiscal year 1998. On fiscal policy,
taking the historical track record of fiscal prudence of the Asian countries into account, we know allow room for
the automatic stabilizer to work. The discussion on monetary policy is more complicated however. In general,
tightening of monetary policy is required to prevent currency depreciation. But, when the financial system is
fragile, tightened monetary conditions can seriously damage not only the financial system, but the entire
economy. In order to improve the effectiveness of IMF programs, I think that further qualification is needed on
the effect of the tightening of the monetary policy, on the various macroeconomic parameters, economic structure
and financial systems.

Certainly, the IMF is facing a challenge in coping with a new situation. faced with the current currency crisis, we
at first tried to address it a rather traditional approach. you could say we had an idee fixe with regard to currency
crises. However, as I have already mentioned, we are now learning from our recent experiences in developing
contents of new programs. Some Asian countries may say that flexibility still isn't sufficient regarding changes in
programs. However, I think this does not justify following different conditionality under institutions independent
of the IMF. This is the way towards isolationism which would surely damage the economic development of the
region in the long run. Instead of following that route, I think the Asian countries should exert more effort to
voice their concerns in the IMF about possible changes in the IMF policy.

Let me know turn to the kind of regional approach that is complimentary to the global approach. Following the
inconclusive discussion in Hong Kong last fall, deputies of Finance Ministers and Central Bank Governors in the
region gathered in Manila in November last year, at the initiative of the United States. The leading role played by
the United States was important, as the crisis had spread to Indonesia from Thailand, and further contagion was
likely. The active involvement of the US was necessary to cope with the regional crisis. US close economic
relationship with Asia and the wide use of the US dollar in the region for international transactions also justified



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US involvement. Thus, an independent regional approach that would exclude the United States and others had
become irrelevant at that stage. And the discussions since then have focused on how effectively we can adapt a
regional approach to the global approach.

In Manila, a new framework for enhanced Asian regional cooperation to promote financial stability was agreed.
There are three initiatives included in the framework for enhancing regional cooperation. Number one: a
mechanism for regional surveillance to complement global surveillance by the IMF. Number two: technical
cooperation in strengthening domestic financial systems. And, number three: a cooperative financing
arrangement that would supplement IMF resources. In addition, measures to strengthen the IMF capacity to
respond to financial crises were agreed. As a result, the Supplementary Reserve Facility was established in the
IMF to allow it to extent very large amount of lending to emerging market countries for short periods of time.
Among the initiatives agreed in Manila, I think the initiative for regional surveillance is the most important for
the region. The new mechanism will provide more intensive and a higher level of process of surveillance and
dialogue among finance ministries and central banks in the region, with support from the IMF, the World Bank,
and the Asian Development Bank. This will not be the only mechanism for regional surveillance in Asia. ASEAN
countries have their own forum for economic policy discussion, and regional central bankers are actively
cooperating. However, the new mechanism is comprehensive in its membership which consists of the main Asia-
Pacific countries, including the United States, as well as the related international financial institutions.

It is a new experience for many Asian countries to have a regional surveillance. In many parts of Asia, reticence
is considered a virtue, and straightforward talks have been avoided in formal settings. However, such an attitude,
especially among the policy authorities, can result in a lack of transparency in the policy making process and
delay necessary policy action. Under the regional surveillance mechanism, peer pressure should encourage
member countries to correct their economic policies not only for the stability of their own economy, but also the
sustainable growth of the region as a whole. In this context, the role of the IMF in the regional surveillance
process is crucial. In December last year, the IMF opened a regional office for Asia and the Pacific in Tokyo.
This office will serve as a secretariat for the regional surveillance process. It will monitor economic development
in the region, including the monitoring of external liabilities, including the maturities structure of member
countries which has increased in importance as a result of the crisis. The role of the IMF in preparing material
for the sovereigns is I think essential to stimulate discussion so that peer pressure can work effectively. The IMF
also provides its views on global economic development and by using this input, the regional surveillance process
will be able to maintain consistency with the IMF global surveillance. For the moment, the pessimistic view on
the future of the Asian economies appears to be prevailing, as the storms still cover the region. However, these
countries' fundamentals remain basically sound, and their savings ratio is much higher than in other parts of the
world. They should be able to return to a path of sustainable growth soon. If they can learn from the lessons of
the current crisis and avoid repeating past mistakes. The regional surveillance process should help greatly
towards that end. It will also help to deepen regional monetary cooperation in Asia.

In Europe, the euro will be used as a single currency beginning next year. The process towards monetary
cooperation in Asia is lagging far behind Europe's, but I believe that the experience of this currency crisis has
changed the sentiment in the region. People now think that monetary cooperation in the region to stabilize the
currency should be strengthened because traditional pegging to the US dollar no longer works. When I was
invited to speak on the EMU in Tokyo last fall by this Committee, I expressed the view that the yen should not
become an international currency junior to the dollar and the euro, but that it should become an international
currency equal in importance to the dollar and the euro that would be widely used, especially in Asia.

To that end, the most important thing is to liberalize the Japanese financial market so that international
transactions in yen can be made speedily and conveniently. The Japanese government has made a commitment to
take decisive deregulation measures in the financial market, widely known as the Tokyo big bang plan. If we
proceed one step further from the combination of regional monetary cooperation and more active use of the yen
within the region, we might consider creating an Asian Currency Unit that would include many Asian countries



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centered on the yen. Asia would then have the basis for a single currency comparable to the euro. And, if regional
surveillance in Asia is to be managed consistently with the IMF's global surveillance, I think we could claim that
Asian monetary cooperation has more potential for global currency stability than that of Europe. This is because
there is an important element missing in European monetary cooperation. Europe's regional surveillance has no
clear linkage to the IMF's global surveillance for the moment.

In sum, the Asian countries are learning from the current difficulties, and their resolve to promote regional
cooperation in manner consistent with global development has been strengthened. I firmly believe in potential of
regional monetary cooperation in Asia which could, in the future, surpass Europe's move to a single currency.
Thank you.

Marc Uzan: Thank you very much, Mr. Yoshimura. Our last speaker, Professor Hak Pyo, visiting professor at
Johns Hopkins University

Hak Pyo, Visiting professor, Johns Hopkins University: I would like to present some parts of the paper that I
prepared. I have a few extra copies, so if you want, you can take some of the copies. originally, I was going to
present some of the after event analysis on Korea bailout and its implications for the systemic risk management
in a global and regional context, as well as warning systems. Together with a supplementary regional
arrangements that Mr. Yoshimura has just mentioned. But since most of the South Korean bailout issue has been
exhaustively reported and discussed yesterday, I will skip most part of the analysis and just emphasize two
effects which may have tremendous implications for systemic risk management in a global context, as well as
regional facility or regional cooperative arrangement.

We have two issues at hand. The first issue is ongoing loan restructuring program being negotiated in New York,
and it is a duopoly-like situation, typically, because debtor banks are represented by Korean governments. At the
same time, many creditors banks are represented by a few big Korean banks. So I am just hoping that resolution
will come up pretty soon, but it would be important for participants to bear in mind that the Asian crisis needs to
be stopped in South Korea. Also, requiring too much interest payments would be sort of a self defeating process
because it would basically ruin the country's repayment capacity. And it would be like rewarding moral hazard
participants. At the same time, it would not be in the interests of international banking community, because
differently from Latin American bailout case, there are not real losses of any foreign interest payment reductions
or things like that. Ultimately, it would have to be decided by duopoly like situation, and I think there will be
some equilibrium solution coming out.

the second issue is the appropriateness of IMF conditionalities. In my judgment, many economists and
institutions argued that there were basically very sound macroeconomic management by many Asian countries,
including South Korea. But I question that argument in the sense that currency realignment was continuously
postponed due to sort of rent-seeking elements or interest groups. they talked about fiscal soundness, but if you
look very carefully at the welfare contents of fiscal expenditure, and if you deduct defense budget and
agricultural support and all other support expenses to local governments, I am questioning whether *** was
sound macroeconomic management in many Asian countries. therefore, I conclude that discrediting the entire
IMF programs is dead ended, it is not fully warranted. But at the same time, I am questioning whether the past
experience of IMF conditionality management was really a reflection of underlying fundamentals in the countries
involved. In the case of South Korea in reflection, I was hoping that it could have been possible for IMF, at least
for the first three months, to stabilize foreign exchange market without major reforms of the entire banking
system or domestic credit situation necessary within three or four months. In other words by supplementing
foreign reserves, trying to restore confidence in foreign exchange market, and then at least one year should be
given to restructuring financial sector, because however imperfect the system is, the system has been there for
over three or four decades. And it is unrealistic to drastically change rules and laws within three months or so. So
ultimately, the mandate to keep BIS standards within three months was of course a failure. therefore, there was
unnecessary anxiety in financial markets. In addition, I think depressing too much consumption would be also



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detrimental to the overall macroeconomic management, because the main input demand comes not from
consumption side but from investment side, so it really does not help restore balance of payments situation. I
think that other than those improvements, there seems to be no realistic alternative except implementing IMF
programs.

Regarding the warning system for currency crises, I was referring in my article that there has been extensive
studies so called sunspots theory approach or economic fundamentals approach or combination of these two is
known as the signals approach, mainly taken by many IMF staffs, as I quoted. But, even the final regional signals
approach was totally a failure in predicting the contagion effect to South Korea, and that is the reason why native
South Korean residents were so upset about the current events. If they were given proper signals in advance, at
least three or six months ahead of time: we are heading to a very difficult situation so we have to reform our
economic programs, they may not have been this much upset. the total failure should be a lesson for everybody
involved, not only for international institutions, but also for private institutions.

Now, why did it fail? I think one of the reasons is because the models have been based on relative magnitude, like
debt/GDP ratio, M3 divided by international currency reserve holding, and so forth. At one point, international
reserves was adequate in the case of South Korea until I believe the end of September. they were holding two and
a half months import bills in terms of international reserves. I think what counts in the event of crisis, is not
necessarily relative magnitude. For example, I think Korean authorities took the *** by having 10 % of bond
market opened, only up to 15 % of stock market was opened. So it was very tempting to them to tell themselves
that they were in good shape, because their relative magnitude over openness was very limited. What has
happened in real crisis like situation is that it is not the relative magnitude affecting the situation, it is absolute
amount of stocks and bonds which has been invested by foreign investors. In other words, the sustainability of the
foreign currency market in regards to absolute amount being invested should be judged, and all these signals
approaches should be modified.

Finally, about supplementary regional arrangement - Mr. Yoshimura discussed in details the recent movement
around this issue - I feel that regional surveillance without regional facility wouldn't be really effective. I am
proposing in this paper that given several proposals being made so far, including AMF proposal, including anti-
AMF proposal, or Mr. Bergsten's proposal to assume the role of regional facility by the APEC, and I think it is
not a realistic proposal. I think one realistic proposal would be under the umbrella of the IMF, and Japan
initiative. There has to be a regional facility being created within the IMF and it should be operated and
monitored by the IMF Tokyo office. Effective regional surveillance cannot be granted without some kind of
regional facility, and I agree that that regional facility should be subordinated to global facility by the IMF, and it
has to go through the Board of Directors of the IMF decision making process. I think Japan was not given
leadership role, even though the reality in South East and East Asia suggests that there is much deeper integration
of South East and East Asian economies into Japan than pure trade weights reflects. In other words, we have to
give Japan some kind of leadership role. And I think one of the reasons why there was a rapid contagion within
South East Asia, is because there has been tremendous discrepancy between the real integration of these
economies into the Japanese economy and superficial , institutional arrangement being made in many countries to
maintain their exchange rate system. In my earlier paper that I delivered at ADB conference, I was proposing,
about two years ago, that Asian countries should give higher weight to yen than other currencies, because what I
found is that yen appreciation periods coincide with South East Asian booms, and yen depreciation always
coincided, there is almost a perfect correlation, with periods of economic downturn in these countries. it was
comforting for the Korean authorities, because according to my estimation, they were giving about 25% of the
weight in narrow banded flexible exchange rate system to the yen, but that 25% was not enough in retrospect.
Therefore, there has to be some mechanisms established to give more realistic weight to the Japanese yen, and it
may have to be almost pegged to the yen.

Now, as Mr. Yoshimura hinted about, yen block is still far away from a reality. I think there has a lot of things
that need to be done before we even can talk about the yen block, but at the same time, the regional facility



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within the IMF supervision is a kind of intermediate solution that I propose and that would facilitate, not
necessarily the yen block, but the implementation of a reflecting real South East Asia, which, as I emphasized, is
more deeply integrated to the Japanese economy. That would be a much more applicable realistic solution.

Finally, I would like to briefly mention that I agree with Mr. Yoshimura in saying that discrediting the East Asian
model is not warranted, in the sense that there was no alternative development model in the past and at the
present time. But, we have a lot of room for improvement both South Korea and Japan, and many other East
Asian countries. I think South Korea has to pay at least for three years the costs of late development in a very
painful way, because Japan was given almost two decades of prolonged balance of payments stability by their
balance of payments surplus. Of course the magnitude of surplus was different from one period to another, but
there was a consistent balance of payments surplus, and it was only after the 1980s than the Japanese economy
was slowly opened up to some extent as far as financial markets are concerned. South Korea was given a very
short period of time without having experienced prolonged period of balance of payments surplus. Therefore, the
South Korean population will have to pay the costs of late development in a very painful way. Thank you.

Marc Uzan:     thank you. We are going to open the floor for questions.

Paul Leake: My first question is for Mr. Yoshimura and Mr. Pyo. One of the speakers yesterday made a very
interesting and provoking pronouncement, and that was that you can talk all you want about regional and global
procedures to deal with the Asian crisis, but at the end of the day, there is only one real way this crisis is going to
be fixed, and that was for Japan to increase its domestic demand, to allow its neighboring Asian countries to
export themselves out of the problems. That is an interesting proposition, because currently Japan is still being
accused of trying to export itself out of its own problems. My question is how realistic is it to expect Japan to be
the driving force in an Asian economic revival, and I guess another way of putting this is, Mr. Pyo, you said that
Japan has to be a leader, and the observation made yesterday was that Japan can be a leader, but only in one way,
it has to earn that right. And it can only earn that right by becoming a market for everybody else. We all know
that Japan spent the past seven years trying to adjust its economy through various monetary legislative reforms,
big public works (500 billion dollars in the last 10 years), low interest rates, tax cuts, everything, and you know,
sometimes they were successful. But for the most part, they haven't been. The question is how realistic is it for
Japan to become an economic engine, especially considering its own financial, and especially banking problems,
most particularly its bad loan crisis.

My second question is addressed to Ms. Westin. As a restructuring lawyer, and also a bankruptcy lawyer, it is
always interesting for me to hear somebody talking about an international bankruptcy system. There was a
discussion yesterday, from my perspective a very interesting one, about the relative possibility of an international
bankruptcy system. I have the dubious distinction now being in the process of publishing a chapter in a new book
by Euromoney, I didn't get my picture in any magazine for that, and basically it has to do with transnational
insolvency. And one thing very clear is that there has been some success at bilateral treaties, there has been
much less, but also some success at regional treaties, and the reason why it works is that for the most part, they
work in regions where the laws are generally similar. One thing is very clear: there has never been a success for
international bankruptcy treaty. The closest we have ever come to was mentioned last night, and that is the model
on cross-boarder insolvency that has been recently proposed by UNCITRAL. two things can be said about that.
One: no country has adopted it yet. And two: even when adopted it isn't an international treaty. It is just a series
of amendments to domestic laws to the extent that any particular country does adopt it. My question to you is
what was the conclusion the GAO? I can't believe it is that there really is a realistic possibility of putting an
international bankruptcy system together. the reason I say that is the same reason that they failed in the past, that
simply is countries will not give up control over something so important as debtor/creditor relationships. I guess
the parallel question is in analyzing that the GAO looked at something that was very interesting which is if you
will never get to an international bankruptcy treaty, you can maybe set in a short or medium term a set of workout
procedures, informal procedures as they were called last night, that could be adopted in the short term and used




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for this type of crises, simply because, even if you have a bankruptcy system, you don't have developed the
judiciary and lawyers to administrate the system.

Mr. Yoshimura: On the Japanese economy, I think you are right when you say the Japanese economy has
stagnated in the 90s for almost seven years. It is because, I think, of the gradual approach to the loan problems in
the Japanese banks. Because of the indecisive approach to cope with it, the gradual approach failed to turn
around the economy and the sentiment of the market. So, now the government decided to inject public money of
30 trillion yen to the banking sector in order to revive the activity of the banks. Of course, the Japanese economy
faces other challenges, including the structural changes. So it is not an easy task, but I believe in the 21st century
japan will be playing a leading role in the Asian economy and in the global economy.

Mr. Pyo: I basically agree with what Mr. Yoshimura said, but in retrospect, I think Japan has already entered a
self-correcting phase. If you look at past statistics of growth, Japan has been almost every year at 5/5.5 %, while
the OECD norm was about 2% or 2.5 % at most. So, such a long period of high growth at almost the maturity
stage of their development requires I think a longer period of self-correcting adjustment. I think no matter what
the international community pressures on Japan, Japan will find its own way of adjusting to a new situation, in a
very maybe repressed manner, but that is the way the Japanese system is built, and that is the way they want to
operate their system. What I am saying is that realistically it would take much more time than a business cycle for
recovery, because they have maintained unprecedented higher growth for a long period of time. Now, the real
issue is why international purchasing power parity failed in predicting this exchange rate realignment. The reason
is because the Japanese economy has had continuously, even though the magnitude varied, balance of payments
surplus, they had a very low interest rates, very low inflation, and still the yen was depreciated. There is no way
other than pegging South East Asian currencies to the yen for these economies to avoid any kind of financial
trouble. So regional approaches have been very much ignored by many participating countries in IMF and
international institutions, and it has to be realigned in a realistic sense. Japan should be given a much more active
role to reflect its dominant. For example, of teh South Korean short term debt, 30 to 35 % is owned only by
Japanese banks. The single largest creditor bank nation is still Japan. So without assigning a positive and active
role to Japan, we are ignoring the reality of the region.

Susan Westin: You asked me to comment on the bankruptcy court, and bankruptcy type procedures. You are
absolutely right. Implementation problems seemed, at least from the proposals that we looked at that were not
really well developed, pretty insurmountable, in terms of getting countries to give up any sovereignty over the
laws, or to coordinate their laws. We also looked at the experience of the WTO and how much problem there is
still in the US agreeing to have decision go there. And we looked at the experience of the Court of International
Justice trying to get a fill for what would be involved with an international court. I think we were also
influenced by two things that the G10 had turned down the proposal although they said possibly it should be
continued to be looked at, and we did agreed with that. We talked to investment bankers and others about bond
covenance, and bond holder Committees and didn't get much of a sense that that would work. The other thing that
we were influenced by is we were doing this after the Mexican crisis experience. From our analysis, the
responses to that crisis, we thought, was pretty much a success. We based that on a couple of things. You will
find in our report on Mexico that we didn't actually ever use the word bailout, because I am not sure that bailout
is appropriate for a country where the real GDP take such a hit the next year, and where they have to pay the
money back. And they did pay the money back ahead of time to the United States and the US made close to a
billion dollars in interest on the money that they had lent. but the reason that we mainly considered it a success is
that after the 82 debt crisis, it took Mexico years to get back into the international capital markets. We found they
were back in the international capital markets by May of 1995. Of course, being able to borrow there was one
reason why they were able to pay back the US debt. So, we were influenced by our conclusion that it was the
speed of the package and the size of the package that really mattered. And it concerned us that with bankruptcy
principles being implied, you wouldn't have that speed and we weren't not sure if that would really have much
impact on stemming contagion or systemic risk.




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 Marc Uzan: Thank you Susan. we are going to have a break and will reconvene in ten minutes. Thank you for
our panelists.


PANEL IV - EXCHANGE RATE ARRANGEMENTS IN EMERGING ECONOMIES AFTER THE
ASIAN CRISIS.


Marc Uzan:       So, what should we do: currency boards, fixed, dollar peg, yen peg? I would like to ask two
experts to provide some ideas about what these countries should do about their exchange rate policies, and I will
ask first Michael Rosenberg, Director of Fixed Income Research at Merrill Lynch, to make his presentation.
Michael is preparing a book on the topic.

Michael Rosenberg, Director of Fixed-Income Research, Merrill Lynch: Thank you Marc. I recently wrote
book on currency forecasting in general, mostly dealing with the industrial countries. So now, I am in the process
of working on a book on forecasting exchange rates in emerging markets. What I thought I would do today is
discuss some of the theoretical aspects of what I am doing right now with that paper, and at the same time, I will
briefly talk about the kinds of exchange rate arrangements.

Let me just start with the outset that it is going to be a difficult problem for Asia to choose the right appropriate
exchange rate arrangement, because we are operating in a world where capital is permitted to flow freely. And
we are also operating in a world where there are huge pools of highly mobile capital that can move in ad move
out. This will clearly have a major impact on the kinds of exchange rate policies that countries choose. In fact, we
may end up getting a market-based solution which I will talk about in a moment, which will basically rule out
things that policy makers may want to choose. In other words, the market will dictate what the authorities will
end up opting for. And, I will let the cat out of the bag by arguing that we may eventually see the dollarization of
Asia. It is not whether Asia chooses fixed or floating exchange rates, it is whether the market chooses to transact
in dollars, and hold as a storing value their money in dollar deposits or dollar accounts, rather than in rupiah, or
other Asian currency accounts. Because when you have such huge volatility and you are probably guarantee to
have volatility in the future as long as capital is permitted to flow freely, and that is part of the IMF guidelines to
open up these markets, they can't go back to the ways of restricting capital mobility, the market-based solution
actually may end up being the best of all possible worse.

Let me just comment about currency crises in general, and what was behind some of these crises. I think there is
a tendency to try to find where the fault was with what Korea did and where the fault on Indonesia and Thailand
was, or go back to Mexico, etc. I am not saying that these countries may not have their policy faults, but I think
we have to recognize one thing about currency crises in the 1990s the ERM crises of 1982-83, the peso crisis of
94-95, and now the Asian crisis of 97-98, they have one common thing that affected all three crises: each crisis
was preceded by a major inflows of overseas capital into these countries. Huge surges of capital inflows into
Europe, you might remember for those who have a G7 orientation, a lot of investors were going long lira, short
marks, long Finnish mark, short marks, off and highly leveraged going in to that period, the same would apply for
the Mexican peso crisis: huge pools of capital flowing into Mexico and now, in the case of Asia, huge pools of
capitals flowing into Asia either in the form of typical emerging market flows where we have got record inflows
... but capital into emerging markets is surging from an average annual pace of around 25 to 50 billion in the 80s,
and even into early 90s, it has now surged to a point where we were up around 250 billion per year. When you
look at the international banking flows into emerging markets, into Asia in particular, they have surged as well.
So, capital flows in and it creates problems of different sorts. When you get a surge in capital inflow, one of two
things typically happens: either you are going to get a significant real appreciation of the currency, which will
sow the seeds for an economic problem down the road, and at the same time, you can lead to huge indebtedness
in certain countries with countries borrowing or paying funds from overseas incurring huge liabilities which
creates another set of problems. In each case, we are setting the stage for a future currency crisis. In fact, Alan



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Greenspan last fall commented and I quote: " It is clear that more investment moneys flowed into the Asian
economies than could be profitably employed at reasonable risk". In other words, it is just too much highly
mobile capital tracing too few investment opportunities. This is only going to grow in the future. Huge pools of
capital, as more and more pension funds in the US, mutual funds, become more and more diversified seeking
higher returns in emerging markets, the issue is of course whether or not the markets can absorb that capital and
do so without incurring a significant risk or engaging in risky activities. the temptation also is, when that capital
is coming in, to invest in risky projects whether it is real estate, stock market speculation, or new roads, and you
develop problems. So, yes, some emerging markets are guilty of certain problems, and in the end, you have a
huge pool of capital, and part of that capital, as it flows in, creates problems. And when it exits, it creates its own
set of problems.

Now when we think of real appreciation on a currency, the historical record shows that real appreciation episodes
actually take place over a period of years. You will see significant real appreciation as capital flows in, and you
wonder why do those exchange rates continue to get more and more misaligned. Well, the reason is that
fundamentals only deteriorate slowly in response to an exchange rate misalignment. Somehow, someway,
countries seem to adjust when the exchange rate becomes overvalued, but inevitably, the economy will either
weaken or the current account will deteriorate, but it often takes several years before that begins to occur. So, as
long as the fundamentals are not deteriorating, the real exchange rate will continue to rise creating future
problems down the road, because eventually, the more misaligned the exchange rate, inevitability the economy is
bound to weaken. And once we move beyond a critical point, we begin to set in motion the forces for a major
currency crisis. The key is when does that attack come, could we build a set of leading indicators to warn of such
a potential attack.

Let me first talk about the way the market operates. And the way the market operates is, let's assume there are
two sets of forecasters out there: some who are predicting an imminent collapse, and the others who say the
existing exchange rate regime will continue to survive. well, those who are predicting an imminent collapse of
the regime inevitably will be wrong if the real appreciation continues to build, so what we would find is that
portfolio managers will begin to place less and less weight on the expectation of a currency crisis because we
have made those people who were forecasting the crash look ridiculous. And those analysts who were predicting
the survival of the regime began to look smarter and smarter, even though we have got a misalignment growing.
So, as investors place more and more weight on the forecasters who were predicting no crash, there will be a
tendency to not expect exchange rates to change in the near future, and interest rate differentials will therefore
narrow as the investors place more weight on those who were predicting no change in the exchange rate. So, what
we have here is we show that the market's assigned weight to the probability of a crash actually tends to decline
overtime, the longer an exchange rate regime persists. When the peso was relatively stable within its range, the
market assigned greater probability that the Mexican government would continue to succeed in keeping that
stable. In the ERM, the longer the ERM stayed intact, the more investors believed that it would stay intact into
the future. What we will find is as we get into an exchange rate misalignment, the actual probability of a crash
coming tends to rise, but the market's assessment of that risk tends to either decline or not change. So, what we
are left with is at a critical stage, and this is what happens in the Asian crisis, it happened in the Mexican crisis
and the ERM crisis, interest rate differentials were in fact narrowing going into each of those crises, or at least
not widening. In other words, the market clearly missed the likelihood of the devaluation. If there was an
expectation of devaluation risk, interest rate differentials would have been widening going into each of those
crises, when, in fact, the exact opposite occurred.

As investors get more and more wont to the existence of a particular regime of stable exchange rate, investors
begin to try to exploit that by taking long positions in emerging market currencies, or, in case of long lira, long
Finnish mark, going into the ERM crisis, and in the case of Mexico: long peso positions, huge peso positions,
highly leverage. And the same thing in Asia. Whether it is Korean corporates borrowing heavily in dollars
representing a net speculative position in dollars, or whether the famous Thai baht basket trade, or investors
along with Thai baht. huge speculative positions tend to build and, therefore, you are setting yourself up for a



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crash when those positions have to be unwound. So, in many ways, there is no ruthless speculator out there that
precipitates the crash. In fact, the speculator more often than not is often leaning the wrong way, because all
along the way, if speculators were trying the short the Thai baht or short the peso, or short the lira, they would
probably be losing money. They learned the best way is to play by the rules of the game: go along the current
regime. As long as the current regime is in place, you are going to make money, but as soon as the regime breaks
and you are leaning the wrong way, you have to get out. And, when everyone tries to get out at the same time,
you get huge depreciation of the currency.

Knowing that fundamentals typically deteriorate going into a crisis, can we construct a set of leading indicators?
Well, there have been a number of studies recently. I just list a number of the indicators that have been used,
some with more success than others. probably, the real exchange rate is still the best leading indicator of a
currency crisis. The more and more real exchange rate appreciates, inevitably there has to be some correction.
The problem is of course always in timing. And timing is everything, and, more often than not, the misalignments
tend to persist far longer that anyone expects and in crashes, when no one is expecting it. Now, Asia is a little bit
different. Asia provided us with very little warning of what was going to happen. The economies were relatively
strong, the IMF was predicting 7% growth for Asia as late as May of this year. The rating agencies clearly missed
it. Those indicated an interest rate differentials clearly missed the risks going forward. What was really behind
this, and can we predict a similar crisis like this in the future? What I tried to show on this chart is that given the
huge capital flows into Asia, and the huge debts that many Asian entities were taking, there was s huge increase
in the supply of debt from BS1 to BS2, but there was also a major increase in the demand for debt, showing that
the interest rate differentials actually dropped over a period of time, even though Asian companies were
borrowing more overtime. Normally given the increase in debt, you would think the market would have
demanded a wider spread. But in fact, spreads were narrowing, because, even though the debt was increasing
excess credibility actually led to an even larger increase in the demand for Asian debt. And there was an increase
of that debt. All of the sudden the contagion effect awakened investors to the reality of the risks that were
inherent there, and we shifted major decline in the demand for that debt drawing the interest rate differentials up
sharply and led to a currency crisis.

Here I show a similar chart to the one I drew before when we showed the real exchange rate appreciation leading
to deterioration of fundamentals. here is something a little different. Remember a capital inflow can either cause
a major real appreciation or lead to a major increase in indebtedness. Here we show how indebtedness goes
higher, and once you have a crisis, indebtedness actually will accelerate sharply because the local currency value
of foreign currency debt pushes up the indebtedness up sharply. In fact, in Indonesia, the local currency value of
Indonesia's debt has quadrupled since the fall, putting almost 90% of Indonesian firms into technical insolvency
at current exchange rates. In the case of Asia we see below, although there was some weakness in economic
fundamentals, there were not deteriorating going into the crisis. We could not have anticipated a crisis just based
on the current trend in economic fundamentals. What happened is that the attack itself in Asia has led to a sharp
decline in the underlying trend in the fundamentals to a point that the attack itself either through higher interest
rates, such as in Hong Kong, even though they successfully defended the currency, the fundamentals backdrop in
Hong Kong have deteriorated as the stock market has decline sharply . And clearly in Korea, Indonesia, Thailand
where the local currency value of the debt has soared pushing once valuable firms into bankruptcy, or potential
bankruptcy, leading to huge increases in unemployment and declines in economic activity which will now be
inevitable.

So, in other words, what we need to measure in trying to assess currency crises in the future, is not only to look at
deteriorating fundamentals, but whether the fundamentals are vulnerable to a shift in the case of an attack. If we
want to distinguish between deteriorating fundamentals and vulnerable fundamentals. They are two separate
things, because if the economic fundamentals are vulnerable to an attack, and that there is no attack, the
fundamentals are sound, but if there is one, the fundamentals deteriorate. We end up with what is generally
viewed as a multiple equilibria situation. And in the case of Asia now, we have a debt crisis which is spilling
over into a currency crisis , and the currency crisis spilling over into a debt crisis right now. It is sort of a



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spiraling effect, and that is what the IMF role is . It is to try to put a *** between these two and slow the spiraling
effect right now. But the indebtedness problem is huge partly the blame goes to Asian countries for taking on that
debt. But at the same time, huge pools of capital from overseas supplied it. So, where is the fault, why, and how
the world system cope with that? Particularly, that many of these economies are generally small relative to the
huge volumes of capital that are flowing.

The one thing about exchange rates is that every currency, I don't care whether it is an industrial currency, the
dollar, any currency, is vulnerable to a speculative attack. In many cases in the industrial world, an attack on a
currency usually tends to be temporary without exerting real effect. As an example, the dollar collapsed by more
than 20 % in the first quarter of 1995 against the Japanese yen, going from 100 yen to the dollar, to roughly 79
yen to the dollar. Only then to come right back to 100 yen to the dollar again in the next six months or so. It did
not have any real effects. The reason is that US companies were not holding over a trillion dollars in yen
denominated debt. If US companies were holding 1 or 2 trillion dollar worth of yen denominated debt, it would
have had significant real effects on the US economy. The French franc also went through a major decline in the
value of its currency in 1993. It has come back and is stronger than it was before the crisis started, and without
any damage as a result of the depreciation period. So, you can get currencies under attack without exerting a
negative effect on your economy, but that is not what happens in the emerging market world. Paul Krugman once
said that exchange rates fluctuate so much because they matter so little. What he meant by that is that if exchange
rates really mattered for economic activity, then policy makers would do something about it. Because it really
doesn't have an effect, a major effect on economic activity, because trade continues with volatile exchange rates,
etc. policy makers will continue to let exchange rates fluctuate, because they really don't have a major bearing on
the overall trend in economy. But that is not true for emerging markets. When these economies have taken on
huge volumes of short term dollar denominated debt, a one shot depreciation of their currencies is vulnerable to
becoming a permanent, and not a temporary move. Because what you do is you are taking otherwise valuable
firms and push them not only into a liquidity crisis in the short run, but potentially an insolvency crisis in the long
run. So, in many cases when you have these huge depreciations, even at the same magnitude that the dollar may
go through, it has significant real effects, and therefore could be permanent and not a temporary attack. That is
when we come now to Asia.

A lot of people are viewing the Asian crisis right now as one way the currencies have overshot their equilibrium
level, and if you take that view, the Asian currencies are a screaming buy today. You have higher interest rates
now, and these currencies have clearly overshot their equilibrium level, at least their old equilibrium level, not
necessary though their new equilibrium level. That is what the chart I show on the right is about. As these
currencies have weakened, and each time a currency weakens, we are throwing more and more once valuable
firms into potential bankruptcy. The equilibrium exchange rate is moving as fast as the actual exchange rate, and
we are at risk of seeing these currencies swings becoming permanent and not just a transitory shock. So, what
does this all mean for Asia going down the road? What has Asia left to do? Part of the IMF agreement is for these
countries to open up their financial markets. This virtually makes a return to fixed exchange rates impossible.
Given the huge volume of capital that can possibly flow across international boarders, which can move in and
out, it is going to be nearly impossible to defend a fixed exchange rate. Is a currency board possible? Not very
likely given that many of these countries suffer very serious banking system problems, and the currency board
arrangements will be very difficult technically to create such a system for these countries, moreover when they
have no reserves to make it buyable. Floating is the only valuable option here but given the huge volatility that
was seen in the Asian currencies and particularly in Indonesia, we are seeing the possibility of these currencies
losing their medium of exchange and storing value function. I think the likelihood is that the dollar may begin to
take over the role the medium of exchange of storing value for a lot of these countries. For the bind of items such
as cars, homes, for sending your kids to private schools. The dollar will become the vehicle. Some people
suggested maybe the yen should take over that role and that might have been the right currency to take over that
role a number of years back. The formation of a yen block for Asia. But given all of Japan's problems in its own
financial system and the inability of the Japanese authorities to cope with the financial problems, and the lack of
a demand for yen internally, it is hard to generate a demand for yen externally if you can't even do it internally.



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And the yen is not very useful as a store value since the yield is so low. So overall, I think the dollar probably
will become more important in that role given the huge volatility and uncertainty that exist right now in the Asian
region. Just like we have seen it in Latin America, and other parts of the world, increasing dollarization which
could have a profound impact on the demand for dollars in general which could continue to send the US dollar
higher against the yen and the DM, which could present other problems for US policy makers down the road.


Marc Uzan:      Thank you very much. I am going to ask Arturo Porzecanski, Global Head of Fixed Income
Research at ING Barings, to make his presentation.


Arturo Porzecanski:
Well good afternoon and congratulations to you all for having made it to the end of the program. Thank you very
much for your presence and thank you Marc, congratulations to you. Since I am the last speaker, but of course not
the least I want to tell you that the program was excellent, and you deserve, and will get, a warm round of
applause when we're done, because it won't be for me, it will be for you, for organizing this.

Now, since Michael did the anatomy of a currency crisis he spared me all that part. I can go straight to the
normative aspect of currency crises namely what should be done to avoid this happening again. What is the
enduring lesson in terms of currency regimes here. I am going to speak in a very extemporaneous manner and
come up with a fairly simplistic idea, but believe me, I thought about it and done research on it for 25 years. I
have lived through lots of currency crises and been watching them. It will sound as I said almost naive but it is
not for lack of intimate experience with many currency crises.

My bottom line is that the lesson from this currency crisis that turned into a debt crisis is the same as all the
others before namely the only exchange rate regime that consistently delivers the best results and avoids the kind
of things we are witnessing is a regime of freely floating exchange rates. Why? First of all, I think there is a little
bit of principles here, a bit of ideology and forgive me, but I think we should all have some principles in
ourselves. And, in my case, I do believe in market forces, and in market signals. I do think that it is very
important that the leading prices in an economy convey the right signal, namely that they convey uncertainty
when there should be uncertainty, and there is, that they convey scarcity, when there is not enough of this stuff
and that they convey abundance when there is too much of it. I think fixing the exchange rate in any way, by
putting it between bands or in a crawling regime, or whatever, anything short of absolutely destroying the
currency closing down the central bank throwing away the key and adopting someone else's currency, anything
short of that is a major economic distortion that is being introduced.

If your god tells you that it is wrong for your government to fix the price of chocolate or the price of shoes or X-
rays, your God should tell you that it is really wrong to set the price of foreign exchange. It is an awful
intervention because the price of foreign exchange is far more powerful a signal than the price of chocolate, X-
rays or shoes. It affects tremendous numbers of decisions between investing in tradables versus non-tradables and
this versus that. It is a tremendously momentous decision to fix the exchange rate. And yet, we have bureaucrats
running loose who think that they know better than the market, and than the rest of us, trying to manage *****,
and otherwise control very key price. So I think that, as a matter of principle, if you believe in market forces, you
have to believe that exchange rates ought to reflect market forces, and that, it has been proven again and again,
bureaucrats don't know best.

The other reasons for a floating exchange rate regime are first of all because as I mentioned exchange rates are a
powerful tool for adjustment. If you are not marshaling that tool you are not going to enforce adjustment as
circumstances change. So, it is like going into the arena, and being expected to fight with yours arms tight
behind your back. This is what you saw in Asia. Many of these countries were impacted by an adverse exogenous
event whether it was the decline of the electronics export industry or greater competitiveness on the part of China



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following their devaluation a few years ago, an exogenous event that triggers a chain of events. And the exchange
rate is not allowed to reflect the new reality. And, of course, these governments believe in controlling just about
everything that moves, so they control interest rates, so interest rates cannot signal that something has changed.
And they control stock markets, so they don't let stock markets signal. They control the local bond markets, so
you have a series of repressed, but potentially very powerful and meaningful, market signals not operating the
way they should. Not only you have as a matter of principle something going wrong, but on the contrary, you
introduce a rigidity, you introduce a distortion, you do away with a very powerful adjustment tool.

I have a principle or a saying that is: Tell me how flexible your economy is, and I will tell you how inflexible
your exchange rate regime can be. In other words, if you tell me I have come up with this dream economy, and it
works as per the classical adjustment mechanism, wages go up but they also go down, interest rates go up but
they also go down, and rents go up but they also go down and profits... If you have that kind of freely really
flexible economy, I say Okay, I think you can have a fixed exchange rate regime, because you have so many other
things that move, so many other things that adjust to exogenous shock, that you don't need perhaps the exchange
rate. Maybe Hong Kong fits the bill, maybe reformed Argentina fits the bill, I am not sure , but in any case, if
your economy is the typical one, full of rigidities, then I think that you do yourself a great disfavor by adopting an
inflexible currency regime because it could well be, as was the case in some of these countries, that you are left
without any powerful signals, or warning signs that something is wrong, and you should curtail your
consumption, or your investment, or you should reallocate your resources. So tell me how inflexible your
economy is, and I will tell you how flexible, to put it differently, you exchange rate regime can be.

The other thing is fixed exchange rate regimes, and all the variants ( I am just saying fixed for all the variants) are
downright pernicious. I mean they not only don't send the right signals when they must, they are not allowed to,
but they send the wrong signals. Why is it that you see this surges in capital that Michael so correctly pointed out
? Well because the fixed exchange rate regime sent that signal. What happens? Governments come in and they
set an exchange rate band or whatever and they send the signal that if you take on foreign currency debt it is the
same as local currency debt, there is not much risk, we will take care of that, you don't have to worry. So what
happens? You create an enormous incentive to arbitrage interest rates, you have local interest rates of 20%,
usually for a very good reason like you have had a hyper inflation in your past or you have tremendous
distortions or you have a lack of transparency, there is tremendous political risk, whatever. So you have 20%
interest rates, the rest of the world has 5% interest rates. There comes the government, it fixes the exchange , it
limits the fluctuations. What is the signal that you are sending? Absolutely the wrong signal. It is go get that 5 %
money until there is no more, until nobody will lend you an extra dime, namely you are sowing the seeds of a
disaster. You are encouraging people to go out, borrow short term money, and borrow foreign currency
denominated money. And then of course if you don't have any control over what the banks and the companies do,
the banks borrow in foreign currency and all lend in local currency, or borrow short term and all lend in long
term, you know, have any kind of these mismatches, of course it is an accident waiting to happen. So, instead of
sending the right signals, these regimes send the wrong signals. They encourage interest rates arbitrage , they
encourage surges in capital flows, they encourage short term indebtedness. Of course, they encourage all kinds of
other things, like reallocation of resources into the non-tradable sector. The extremes to which this can be driven
are exemplified by some of these countries. Here is Korea, a country that was very highly rated. It could have
gone to the markets and borrowed a hundred year-money, if you will. And yet, it borrowed a hundred billion
dollars worth, yen and everything else equivalent, of short term debt. And has practically no long term debt.
Why? Because all these companies and all these banks thought that why pay 6% for a thirty year bond when we
can pay 4% for short term money. It was the same principle carried out to its extreme, arbitrage interest rates to
the *** And the same thing in Thailand and Indonesia, and so on. So I think that, it is not only that floating
exchange rate regimes are better, fixed exchange rate regimes are downright pernicious.

Then you also have the cosmetics or public relations aspect, as I call it. Which is that if you have a freely floating
exchange rate regime, and it is the yen-dollar, and it goes from a 120 to 80, and then back to 120, it is not a
currency crisis by definition. If Washington had said the currency cannot go lower than 100 and it cannot go



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higher than 105, we would have had a currency crisis, by definition. So I think that the mere setting of bands, and
limits, and throwing the central bank to the task of defending the currency and so on guarantees to make what is
natural moving in a price up and down into a political thing, into a market signal, into an event in itself. I think
another principle of mine is that you really can't have a currency crisis especially one that turns into a debt crisis,
if you have a freely floating exchange rate regime. Part because of the fundamentals. The fundamentals would
tend to be much better. but part because of the cosmetics. I think if you are a government, and you are thinking of
the long term, never mind the resource allocation issue, and the adjustment issue, and the pernicious effects, and
so on, you should have as freely floating an exchange rate regime as absolutely possible so that you don't paint
yourself into a corner, so that you don't box yourself in. To me, you are planting a ticking bomb every time that
you plan to surround an exchange rate, or any price for that matter, with artificial bands.

Now, you will say, okay, if you have a freely floating exchange rate regime, what will be the anchor for the
economy, what will be the anchor for behavior and for expectations, and so on. And I grant you. Every economy
ought to have an anchor. The issue is which anchor. And personally, I favor either a fiscal anchor or a monetary
anchor, or some combination of both . And I think that is the appropriate one, because if you don't have a
monetary anchor or a fiscal anchor, your exchange rate anchor is not going to work anyway. What did we see in
Asia? They had an exchange rate anchor, but then when there is some pressure, people start buying dollars or
yen, the authorities refuse to let domestic interest rates go up, namely they refuse to let the system work, to let
liquidity and local currency become very scarce as people turn in their local currency and demand foreign
currency, they refuse to do that. And so interest rates cannot adjust to signals of scarcity of foreign exchange, and
of course, because they are afraid that the banks would be in trouble or the companies would be in trouble. So
you are dead, because if you don't have a monetary anchor, you are not going to have an exchange rate anchor for
very long, and so all these countries are also guilty not just for the choice of the currency regime, but because
they didn't act in a consistent fashion to defend that choice. In other words, all these governments when in the
course of 96 there were declines in exports and electronics and so on they should have taken fiscal and monetary
measures to buttress their choice of currency regimes. So if you're gonna have it , at least do something about it,
do the right thing. It is unconscionable I think abdication of central banking 101, and healthy public finances 101
what we have witnessed there.

That leads me to another kind of principles. I believe that inflation is always a monetary phenomenon, and
currency depreciations are an inflationary phenomenon. Ergo, currency movements are monetary phenomena. In
other words, you have to have a sensible monetary policy anyway so you might as well make that the anchor.
How many countries have you seen that picked an exchange rate anchor, and then say okay, we have picked the
exchange rate, we are off the hook now. And they don't make the fiscal reforms that need to be made, and they
don't establish that central banking discipline that needs to be established, and they don't clean the banking
system, and they don't set prudential standards, and so on. Because, you know, they fix the exchange rate and that
is it. This is another example, very pernicious, where fixing the exchange rate gives you the illusion that you
have done your job, and think okay I did that, I set the signals, I set my anchor, and that is it. Never mind that it's
a drifting anchor or that the level of the ocean can go up or down, you think you are safe. So I think it is really
pernicious and misleading in that sense.

So, my conclusion is in my own assessment of currency risk and my own assessment of country risk, I look very
much at the currency regime. When I see a country that has a freely floating, or as close a freely floating
exchange rate regime as possible, I think the chances of a disaster are much much less. And whether that is the
United States or Mexico or any of the number of countries that have now gone for a freely floating exchange rate
regime, I think that the chances that they will encounter a major currency crisis that leads to a debt crisis are
absolutely minimal. That is all.




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