Subprime mess: Asia offers lessons for US

Subprime mess: Asia offers lessons for US
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First Published: Fri, Apr 11 2008. 11 09 PM IST
Updated: Fri, Apr 11 2008. 11 09 PM IST
As the US grapples with perhaps the worst financial crisis since the 1930s, many eyes are on Japan. Some analysts suggest that Japan’s “lost decade” will offer a blueprint to officials in Washington.
More insights may be gleaned from South Korea.
Korea? What in the world could the 12th biggest economy teach the biggest? Spend some time with Kim Yong Duk, a former deputy Korean finance minister, and it will become clear how Asia’s experiences in the late 1990s could inform US officials.
“A lot of the features are similar between the US’ problems and the Asian crisis,” Kim says. “In Asia, we had reckless lending, reckless investment and excess liquidity spilling over into the economy, bailouts and moral hazard risks. This time, we see those same factors in the subprime crisis.”
Kim knows a thing or two about crisis. He recently stepped down from his job as chairman of Korea’s Financial Supervisory Commission and was a top finance ministry official when the crisis began in 1997. He was nicknamed “Mr. Won” for his ability to move currency markets. After Korea received a $57 billion (Rs2.2 trillion) bailout from the International Monetary Fund (IMF), there was no time to waste. Weak companies and commercial banks were allowed to fail. Several merchant banks were closed and their employees were fired.
Korean experience
The steps created considerable uncertainty, yet Korea was the first of the Asian-crisis victims to recover and repay IMF. While it took Latin America a decade to lure back capital after its meltdown in the 1980s, Korea was regaining investors within 18 months.
Things didn’t always go smoothly. The credit bubbles that were confined to the corporate sector in the 1990s were shifted to households. That complicated the challenge of moving from a developing economy to a developed one. Still, Korea’s experiences are more relevant to the US than treasury secretary Henry Paulson may realize.
Comparing the $13 trillion US economy to Korea’s $970 billion one seems a reach. Its economy is smaller than Russia’s, Brazil’s or Spain’s. The US also isn’t used to taking advice from anyone. You will notice IMF isn’t publicly criticizing the US the way it did Asia a decade ago.
Yet, for US officials grasping for precedents, Korea is worth considering. Kim mentions four specific lessons: denial, investor confidence, low interest rates and the risk of so-called moral hazard that encourages reckless behaviour.
In denial
The US is doing most of what it told Asia not to. It counselled higher interest rates, stronger currencies, fiscal belt-tightening, avoiding fresh asset bubbles and limits on bailing out investors. These days, the US is reminding the world it’s better at giving economic advice than taking it.
What concerns Kim is that by attempting a short-term fix with lower rates, the US is in denial. The Bush administration has been reluctant to act boldly or provide guidelines to restore calm to Wall Street, Kim says.
“The steps so far—like relying on more liquidity—aren’t enough to resolve the current market turmoil,” Kim says.
That lack of leadership is weighing on investor confidence. As Korea learned a decade ago, Kim says, investment banks need to disclose their true exposure to credit markets, write down losses immediately and shore up capital bases as fast as possible. If public money is going to be used to stabilize things, it’s best to do it sooner rather than later.
“The worst thing to markets is uncertainty,” Kim says. “If the news is good or bad, it doesn’t matter—just get it out.”
Soros’ warnings
When I asked George Soros about all this on Wednesday, the billionaire investor agreed that President George W. Bush’s all-regulations-are-bad mindset—which Soros calls “market fundamentalism”—may prolong the crisis. Soros’ basic take on things: The US isn’t responding enough.
History will show whether saving Bear Stearns Cos. from collapse was the right thing to do. Kim says the US needs to be careful not to make a habit of bailing out Wall Street and rewarding reckless risk-takers. Equally important are regulatory changes that will prevent similar crises down the road.
Wall Street’s woes offer an intriguing comparison with Korea’s family owned conglomerates, or chaebol. Much analysis has explored the “shadow banking system” that has emerged in recent years to subvert government regulations and allow banks to make highly leveraged bets. Many chief executive officers didn’t even know how vulnerable their institutions were.
Seoul searching
As Wall Street’s speculation went wrong, losses spilled over onto the laps of government officials and average consumers. That’s a lot like what happened in Korea in the mid-1990s. Are investment banks now the US’ answer to the chaebol? Korea isn’t a role model for change. It’s too closed to foreign investment, needs more entrepreneurship and the chaebol are still too dominant and slow the nation’s efforts to break with the corruption of the past. That doesn’t mean Korea’s crisis playbook isn’t worth a look.
“The priority is to restore confidence and fast,” Kim says. “Otherwise, problems balloon and hurt the real economy.”
-Bloomberg
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First Published: Fri, Apr 11 2008. 11 09 PM IST
More Topics: Subprime | Asia | US | Seoul | South Korean |