Remedy Is Settling Up And Shaking Out
The recent turbulence in financial markets, especially in South Korea, has led to calls for more international regulation. The inability of Asian countries to repay their foreign loans, it is said, is the result of unwise overlending by private banks and investors.
That is true, but the prescription - to have governments oversee international lending - would make things worse.
In fact, the troubles in Asia are linked directly to intervention by Washington in financial markets in other parts of the world. When the Mexicans overborrowed in foreign currencies through the end of 1994 and were unable to repay their debts, the U.S. Treasury led what amounted to a bailout of Mexico’s creditors in early 1995, signaling to international lenders that the risks of overlending would be cushioned by U.S. government intervention. The escape of Mexico’s creditors from the consequences of overlending in 1995 encouraged an extension of overlending to Asia in subsequent years.
Asian banks that borrowed in yen and dollars and lent in local currencies exposed themselves to losses incurred when their currencies weakened against the dollar, adding a currency crisis to Asia’s problems. The Asian banks are caught in the middle, between local currency loans to Asian producers and speculators unable to repay them even in local currency, let alone much appreciated dollars and yen that the banks owe on their loans. Asian companies that borrowed directly from foreign lenders face the same currency mismatch problem.
The institutions that critics of global lending propose to regulate the system - the International Monetary Fund and the G-7 governments - failed entirely to anticipate the scope of the excess capacity and deflationary pressures that would result in Asia.
The solution is less, not more, government intervention. Banks that have overlent to Korea and elsewhere in Asia should be forced to sit down with their borrowers in those countries and renegotiate loans. Where the borrower cannot be reorganized to service the loans, the loans should be closed. Losses should be borne by the banks and financial institutions that made the loans.
Once international lenders realize that governments are not prepared to bail them out, they will be more cautious about granting loans.
Unfortunately, the approach of the International Monetary Fund and, more recently, of G-7 governments to the Korean and Asian crisis has been exactly the reverse of the correct approach. The IMF is again applying counterproductive, broad-gauge, restrictive policies that will punish borrowers more than creditors while prolonging the agony of uneconomic banks and companies created by past overlending.
At the end of December, U.S. Treasury Secretary Robert Rubin called heads of major U.S. banks and urged them to roll over short-term loans to Korean institutions. This was an attempt to avoid defaults on loans, some of which should be terminated.
In doing this, Rubin was urging on American banks exactly what he had rightly criticized Japanese authorities for doing with their banks: rolling over uneconomic loans, rather than engaging in tough negotiations between borrowers and lenders that would result in the closure of weak institutions and consolidation of resources in stronger institutions.
This solution only puts off the problem for another month, at which time the banks will have to decide which loans to roll over and which to close. Rubin must urge the lenders to Asia to begin loan restructuring negotiations with viable Asian borrowers. This entails writing off bad loans while extending the payment schedule to borrowers that banks think can ultimately repay.
If international lenders are forced to renegotiate with borrowers while absorbing the losses that are the consequence of overlending, the international financial system will operate more smoothly, without the aid of government intervention. There will be less lending and less investment in new capacity in Asia for several years - exactly what is needed to ease deflationary pressure.
If, however, governments bail out international creditors at the expense of international debtors, either the current system will collapse under the deflationary pressure coming out of Asia or we will get through one more round of crisis only to see a larger crisis emerge in the future.
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