In an Uncertain World (38 page)

The first key to prevention is to reduce countries' vulnerability to crisis. There is no simple way to promote this, although a number of ideas were put forward. Some focused on tying future IMF and World Bank money to the adoption of good policies in advance. Others looked at new systems that would send an official signal about countries' policies—for example, some kind of red flag that the IMF should wave when it was concerned about a country. Neither type of scheme was practical. In a time of crisis, the IMF and its shareholder governments will always need flexibility, if only because of the risk of contagion. I thought that an IMF warning system simply wasn't sensible. Predicting what will happen to a country's financial circumstances is highly uncertain at best, and IMF warnings could precipitate crises that might otherwise not occur.

One decision we did make was to focus attention on the dangers of a fixed-exchange-rate system. Attempts to hold a currency fixed when economic fundamentals were not in line had led to trouble time and again. These situations were inherently unstable and provided a kind of one-way bet for market speculators, as a central bank would first defend a particular rate but then had to let the currency move sharply when its foreign exchange reserves were exhausted. Exchange rates that are allowed to fluctuate with market movements are less subject to such bets. More important, they allow countries' currencies and economies to adjust to outside shocks more gradually. In this case, we did call for the Fund to adopt a policy that prohibited lending to countries that maintain fixed exchange rates except under very unusual circumstances. Though that policy was not officially adopted at the IMF, the practical effect of the crisis, and of the general change in thinking that was taking place, was to eliminate almost all fixed-exchange-rate systems. By now, there are only a few economies left, such as those of China and Hong Kong, with the reserves and the policy determination to hold the pegs. And in the case of China, at least, this peg has become quite controversial, though for trade reasons, not financial stability reasons. My own view is that in time China will move to a more flexible exchange rate regime in its own interest. China has a large trade imbalance with the United States, but that's because so much of non-Japan Asia's exports to the United States pass through China. China's global trade surplus is relatively small and has been declining.

Another idea for improving country policies was to develop a catalogue of best practices in such areas as debt management, bankruptcy, public statistics including disclosure of levels of international reserves, deposit insurance, and bank supervision. U.K. chancellor of the exchequer Gordon Brown pressed particularly hard for codes and standards in these areas and some progress has been made. The question going forward is how to encourage countries to adopt these policies, with due allowance for differences in cultural, economic, and historical circumstances.

The crisis also showed how much countries need adequate social safety nets, such as unemployment insurance and programs for the poor, to mitigate the hardship of financial turmoil and to protect the most vulnerable from economic downturns. The World Bank has greatly stepped up its work in this area, both to develop understanding of the policies that are needed and to provide financing for countries to implement better social programs.

Since poor lending and investment decisions helped cause the crisis, it is important to search for ways to improve risk assessment and management by industrial-country creditors and lenders. Again, this is very hard to effect with official policy. But greater transparency—involving both information on the IMF's views and analysis of a country and data about that country's economic situation—could be helpful, and progress has been made. For example, today any country that hopes to attract foreign investment feels obligated to disclose data about its currency reserves and forward obligations. It would be close to impossible for a country to do what Thailand or South Korea or, earlier, Mexico did and hide its true reserve position. The IMF also now publishes information that countries provide about their adherence to the various codes and standards of best practice that have been developed, reinforcing the pressure to put such standards into place. Greater disclosure should reduce capital flows into riskier situations. This in turn should encourage countries to reform before a crisis occurs. At the same time, transparency on its own will not prevent Asian-type crises. The United States is generally regarded as having the most advanced transparency regime in the world, and it still experiences speculative excesses.

Perhaps the greatest challenge in improving financial architecture is finding more effective ways to induce investors and creditors to exercise discipline and focus appropriately on risk during good times. One key here is for creditors and investors to bear the consequences of their decisions to the greatest extent practical. Some pointed to the big losses that many lenders and investors had suffered on their emerging-market positions in the Asian crisis and argued that the lesson about risk had been learned. But I felt strongly—based on all of my own market experience—that the moral-hazard argument had not been adequately addressed, and I fully supported private-sector burden sharing conceptually. But it was no easy matter to allocate more of the burden to private-sector foreign lenders and less to the poor of the affected countries, without making the situation worse for the poor by scaring creditors off from the country in crisis or from other emerging-market countries. Also, there were often legal problems in doing this.

In South Korea, where most of the foreign debt was held by banks, private-sector involvement was feasible because banks could be involved in an organized fashion and came to see that their interest was to restructure the debt. But in Mexico, and later Russia and Brazil, where foreign debt was in the form of securities widely dispersed among individual investors and institutions, there was no practical mechanism to create a “bail-in.” And the risk of provoking a wider pullback was much greater. This leads to another important rule of mine that Tim and his colleagues neglected to put on their list: number 12:
Reality is always more complex than concepts and models.

In domestic markets, bankruptcy procedures serve the purpose of sorting out the allocation of losses in an orderly fashion and giving those who fail financially a chance to start over. The Federal Reserve and Treasury had explored this idea after the Mexico crisis in concert with the G-10 group of industrialized countries but had eventually concluded that it wasn't practical for a host of reasons, and that idea seems to have fallen by the wayside at least for now.

We also looked at the possibility of a “collective action” clause in bonds that would authorize some party to negotiate for bondholders in the event of default. This kind of binding arbitration would promote more cohesive action among creditors and could provide for private-sector burden sharing when there are thousands of bondholders. I always believed such clauses would be introduced when there was sufficient market pressure for them, and a number of emerging-market countries have issued new bonds with these clauses. Most important to me was that IMF programs should have the maximum practicable focus on private-sector burden sharing, and we pursued this where feasible, as in South Korea. Finally, I supported a new framework for IMF decisions that stressed burden sharing and laid out considerations to guide the Fund on a case-by-case basis, given the practical difficulties that made a rigid mandate infeasible.

The greater focus on private-sector burden sharing is just one of the changes that has taken place since the Asia crisis. In addition, as we had hoped, most countries have shifted to floating exchange rates and have become much more transparent, as have the IMF and the World Bank. The enormous leverage in the system that contributed to the Asia crisis spreading so rapidly has also been reduced, at least for now. This does not, however, warrant any degree of complacency. Financial crises have continued to rock emerging markets and are likely to remain a factor in the decades ahead. The international community must continue to try to improve its means of prevention and response.

   

FROM EARLY 1998, we faced the intensification of a long-simmering issue in Congress over support for the IMF. Even as the criticism of IMF actions in Asia increased, we had to go to Congress to ask for more funding for it. I had signed on to a routine replenishment of the IMF's resources in September 1997, at the annual meeting in Hong Kong, but fulfilling that agreement required congressional action. And now this money was urgently needed, in case still more countries fell victim to the spreading financial market contagion and had to borrow from an IMF that was beginning to face the possibility of running short of funds. The President's January budget asked Congress for an $18 billion contribution, our share of a $90 billion increase in the IMF's resources. Although the amount seemed large, it did not come at the expense of other programs. Our contribution to the Fund is more like a deposit at a credit union. We get an asset in exchange—a claim against the IMF—and we have never suffered a loss. But niceties of this kind were hard to explain in the heated atmosphere of the budget debate that year.

The debate over IMF funding was overwhelmed by another story that broke that January, the one concerning Monica Lewinsky. The Lewinsky revelations became the subject of a media firestorm that lasted through 1998 and resulted in far less attention being paid to events overseas. This disproportionate focus on the Lewinsky matter didn't make any difference to what we did in responding to the crisis. In another sense, though, it did real damage by crowding out media coverage of what was happening in Asia. As a consequence, the American people didn't learn what they might have learned about the critically important issues raised by the crisis. The distraction kept the public from recognizing the threat from crisis abroad to the stability of the U.S. economy. Thus, when we most needed support from a well-informed public, that public was nowhere to be found.

The struggle over IMF funding was just one more example of how complicated the issues regarding our interdependence with the rest of the global economy are, how little they are understood by the American people, and how difficult dealing with international economic issues in our political system often is. I saw the IMF as a vital and necessary institution, in the front line of the fight to contain the spreading financial crisis. Although the international financial architecture needed to be modernized, I believed strongly that the IMF was critically important and should be strengthened through reform. Some of our critics thought we'd be better off having no IMF at all.

Talking about the need for these funds put us in a delicate situation of a familiar sort. We didn't want to say that the world would collapse if Congress didn't act—which might have helped to secure congressional support—because doing so might increase the level of distress in the global financial markets. On the other hand, there was a pressing problem, because in our view the IMF was in danger of running out of ammunition. Even if it had enough money to deal with the immediate problems, the Fund needed to have—and to be seen as having—the power to deal with new problems that might arise. By calling this into question, Congress's failure to act could itself contribute to the loss of confidence afflicting the markets. The IMF's other major shareholders, who viewed the increase in funding as a routine manner, had all already acted. By holding up the new funding, Congress was diminishing our leverage within the IMF, diminishing confidence in American leadership in Asia and elsewhere, harming our ability to exercise leadership in the crisis, and, most important, risking extending or deepening that crisis.

Some of the hostility we encountered in Congress recapitulated the opposition's arguments at the time of the Mexican rescue. But once again, the underlying substantive issues didn't quite explain the intensity of the opposition. This time it seemed to me that the reaction of many in Congress was exacerbated by irritation at their lack of input into our previous decisions about Thailand, South Korea, and Indonesia. With the IMF funding issue, members of Congress now had an outlet for doing something about their objections.

Politically, we confronted objections from both sides of the aisle. Some Democrats took the position that IMF programs were too hard on people in developing countries, who were already suffering from collapsing economies. Others complained that IMF programs didn't require nations to take steps to protect the environment, uphold labor standards, or respect human rights. A focal point for many of these issues was Indonesia. A number of liberal Democrats, such as Barney Frank of Massachusetts and David Bonior of Michigan, told us they wouldn't support IMF funding unless Suharto released an Indonesian labor leader named Muchtar Pakpahan, who was being held in prison. Bonior, the tough-minded House Democratic whip, who represented a district outside Detroit that is heavy with unionized autoworkers, argued that respecting the right to organize unions should be a condition of any country receiving IMF money.

My answer to Bonior—whose intellectual integrity and concern for the least well off was unquestionable—was that the test for getting IMF support should be doing what is needed to reestablish the fundamentals for economic growth and market confidence. Reestablishing stability was imperative for the very people Bonior was most concerned about, and trying to use the IMF to serve purposes other than effectively promoting economic recovery could impede those efforts. But for me personally, there was another point as well—one I didn't make to Bonior. Civil and political rights are at the core of America's identity and beliefs, and I think we should promote our values abroad through moral suasion, advocacy, and public exposure. But it seems to me there are complex conceptual and practical questions about
imposing
our values—however strongly we believe in them—on other people.