Watch Whom You Save, Not What You Advise
In late September, a group of the country’s most powerful bankers met in New York to arrange a bailout of Long-Term Capital Management, a hedge fund that had leveraged, and lost, billions of dollars more than it held in capital. While the bailout funds came from private banks, to protect their loans to Long-Term Capital, the joint effort was carried out at the initiative of the Federal Reserve Bank, which worried that the hedge fund’s failure might have had serious negative repercussions on both the national and international economies. Some critics questioned whether it was appropriate for the government’s central bank to involve itself in saving private hedge-fund investors, whatever the consequences. Might the role played by the Fed signal to other large hedge funds that they, too, can find protection if their risky gambles do not pan out?
Yet, there is another public-policy question attached to the Long-Term Capital affair, one that goes to the credibility of the United States in its efforts to solve the current international economic crisis. The United States, in conjunction with other Western countries and international organizations, repeatedly has pushed Asian governments to swallow the medicine of financial austerity to heal their sick economies. Primary among the ingredients of the austerity is a hands-off approach to failing banks and other financial institutions.
In light of the Long-Term Capital bailout, however, such a prescription may ring with hypocrisy in the ears of Asian leaders. Western officials have warned Asian governments about the “moral hazard” posed by financial institutions and banks that make risky loans and investments on the assumption they will be bailed out if they fail. Making this case to anxious foreign politicians more interested in short-term solutions than in long-term structural changes is an uphill battle to begin with. Making it to an audience wary of U.S. hypocrisy may be impossible.
Asian leaders already had reason to doubt the credibility of Western governments’ advice. Eighteen months ago, when the financial contagion was spreading across Asia, the region’s leaders urged the United States and healthy European nations to act and prevent a financial meltdown in Asia. Instead, Asians heard Washington and the International Monetary Fund extol the virtues of nonintervention in the economy and “letting market forces decide.”
What has this advice done for the affected countries? In Thailand, where the financial crisis began, the government has strictly adhered to the conditions laid down by the IMF and the United States. After shutting down two-thirds of its financial companies, Thailand is still reeling under the weight of leveraged operations. Currently, about 2,000 people a day are losing their jobs.
The situation is worse in Indonesia, where the IMF has pushed hardest for austerity. The country’s financial system is in shambles, unemployment is at 20% and 100 million people (half the country’s population) will be living on less than a dollar a day by the end of the year.
Austerity may be the right way to stem the economic bleeding in these countries. But how can the Thai and Indonesian governments plausibly explain to their suffering citizens that the hardships they endure are necessary to reform their economies when the United States rushes to the rescue of a hedge fund composed of some of America’s wealthiest investors?
Such U.S. hypocrisy will most likely hurt our relations with Japan. Conventional wisdom holds that the catalyst for Asia’s economic recovery must be Japan. For that to happen, the Japanese government will need to recapitalize the country’s banks, mandate greater transparency and, perhaps most painfully, allow failing financial houses to fall. This last step will require strong political will, economic farsightedness and a partial repudiation of a culture of collaboration between the government and Japan’s major financial institutions. But how can the U.S. government effectively complain about cronyism and cooperation among Japanese elites in government and the financial world when it encourages U.S. banks and brokerage houses to bail out some of America’s savviest investors?
Further complicating U.S. relations with Asia was the target of the rescue: a hedge fund. Hedge funds are a sensitive subject for Asian leaders. Malaysian Prime Minister Mahathir Mohammed, one of Asia’s most outspoken leaders, partly blames his country’s economic woes on Western hedge-fund speculators. Just before Long-Term Capital’s bailout, the Mahathir government implemented foreign-exchange controls that prohibited both short-term investment in Malaysia’s stock market and offshore currency trading. Similarly, Hong Kong’s monetary authorities, who also blame hedge funds for their economic instability, have spent $15 billion in foreign-currency reserves in part to defend their own currency against international speculators. The U.S.-inspired bailout of an adventurous hedge fund will hardly endear Washington to these Asians.
Over the past year, Asian countries have heard a constant refrain from the IMF, the World Bank and the United States urging them to better regulate and oversee their financial systems. Yet, hedge funds operate largely unregulated and are only beholden and, more important, transparent to their investors. Unless the United States responds to Asia’s concerns about hedge funds’ lack of accountability by devising a reasonable and workable set of rules to govern them, Washington may find its influence diminished among Asian leaders.*
