Introduction

The 2008–2009 economic “earthquake” may have had its origins in the United States (US), but the resulting tsunami has pounded the Asian economies no less than the US'. Negative growth rates in a number of Asian economies have even been more pronounced on the opposite side of the Pacific. Such an economic shock has not been seen in Asia since the economic crisis of 1997–1998. And for several economies in the region, the current global economic crisis has even taken a higher toll than did the previous one. When the dust clears, it is likely that the duration of the global economic crisis will be longer than that of the 1997–1998 crisis for most of the region.

From an Asian perspective, the main difference between the two crises in terms of policy is arguably that the crisis of 1997–1998 was mostly homegrown, while the global economic crisis has been imported. Most Asian economies were conservative in terms of their macroeconomic management prior to the global economic crisis, with relatively low inflation, budget deficits under control, stable exchange rates (relative to the Organisation for Economic Co-operation and Development [OECD] anyway), high current account surpluses and the build-up of a large cushion of foreign-exchange reserves. Asian economies did not invest heavily in “toxic” assets and other high-risk financial activities. While the “savings glut” hypothesis would assign some blame to the Asian economies in terms of the perpetuation of global economic imbalances (Bernanke 2005), ultimately the main responsibility for the crisis lies in the US and other developed economies where the global economic crisis broke.

Indeed, analysis of the global economic crisis “blame game” has already become popular and will continue to be an important topic for economists for years to come. Certainly many actors were culpable. The media places most of the blame on unsustainable high risk assets, such as subprime mortgages, credit-default swaps (CDS), and mortgage-based securities (MBS), overzealous financial deregulation, and lack of consistent and effective oversight of the international financial system, as well as unethical financial actors. Economists would add to these macroeconomic factors, such as overly-expansionary monetary policies, exchange-rate misalignments, and unsustainable global current account imbalances.

The goal of this paper is to ascertain how crises might be mitigated in the future through better regulation, supervision, institution-building, and regional cooperation. Section II is an overview of the regulation of capital flows and their implications for the economy in the context of rapidly-changing international financial markets. In this discussion, I also focus on highly-leveraged institutions such as hedge funds, which have been hitherto unregulated in major markets like the US, and credit-rating agencies, which are necessary to the smooth functioning of the international financial system but subject to conflict-of-interest problems. Next, Section III addresses issues surrounding the development of new regulatory regimes. In particular, I highlight and critique many of the shortcomings of the previous international and domestic regulatory and supervisory institutional structures. Section IV considers this analysis in the context of Asia. It first makes the case as to why improving financial markets in Asian economies is so crucial to future development, and surveys approaches to regional financial cooperation in recent years. Section V considers fresh approaches to financial cooperation. It begins with a discussion of when regional cooperation—as opposed to global cooperation—makes economic sense, and considers the potential for an Asian Financial Stability Dialogue (AFSD) (and how it might interact with the new Financial Stability Board and other institutions). It also makes the case for closer financial integration in the region with a focus on deepening asset markets in developing Asian economies and argues that this objective should be an important component of the Asian Financial Stability Board. Finally, Section VI summarizes key recommendations regarding the improvement of monitoring and regulation in the global and regional economies.

One important caveat before beginning: this paper mainly takes a microeconomic approach to the issue. But while I suggest that better regulation and monitoring can be developed in order to mitigate the effects and reduce the frequency and occurrence of future crises, it should be understood that crises cannot be avoided altogether. In the US, for example, the financial crisis of the late 1980s stemmed from a combination of deregulation, aggressive marketing of high-risk (“junk”) bonds funding leveraged buy-outs, and unethical financial participants, some of whom went to jail. To “prevent” further crises of this sort, new legislation was implemented. In the early 2000s, the crisis produced by the likes of Enron, WorldCom, and Vivendi had its origins in lack of transparency, risk-management problems, off-balance-sheet shenanigans, and unethical financial participants, some of whom went to jail. New legislation was implemented in the form of Sarbanes-Oxley.¹ The current crisis is a far more serious one sparked by a collapse in the financial sectors and characterized by both new and old abuses. And some of the perpetrators of the crisis have already gone to jail.²

In the modern, open international financial marketplace, it is impossible to avoid crises altogether without stifling innovation. And there will always be fraudsters. The task of policymakers, therefore, must lie in improving transparency, regulation, and monitoring in such a way as to nip incipient excesses in the bud, identify bubbles (and do something about them), minimize “moral hazard” problems inherent in finance, and detect scams as early as possible so as to reduce their potential effects on the real economy. I address many of these issues in this paper; but I do not discuss the need to improve aggregate demand management in general and monetary policy in particular. Arguably toxic assets and other high-risk products that emerged prior to the global economic crisis were fed by overly-expansionary credit, not just regulatory failure. In this sense, it might be argued that this paper reviews the symptoms, whereas much of the “disease” lies more in macroeconomic management.

Download this Paper [ PDF 280.6KB| 29 pages ].

Comment(s)

There are [0] comment(s) for this entry. Post a comment.