Heeding the Lessons of the 1997 Asian Financial Crisis as Wall Street Bleeds

by Heda Bayron

Originally published in OpinionAsia, September 19, 2008

NEWYORK - The collapse of Lehman Brothers, the buyout of Merrill Lynch, and the crisis at the world’s largest insurer AIG have stoked fears among investors worldwide of the precariousness of the financial system of the world’s superpower.

Howtimes have changed. Indeed, there was once a time when troubled nations would call on the United States to rescue them during economic crises. The bailout of South Korea and Indonesia during the 1997 Asian financial crisis was decided in the halls of the Clinton White House and executed by the International Monetary Fund.

Today America is in distress and it is Asia (and the Middle East) that has thrown a lifeline. Asian sovereign wealth funds, primarily Chinese and Singaporean money, have provided a critical capital to Wall Street over the past several months.

Today Asia could well remind America of the lessons it painfully learned through the 1997 financial crisis. Asia could remind America of the policies it had lectured the region’s governments on after 1997 -- of the importance of good corporate governance and regulatory oversight.

Take Indonesia’s experience in 1997 (which is not too dissimilar to the current U.S. predicament). Bad lending practices and regulatory weakness encouraged Indonesian banks to want only lend to companies without proper credit checks. They lent disproportionate amounts of money beyond what their capital base could cover. As Indonesia’s currency rapidly lost value, borrowers began to default and the house of cards collapsed. When an Indonesian taxi business, Steady Safe, defaulted on a US $260 million-loan, it dragged down with it a prominent Hong Kong-based investment bank, Peregrine, which lent a third of its capital to the business.

Steady Safe’s failure and many others triggered a tsunami that ripped through the Indonesia’s financial system. Banks suffered massive withdrawals and the central bank stepped into save them. But the central bank itself ran out of funds. As losses mounted, the entire financial system headed for a meltdown.

In the end, Indonesia was brought to its knees. Few would forget the picture of Indonesian President Suharto signing an IMF bailout agreement with then IMF chief Michael Camdessus standing over him. A quarter of Indonesian banks had to be closed. Credit became scarce, choking the real economy. Unemployment rapidly rose. In the spring of 1998, riots erupted in Jakarta (largely targeted at the affluent local Chinese community) and President Suharto stepped down after 32 years in office.

Like the Bank of Indonesia 11years ago, the Federal Reserve has taken on the task of bailing out reckless financial institutions. Unlike the Bank of Indonesia, the Fedhas a better arsenal to deal with such emergency. However, unlike Bankof Indonesia, the Fed has to deal with mammoth institutions such as AIG, Freddie Mac and Fannie Mae and the still unknown number of companies out there that may need a lifeline.

If there is one thing America can learn from Indonesia it is that once you rescue one bank, it provides an argument for other, perhaps, bigger bailouts.

The Indonesian government ended up with a multi-billion dollar bill for the financial crisis, too heavy a price for a developing nation. The Indonesian Bank Restructuring Agency struggled to sell 533 trillion rupiah-worth ($56 billion at today’s exchange rate) of government-seized bank assets to recoup the funds used in the bailouts– bank furniture, cars, art, properties, stocks, bonds, loan portfolios, etc. (Incidentally, Lehman Brothers had acted as advisor to the Indonesian Bank Restructuring Agency).

But seeing the social and political turmoil the crisis unleashed, Indonesia followed what the U.S. preached. Indonesian regulators were given greater independence and power to discipline financial institutions. Strict capital adequacy requirements and risk management mechanisms were put in place. On the other hand, independent watchdogs and civil society groups have increased vigilance against the return of widespread corruption and cronyism that had contaminated both government and the private sector in Indonesia.

The severity of the 1997 crisis has left Asia wary of making the same mistakes again. And this is partly why Asian governments have amassed the trillions of dollars in liquidity that has been used in shoring up U.S. financial institutions.

Wall Street’s financial troubles could have been portrayed in Asia as a humbling of America, avenging that infamous photograph of Suharto and Camdessus. But since Monday, Asian policymakers have been watching closely the turn of events. Asia understands its role in helping stabilise the global financial system as precarious as it is right now. And where it is necessary and prudent, Asian financial institutions are likely to step in to help.

How America deals with this crisis is being closely watched by the rest of the world.  But it could cost America its credibility if it fails to heed the same advice it offered Asia during those turbulent times 11 years ago.

Heda Bayronis Senior Press Officer at the Asia Society in New York. Prior to joining Asia Society in September, she reported on Asian political and financial issues (including the 1997 crisis) from Hong Kong.