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Lessons from America for the US Financial Crisis?: the case of Chile (1)
By Kaufmann | January 31, 2009 2 Comments »
Forbes Magazine invited me to write an article on corruption. One argument I made was that the US financial crisis constitutes a major and overdue wake-up call to the dormant anticorruption field, which for too long has focused on conventional second-order issues (here the article). I also suggest that some humility could help: for a change, lessons from an emerging economy could be useful to the current situation in the US. We know that the experience of Sweden in addressing their past financial crisis offers some insights. But it is also important to draw on the lessons from other countries…
Let us focus on Chile, another country in the Americas (the era of equating the US with America should be over anyway). I am getting questions about the parallels and insights from Chile for the US crisis. Let me bring up a few points here, with some more detail than in Forbes.
To address the US financial crisis, two huge financial rescue packages are currently proceeding in parallel: the bailout of the financial system, and the fiscal stimulus package. They may soon reach close to a trillion dollars each. In the case of the bailout, Chile offers insights on both how the financial crisis was addressed. For the fiscal stimulus, Chile also provides lessons on how to improve the efficiency and probity of public investment programs. And there are also common challenges in terms of how to address capture by private vested interests (also addressed in the Forbes article]. The focus here is on the first set of lessons (financial); possible insights related to the fiscal stimulus for infrastucture, as well as the politics of capture, will be addressed in future entries.
Almost twenty years ago, Chile experienced a major banking crisis, covering the period between 1981 and 1984. The short-term costs of resolving the financial crisis at the time were very high. Studying how the US may strive to end up with lower costs may be warranted, although it is already apparent that the costs in the US are likely to be very high as well.
High costs in resolving the crisis is one likely common characteristic, but far from the only one. Another one is in some of the causes of the crisis. In particular in the following: i) dogmatic and reckless financial deregulation for years prior to the crisis; ii) macro-economic mismanagement (in the Chilean case through a subpar exchange rate regime, in the US case with macro-imbalances, fiscal irresponsibility); iii) incentive structure favoring a highly risky over-reliance on debt by corporates, and, iv) private vested interests unduly influencing the regulatory and policy regime.
In spite of all the negatives that contributed to the crisis in Chile, the shock spurred concerted action, mostly carried out rather effectively. In brief, the positive lessons from Chile in addressing the financial crisis include the following:
Santiago financials: conservative, modern
First, the sounder short and medium term macro-economic management. This included sounder exchange rate management, prudent fiscal policies to limit deficits, and tax reforms that provided incentives to increasingly rely on equity rather than debt.
Second, the quick and effective micro-interventions of the Central Bank in the banking sector to restore confidence in the financial markets. This included a decisive restructuring of corporate and household loans, the sale or liquidation of insolvent financial institutions, the temporary purchase of non-performing loans from troubled yet viable banks and the provision of secured loans by the public sector to such troubled banks.
Indeed, troubled yet viable banks sold their toxic loans to the Central Bank. They were required to repurchase these nonperforming loans once loss provisions could be made. These banks were banned from distribution of profits until these loans were retired and they returned to financial health. And in providing secured loans to troubled financial institutions, so to help them recapitalize, the Chilean government used the bank’s own assets as collateral. The government was a subordinated creditor, which facilitated attracting fresh private capital into the banks.
Third, revamp of the institutional prudential supervision and regulatory institutional framework. Actually, perhaps more apt would be to depiction what Chile did as the creation of a prudential supervision and regulatory institutional infrastructure, since prior to the crisis such infrastructure had become largely inexistent. De facto, Chile did not even have a Securities and Exchange Commission (SEC in the US). It is from the ashes of such a financial debacle that a serious regulatory institution emerges (Superintendencia de Valores y Seguros, or SVS), one which to this day is very effective and highly respected. Further, the major overhaul in the oversight, disclosure and prudential regulatory requirements undertaken by Chile are also worth study for the current case of the US.
Much is being debated in the US today as to whether it is essential to create a ‘bad bank’ or not. Chile did not create one. This does not imply that the US shouldn’t, since despite similarities there are also differences between both cases (e.g. the absolute magnitude and global scope of the financial crisis, and the diversity, sophistication and obscurity of financial products and institutions). The point is that beyond very specific questions about what to do regarding one institution, such as the ‘bad bank’, the focus on an integrated strategy with broad-based policies (such as the macro and institutional stance with major implications for the Fed, Treasury, SEC and others), is paramount. If those broader fundamentals are not addressed correctly, no amount of fine-tuning of a ‘bad bank’ will do.
Having derived the lessons from the financial crisis of the early 1980s, and susequent prudent macro-economic and financial management, Chile’s financial sector does not need a ‘bailout’ today. Yet a stimulus package for the real economy is warranted, given that the effects of the global economy slowdown. Such stimulus package has been prepared already; there are insights to be derived from it for other countries as well.
Further, there are also important lessons, relevant for the US, as to how to improve the effectiveness and transparency in infrastructure projects. I will discuss these in another blog entry, including the political dimension as well: how to reduce the likelihood of capture by vested interests (privates, lobbyists) of the proceeds from the bailout and stimulus package, or unduly benefiting by differential treatment from the regulatory framework.
Topics: capture, Corruption, financial crisis, G-20, Public Financial Management, Public-Private Linkages | | 2 Comments
February 1st, 2009 at 1:59 pm
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