NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Past International Rescues were More Successful than Recent Ones



"it was not contagion from Thailand that made other countries vulnerable to financial crisis. They were vulnerable because of their own home-grown problems."

The specter of the International Monetary Fund or some other international institution riding to the "rescue" of a country in financial distress has become such a routine event in the 1990s that, increasingly, it invites only the cursory scrutiny that accompanies the common place. But in Under What Circumstances, Past and Present, Have International Rescues of Countries in Financial Distress Been Successful? (NBER Working Paper No. 6824) NBER Research Associates Michael Bordo and Anna Schwartz conclude that since 1973--and especially in the 1990s--rescues have presented more problems than solutions to the effort to stabilize emerging economies.

They note that, for more than 100 years, financial rescues mainly involved provisioning countries with "relatively small amounts of money" at "commercial market interest rates" with the goal of "staving off" actions that could cause currency problems "while remedial policies were put in place." By contrast, Bordo and Schwartz point out that rescues today usually involve large amounts of money provided at below market rates, occur after a currency crisis is already in full bloom, and contain conditions for policy reforms that are "easily evaded."

The result, they claim, is that bailouts provide investors and countries with an excuse to ignore the potential pitfalls of market conditions and macroeconomic policies. Bordo and Schwartz observe that foreign lenders now often assume that any losses on their loans will be covered by international lending agencies, while "emerging countries may believe that they have an implicit contract with the IMF to be saved from their own folly."

They note that recent recipients of high profile rescue packages--Mexico, Russia, Thailand, Indonesia, and South Korea--still have failed to make changes in fundamental problems that required the bailouts in the first place."By contrast, in earlier times, presumably borrowers and lenders learned the hard lesson that caution paid," the authors write.

Bordo and Schwartz dismiss as "fallacies" two of the central preconceptions that drive 1990s style bailouts: contagion and investors' need for "a safety net."

Implicit in the notion of contagion, they write, is the flawed assumption that other countries will be infected with a neighbor's troubles largely by virtue of proximity, not because they share "the same problems as were present in the first country." For example, they note that when the Thai currency, the baht, collapsed, "it was not contagion from Thailand that made other countries vulnerable to financial crisis. They were vulnerable because of their own home-grown problems."

As for the safety net, Bordo and Schwartz observe that the need to "cover investors' foreign holdings, such as large investment firms, presumes that the national welfare depends on their welfare." "It is far from clear that protection of any sector or industry benefits the whole economy," they write.

Bordo and Schwartz believe policymakers should look to the successful (and modest) financial rescues of the past--such as the initiatives directed at Canada in 1962 and Italy in 1964--for lessons on how to proceed in the future. They observe that past successes demonstrate how the IMF could "rescue a monetary authority that has a temporary liquidity problem, is adopting remedial policies, and has a good chance of timely repayment."

"Were today's (international) monetary authorities, including the IMF, to lend at short term at a penalty rate on good collateral that exceeds the value of the loan, they would be following (time-honored) principles," conclude Bordo and Schwartz. "However, in a world of deep capital markets, such as prevails today, there are few good reasons why the private markets cannot perform this role."

- Matthew Davis


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