The Subprime Crisis and Global Justice

Large numbers of real estate loans drive up prices in the housing sector — and thus create never-ceasing demand for more mortgage loans. Banks, striving to profit from the low interest rate environment, refinance these loans — by issuing ever larger volumes of short-term paper, thus piling up substantial risks if and when rates rise.

All along, long-established risk evaluation and credit screening mechanisms are treated ever more cavalierly. Supervisory authorities neglect their time-honored duty to ensure prudent banking operations.

If this sounds like a description of the present subprime loan crisis in the United States, Spain or the United Kingdom, think again. As a matter of fact, it is a description of the so-called Asian financial crisis of 1997, which marked its tenth anniversary last year.

At the time, the poor banking practices of upstart Asian economies were the bane of all analysts in the West, who warned these "emerging economies" not to throw caution to the wind.

To be sure, in retrospect Western banks and institutions are now remembered to have looked with a strong air of superiority on Asian markets and their apparent lack of professionalism.

The International Monetary Fund sent hundreds of experts to the region to give advice to whoever liked it or not — governments, central banks, supervisory authorities and, of course, also to bankers and investors.

The major implication was always the same. Stuff like that can't happen "here" (meaning: in the West) — only "over there" (read: up-start emerging markets). That plenty of Western private-sector banks had been busily supplying the quite happy-go-lucky investors in Asia with the financial products that were instrumental in their eventual downfall, of course, went largely unmentioned.

But let bygones be bygones. Rather, let's examine the here and now. Now, the tide has turned. It is primarily the United States that is in trouble. Meanwhile, the Asian corporations and financial institutions stand on the sidelines of the current crisis, with clean shirts and balance sheets, comparatively speaking.

It is remarkable that virtually everybody is hit by the fallout from the subprime crisis — but not the Asians. Yes, there are a couple of banks in Japan, in China or in Australia that are reporting some losses with asset-backed securities.

However, the figures they are publishing for their loan-loss provisions seem rather like "peanuts" compared to what we are seeing in big American and also European banks.

This turn of events is all the more astonishing, as the Asians in the past few years recycled huge current account surpluses back to the United States — and amassed so many assets in dollar-denominated paper in their portfolios. Evidently, Asian investors were more cautious, and ultimately more prudent, in their investment practices than their Western counterparts.

What explains all of this? Some analysts say Asians are just not honest; they are hiding the stuff off balance sheet. We in the West should be careful voicing such a reproach as long as it can't be proven. More important is that the Asians still have the experience of the end of the 1990s fresh in their mind — and that they are therefore more cautious.

Another likely reason is that, due to their booming economies, banks and investors in Asia had better domestic business (and risks) in recent years — so that they were not forced to look for better earnings via special investment vehicles or other dubious financial instruments.

Just as Asian markets wisened up before, and are no longer throwing caution to the wind, it is now the turn of Western — principally U.S., but also European — institutions to come to their senses and to return to proper risk management. In short, what was done by the Asians before now has to be achieved in the United States and Europe, too.

In that regard, it is remarkable just how much the subprime crisis today is a replay of sorts of the Asian crisis. Both crises emerged from the violation of the three basic rules of good governance in financial matters.

The first rule is that investors can obtain higher yields only by incurring higher risks. The second rule is that prudent banking implies thorough credit checks, cautious management of currency and transformation risks and sufficient cover of the risks by equity capital.

The third rule is that central banks have to keep money in the economy scarce and expensive — thus forcing market participants to get along with scarce money.

What the Asian crisis teaches us all is that financial systems can exit from a major crisis in a reinvigorated fashion. The Asian crisis clearly helped save banks and other investors in Asia from repeating imprudent risk-taking in the present crisis.

We Westerners, however, should not have just preached, but been listening to our own prescriptions. That we didn't do so is unconscionable.

Fortunately, the subprime crisis, once overcome, will leave Western institutions more resilient against future crises.

If this analysis is correct, the economist in me inevitably drifts to making a forecast: The next financial crisis, by the logic of human foibles presented here, will not be a Western one — but rather may be an Asian one again. Whether or not it materializes, we in the West should be exceedingly careful in phrasing any comments about the shortcomings of others.