Asia No Innocent Victim

From Asian to Global Financial Crisis: An Asian Regulator's View of Unfettered Finance in the 1990s and 2000s
By Andrew Sheng
Cambridge University Press, 2009, 504 pages, HK$285

This book is wide in its ambitions and troubling in its conclusions. With the global financial system at a once-in-a-generation inflection point, Andrew Sheng (沈聯濤), one of Asia's most experienced and international financial regulators has drawn lessons from the 1997-98 Asian financial crisis.

What emerges from this detailed portrait is yet more evidence that the dizzying complexity of the system is a major part of the problem. Complexity mixed with simplistic moves to liberalization at a time when regulatory regimes were weak ended badly.

In Asia, the Washington Consensus' advice to liberalize financial systems ended disastrously for many of the countries that heeded the advice before their regulatory systems were ready to handle the new demands of an aggressive globalized financial culture. In similar fashion, in the U.S. the repeal of Glass-Stegall's legislative separation of banking and investment banking while regulatory oversight was throttled back sowed the seeds for the current crisis.

In tracing the threads that stretch from the Asian financial crisis to the present day global meltdown, Sheng has done an immense service in diagnosing the many failures that prepared the ground for each crisis.

To crudely simplify Sheng's argument, there was too much cheap money. Regulators, ratings agencies, accountants, and other gate-keepers didn't do their jobs. Players gamed the system, using increasing complexity to cover their tracks: Derivative instruments amplified risk rather than moderated it.

More crises are inevitable. The West proved to be a fickle and ideologically blinded friend in the last crisis. Now with the U.S. trying to heal its self-inflicted wounds, the time is right for Asia to take care of itself. Individual countries, with the memories of 1997-98 seared into this generation of businessmen and officials, have learned to be more prudent.

Next, hopes Sheng, will come regional arrangements that could help build shock absorbers to mitigate the shocks of the next crisis. Yet even as thoughtful a commentator as Andrew Sheng has no easy answers beyond a plea for more enlightened leadership by regulators and other so-called wise men.

Sheng gives readers a useful tour of what forms this regional integration could take. Fittingly for someone who has spent his entire working life employed by the government or multilateral institutions, he lays great hope in the various government-sponsored initiatives to spur Asian integration.

The reality is that trade integration, although uneven, is the only area where there is serious progress, and that is driven by the private sector. Financial integration has taken some halting steps, but far fewer than most people would have imagined a decade ago as the crisis waned and big plans for regional financial cooperation were lauded. Finally, unlike in Europe, monetary and political integration are far, far off in Asia.

Hong Kong readers will remember Andrew Sheng for the 12 years he spent in the city, first as the deputy chief executive at the Hong Kong Monetary Authority and later as the head of the Securities and Futures Commission from 1998 to 2005.

Sheng was a firm believer in markets when he lived in Hong Kong: His guiding principle was "buyer beware." Sheng treated investors as consenting adults. Assuming that risks were disclosed, Sheng didn't think it was the regulator's job to protect investors from their own decisions.

Now Sheng is a lot less certain. Being on the other side of New York and London speculators during the 1997-98 financial crisis certainly tempered his enthusiasm for anything-goes finance. But it is the current recession that has really shaken him up.

Sheng starts his book with a top-down view. He then, less evenly, takes us down to ground level for a country-by-country view of the Asian crisis that takes up the bulk of the book. Finally, he steps back for a more macro view, bringing in the recession of 2008-09 and discusses challenges ahead for policy makers and regulators.

This is a superb book and will serve as a standard reference work for many years to come. But its failings need to be noted. Certainly, the country chapters that make up about half the book are useful for detail. Any student of Asian financial and economic history will find them a useful reference (especially the many data tables). But they suffer from some limitations.

First, the relative lack of attention given to China is surprising. In some senses that's understandable because China was not a victim of the first crisis. But by some accounts, China's decision to unify the currency in 1994, a devaluation for its export industries and a competitive advantage in relation to its neighbors, was one of the triggers of the subsequent Asian crises. Sheng doesn't really take a stand on this issue, despite a chapter on China, though he quotes studies that minimize its effect.

More recently, China's extraordinary loan growth seems almost certain to presage trouble ahead in the form of a stock and property collapse and a new round of non-performing loans for the banks. Yet Sheng, the chief adviser to the China Bank Regulatory Commission, simply doesn't touch the issue.

Similarly, though Sheng was at the Hong Kong Monetary Authority at the time of the dramatic stock market intervention, he doesn't provide new details. In fact, he doesn't provide a very robust defense of the intervention. His account of the intervention is threadbare, blandly quoting then Financial Secretary Donald Tsang (曾蔭權) defending the intervention. (Moreover, Sheng's account is confusing: he cites an interest cost of HK$4 billion a day for speculators, although from the context he seems to mean $4 million.)

There's a positive story for Hong Kong that can be told more robustly than Sheng does. High capital levels and a robust banking system as well as relatively low leverage in the corporate sector contributed to Hong Kong coming through the crisis virtually unscathed.

One wonders if the same discipline would be in place today. Has the existence of deposit insurance contributed to moral hazard? Has the political climate in Hong Kong, where losers demand to be compensated for their bad mistakes, created a new climate? The way in which the government rammed a settlement for the Lehman minibonds down the banks' throats is a classic example of regulatory cramdown. Sheng doesn't weigh in on any of these issues.

More broadly, there's an underlying sense that Asia was somehow an innocent victim of the Asian crisis. In Sheng's telling the storm came more or less from nowhere and Asians were simply unlucky enough to be in harm's way; the IMF and Washington then made things worse by refusing to provide any shelter. In the case of Korea, "even as late as October 1997 no one dreamt that South Korea would find itself a victim of the tsunami that was tearing apart its Southeast Asian neighbours."

This simply isn't so. In September 1997, around the time of the World Bank meeting that took place that month in Hong Kong, South Korean officials speaking at an Asia Society event stunned many of the members of a sizeable audience with their extreme level of denial about the crisis. It was clear that the country faced the danger of being flattened by the tsunami that was crushing Southeast Asia. The markets knew it. And I think that the officials did too. Or they should have.

Individually, it would be easy to pass these off as minor quibbles. Taken together, they have the effect of distorting Sheng's argument. Korea, for example, had a hollow financial structure. This was no secret. Its chaebol were dangerously leveraged. Again, this was well known.

But Sheng would have us believe that Korea was some sort of innocent victim and that the crisis simply came out of the blue. In fact, the Korean crisis had been building for some time. A deliberately weak financial system and an overleveraged corporate structure meant that as financial liberalization lurched forward the question was not if a crisis would happen, but how bad it would be.

Yes, the IMF made many mistakes in the wake of the crisis. And the US is certainly guilty of hypocrisy, at the very least, for saving its banks and turning on the fiscal and monetary spigots after it told Asians not to adopt those very measures.

But the post-crisis mistakes imposed on Asia by the West shouldn't detract from the fact that Asia had serious problems in the run-up to its crisis. And in most cases it has emerged stronger from the crisis. Rather than being crippled by the crisis, as Sheng's book implies that Asia was, Korea and Korea's chaebol are far stronger today than they were in the mid-1990s.

But Sheng raises serious questions about the role of modern finance, especially in Asia. He poses the right questions and he has many of the right answers in a book that is unrivalled in its scope. Let's hope that his message is heard widely.

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