Last month's bailout of Long-Term Capital Management, a hedge fund that leveraged megabillions more than its capital and lost, raises some serious public policy questions that may have significant foreign-policy implications. The biggest question might be: How can the United States speak with a straight face to Asians about "moral hazard" when US authorities do the exact opposite of what they preach?
"Moral hazard" is the temptation by financial institutions and banks to make risky loans and investments on the assumption they will be bailed out if they fail.
Though no US government funds were used, US authorities viewed the unprecedented bailout of Long-Term Capital Management by 14 major banks and brokerage houses as necessary. It was feared the hedge fund's failure would send tremors throughout the world's financial markets at a delicate moment. Asians, however, are viewing the bailout as a demonstration of US self-interest in protecting its own system.
Just 15 months ago, when the financial contagion was spreading like wildfire across Asia, the region's leaders were asking the US and European nations to prevent a financial fallout in Asia. Instead, Asians heard the US and the International Monetary Fund extol the virtues of "non-intervention in the economy," to "let market forces decide."
In retort, one of Asia's most outspoken leaders, Malaysian Prime Minister Mahathir Mohammad, blamed hedge funds for his country's economic meltdown. (These funds are largely unregulated investment pools designed to protect against market downturns while providing larger than normal returns on investments in stocks, bonds, or currencies.)
Just prior to Long-Term Capital Management's bailout, Malaysia implemented foreign exchange controls that prohibited both short-term investment in Malaysia's stock market and off-shore currency trading.
Hong Kong's monetary authorities have spent $15 billion to defend their currency and nearly as much to prop up the stock market. Hong Kong officials are also blaming hedge fund speculators and are trying to track movements of money going in and out of the city.
Thailand, where the financial crisis began, has strictly adhered to the conditions laid down by the IMF and the US. The Thai government shut down two-thirds of the country's financial companies and is reeling under the weight of similarly leveraged operations, as are other Asian economies.
While the people who ran Long-Term Capital Management into the ground keep their jobs (though management's ownership was greatly reduced) and even reap a management fee on their rescue fund, 2,000 people in Thailand are losing their jobs each day. The situation in Indonesia is much worse - the financial system is a shambles, unemployment is at 20 percent, and 100 million people will live on less than $1 per day by the end of 1998. How can the Thai and Indonesian Governments explain that the hardship economic reform entails is necessary when the US signals approval for rescuing a hedge fund comprised of some of America's wealthiest investors?
The Thai and Indonesian governments, as well as others in Asia, can only be lost for words. Transparency is constantly evoked by the IMF, the World Bank, and the US, yet hedge funds aren't regulated and aren't responsible to anyone but a relatively small number of investors.
Prime Minister Mahathir's much-reported shortcomings aside, Long-Term Capital Management's bailout gives the Malaysian prime minister's criticism of the destructive forces of hedge funds some degree of credence. Hedge funds need to be regulated, and investors in hedge funds should gain or lose as market forces dictate.
The key to Asia's economic recovery is Japan. This will require recapitalizing Japanese banks, mandating greater transparency, and, perhaps most painfully, allowing failing financial houses to fall. But how can the US complain to Japan about insider dealings when it encourages US banks and brokerage houses to bail out some of America's allegedly most savvy investors?
If the US is to have credibility as the world's financial leader, then it must learn to practice what it preaches and shun double standards. If the US fails to do so, then America's policymakers should not be surprised to hear more Asian leaders beginning to sound like Malaysia's prime minister. If this happens, Asia's crisis may become America's mess.
* John J. Brandon, a Southeast Asia specialist, is assistant director of The Asia Foundation's Washington office. The views expressed here are his own.
If the US is to have credibility as the world's financial leader, it must practice what it preaches.