Commentary: Let The Markets Do The Rescuing

It was supposed to be a time to toast East Asia's economic successes. Instead, the currency crisis that has hobbled many of the region's Tigers overshadowed the annual meetings of the World Bank and International Monetary Fund that ended in Hong Kong on Sept. 25. Amid the chardonnay and dim sum on the party circuit, the talk was of recriminations and contrition over the collapse of the Thai baht and other regional currencies.

How should emerging economies and investors be protected against financial crises like this? The most popular cure--throwing money at them--is a potential recipe for further trouble and even bigger bailout bills. Perhaps a market solution would be better. That wouldn't keep the likes of Malaysian Prime Minister Mahathir Mohamad from calling billionaire hedge-fund operator George Soros and other speculators "unnecessary, unproductive, and totally immoral." Nor would it keep Soros from terming Mahathir a "menace." But it's possible that market-based financial crisis management would be cheaper and better than the current approach.

ROAD TO RUIN. Consider the last two bailouts, of Thailand and Mexico. So far, Japan and the IMF have cobbled together $17.2 billion in credits to help Thailand. That's on top of the billions in emergency loans to Mexico after the peso collapse of 1994. Now, the Fund is planning to boost its capital by $285 billion to cope with the next crisis. Taxpayers in industrial countries would foot the bill. Japan even suggested a $100 billion fund for Asian weaklings. But open-checkbook policies may be the road to ruin. As Indian Finance Minister P. Chidambaram sees it: "Rescue packages encourage bad behavior."

The IMF should always help the world's neediest. But it must be more choosy about where to step in. As long as emerging-market governments believe the IMF will come to their rescue, some may be prone to pursue irresponsible policies. Likewise, investors in these countries may assume undue risks if they feel the Fund will put a floor under markets in times of stress. Investors may even be doing that now, judging by the state of emerging-market "spreads," the difference between yields on developing countries' debts and those on U.S. Treasuries. These spreads should be wide to account for the kinds of troubles that have beset the Thais and Mexicans recently. But with bond yields low in the industrial world, investors have poured money into emerging-market paper. The influx of cash helped the Salomon Brothers Brady Bond Index return 31% in the year ended Aug. 31, against only 0.7% for Salomon's World Government Bond Index, as spreads narrowed to some of their lowest levels ever.

If investors need insurance in emerging markets, let them pay for it up front. Instead of ad hoc IMF coverage, why shouldn't profit-driven insurance companies get in the act? Insurers could urge countries to change unsound policies the same way they do with commercial accounts--by threatening to cancel coverage before disaster strikes.

Emerging-market policymakers can craft some insurance of their own. Sound economic and monetary policies are essential. Governments must also make sure domestic financial systems are up to the challenge of dealing with huge inflows of hot money. Central banks need to think carefully about how liquidity from abroad is turned into credit locally. Most important, they need to better supervise commercial banks so that they don't run into the bad-loan problems that have helped destroy investor confidence in much of East Asia.

Setting up sophisticated regulatory systems and deposit insurance plans will cost money. Some countries, including Chile, have limited hot-money inflows. That has a cost too--slower economic growth. But they are gaining more stability. For the IMF, investors, and emerging markets, the focus now should be on preventing accidents, not shelling out big bucks to clean them up.