[Outlook]Putting out the fire

The financial crisis that broke out in the United States has spread across the world like wildfire. Even so, its effects have been lessened in the local economy by financial authorities’ actions to put out the fire.

It is positive that central banks and government officials around the globe understood the danger of the credit crunch and enacted bold emergency measures, unlike the response to the Great Depression in the 1930s.

However, the fire is still smoldering and there are signs the blaze could spread to the real economy.

It will take some time before the financial insecurity is cleared and the global economy is restored to normal. The speed and the scope of the procedure will be determined by the reforms to the financial industry and monetary and credit policies. Restructuring of commercial and investment banks, reinforcement of a financial supervisory system and adjustment of liquidity will surface as key tasks internationally. Korea is no exception.

Let’s look at the argument that the current crisis means the end of U.S.-style capitalism. In the early stage of the crisis, European countries and anti-American economists made this argument. But it has become less and less persuasive, as it turns out that European countries and other developing nations are also experiencing so-called American issues - that is, a mortgage industry crisis, loose monetary and credit policies and excess household loans.

Some blame the boom in the financial derivatives market. But we shouldn’t overlook the fact that derivatives didn’t spark the mortgage crisis, and can actually trade off risks.

Another false argument is that the current financial crisis means the financial market has failed due to deregulation and globalization, and even that the market economy has collapsed along with neoliberalism. Some argue that the free market system will be difficult to sustain any longer, claiming intervention is inevitable. Left-wing experts who had been in the minority seem to view this crisis as a chance to improve their standing.

However, these arguments are farfetched. The possibility of bubbles in the real-estate market has been repeatedly pointed out for more than a decade, and it has been widely known that market indexes were showing signs of irrational exuberance.

Most economists and experts understand that the current crisis stems from the failure of monetary and credit policies that, in fear of a slowdown, put an end to self-regulation in the market by expanding credit.

As George Cooper of J.P. Morgan points out, the central banks intervened only during economic doldrums, leaving the markets alone during excessive booms. Such imbalanced intervention policy prevented the markets from calming bubbles in their normal manner. And this phenomenon was not restricted to the United States.

This market environment encouraged financial institutes to take excessive risks, creating a moral hazard, and led to mass production of mortgages that were expected to yield high profits but turned out to be nonperforming. The only mistake that most scholars and experts made was that they didn’t understand that the distortion of the financial markets could bring about such a serious catastrophe. The current crisis is the way in which all the distortion accumulated in the markets is resolved at once, displaying in a terrifying manner how the market works.

So, do the bailout plans that many countries are now introducing mean that governments will now intervene in the markets at will? Do the rescue plans justify the governments in so doing?

The answer to the first question entirely depends on the political decisions of different countries.

But to the second question, the answer is “No.” These rescue measures are emergency contingency plans to normalize the policies that have distorted the markets so far and the purpose of emergency plans should be limited to putting out the fire.

As the United States has nationalized some banks, some think of this as going back to a British model, under which the government intervenes directly in the market. But Prime Minister Gordon Brown of Britain denies this view, saying that this is only a temporary contingency measure, and that those banks will be privatized again as soon as possible.

What we should be concerned about is how to make sure that these contingency plans restore the markets as soon as possible without any negative side effects. We should discuss minimizing the moral hazard that bailout plans could cause, delicately intensifying the financial supervisory system and blocking political pressure on monetary and credit policy.

*The writer is a professor of finance at Hallym University. Translation by the JoongAng Daily staff.

by Chang Dae-hong