Statement by Representative James A. Leach
Chairman, Committee on Banking and Financial Services
The Dilemma of Public Policy in an Era of Kleptocratic Greed
Professional Bankers' Association
Washington, D.C.

I would like to speak today about the interplay of three issues -- international economics, foreign policy, and finance -- with U.S. public policy.

As most Americans understand, this has been a year of exceptional strains on the global economy. By early fall, the deteriorating financial conditions in emerging markets began to raise concerns about systemic risk in the international financial system. With events moving in rapid succession -- Russia's financial collapse, concern that Latin America was at risk from contagion, the collapse of the American hedge fund, Long-Term Capital Management, and a growing global credit crunch -- the world financial system appeared to teeter on the precipice of its greatest crisis in a half century.

Since the IMF/World Bank meeting in early October, Federal Reserve action to ease monetary policy, Congressional approval of new funding for the International Monetary Fund, and coordinated G-7 recognition of the crisis environment has helped stabilize financial markets.

Nonetheless, it would appear premature to conclude that the danger to the world economy has passed. At issue now is the duration of the crisis in emerging markets and the recession in Japan, their potential effects on the U.S. economy and American national interests, as well as the appropriateness of responses by policymakers in Washington and elsewhere around the globe.

This is a defining moment for the United States. The current economic outlook, while more hopeful than many would have dared to conjecture just two months ago, remains fraught with economic and political risks.

Maintaining global financial stability and economic growth is self-evidently a vital U.S. national interest. Financial crises, economic recessions or depressions, and collapsing currencies all have a direct impact on the competitiveness of American goods and services in global markets, the continued growth of our economy, the well-being of American farmers and workers and, not incidentally, conditions that make a more civil, peaceful world possible.

There are no assured stabilization answers, but a critical ingredient of a U.S. approach should include leadership through the international financial institutions and cooperation with our friends and allies on strategies to advance sustainable economic growth. In this context, new prudential approaches to international economic problem-solving need to be developed before the global trend toward democracy and open markets is placed at even more serious risk.

Accordingly, I've gone out of my way to insist that the Banking Committee work cooperatively with the Administration on national interest issues which are increasingly in the economic, rather than the political, arena. In this regard, I am pleased that the 105th Congress approved a full replenishment of the financial resources of the International Monetary Fund, with a policy framework that follows the basic model of the legislation I drafted and moved through the Committee in March.

Yet funding and reforming the IMF alone will not promote international financial stability. If the world is to avoid ever more expensive IMF programs and their attendant moral hazard problems, a new consensus on reforming the international economy, particularly financial standards, must be developed. The world community needs to examine anew issues related to appropriate exchange rate regimes, strategies for resolving public and private debt problems, and the roles of the IMF and World Bank in the 21st Century.

In this regard, I welcome the October announcement by G-7 Finance Ministers and Central Bank Governors of a broad set of principles aimed at strengthening the international financial system and improving crisis management

Several of the G-7 proposals, particularly those focused on developing internationally accepted standards on transparency and the rule of law, are non-controversial, although difficult to implement in certain countries. The IMF legislation passed by the Congress emphasized the importance of establishing sound international principles of corporate and financial accounting in the private sector and of increasing the transparency of the economic situation in the public sector, including Central Bank reserves. In this regard, I am also broadly sympathetic to new international efforts to assess the adequacy and availability of data on the exposures of investment banks, hedge funds, and other institutional investors.

Likewise, the Banking Committee has long emphasized the importance of redoubling international efforts to strengthen national financial systems. A number of serious efforts are underway in the official community, including a long-overdue review of the 1988 Basel-based system of capital standards, which is likely to receive Committee attention in the next Congress.

With regard to the debate underway about techniques to promote an orderly integration of international financial markets, the IMF's new contingent credit facility and the Brazil package raise profound questions. What is the criteria for deciding when countries qualify for stand-by credit under this contagion facility? Will the criteria and the countries be publicly known? Once a credit line is announced, can it subsequently be withdrawn from a country if imprudent economic policies are adopted without precipitating a crisis? Despite all the wrenching about moral hazard, whatever happened to private sector involvement? And why, in contrast to the so-called "Manila Framework" applied to stabilize the Asian financial crisis, is bilateral assistance provided in tandem with multilateral support -- instead of as a "second line" of defense?

More broadly, it is telling that neither the Brazil package nor recent G-7 summitry has addressed the issue of exchange rates. As Deputy Secretary Summers underscored in a recent speech, "the core proposition of monetary economics is a trilemma: that capital mobility, an independent monetary policy and the maintenance of a fixed exchange rate are mutually incompatible." On one side of this argument is Federal Reserve Chairman Greenspan, who has observed that market forces have made exchange rate pegs untenable, implicitly suggesting that some form of floating rates is desirable. On the other are "liberal" economists such as Paul Krugman (and the World Bank's Joseph Stiglitz), who argue that the best defense against capital flight may be some form of capital controls. The Administration and the G-7, however, are attempting to occupy the middle ground -- skirting the issue of exchange rates but describing capital controls as anathema -- and defending that position against market skeptics with the public's money. Only time will tell whether this approach to the policy trilemma is credible or prove untenable.

In any regard, the Bank is certainly correct that Americans and the world need to be responsive to the humanitarian needs of peoples who have been devastated by events beyond their control. Indonesia, the world's fourth most populous country, has not only experienced an economic collapse, but been beset by an El Nino-related drought that has brought it to the edge of famine. In Eurasia, Russia has sunk into an economic and political abyss that brings the revolutionary conditions of 1917 to mind. The ruble has lost virtually all value, banks have closed and store shelves are empty. Indeed, Russia is struggling to prevent potentially catastrophic food shortages as economic chaos has all but shut down imports ahead of its always bitter winter. The prospect of a Russian food crisis can only amplify voices from the left and right --- the Communist past and an intolerant and militant nationalism with possibly Fascist dimensions – each of which clamors for return to a more politically repressive, state-directed economy, however growth-stifling it may be.

How could the bursting of the financial bubble in Thailand last year have precipitated a global crisis?

A review of origins of the Asian crisis suggests that those countries with modern, well-regulated financial systems have done well, while those without have found public treasuries jeopardized and economies in peril.

But even if the world were suddenly to adopt the market policies and practices along the

American model, that would not prevent financial crises from occurring. As former Federal Reserve Chairman Paul Volcker wrote this fall in the Financial Times, "Consider the latest bit of evidence from the U.S. itself: one unsupervised and unregulated financial institution -- an institution boasting the most elaborate models of market behavior and sophisticated advisors -- carried the possibility, by testimony of the U.S. Federal Reserve, of pulling down the financial tent."

The failure and government-led rescue of America's most heavily-leveraged hedge fund,

Long-Term Capital Management represents one of the most serious and symbolic financial events of the decade.

Dubiously enshrined in establishment economic thinking is the "too-big-to-fail" doctrine – the notion that government will intervene to save a bank in trouble if its collapse would cause major harm to the economy. With the rescue of Long-Term Capital Management a corollary appears to be in the making: "some financial firms are too big to liquidate too quickly."

The application of the "too big" doctrine for the first time beyond a depository institution raises troubling public policy questions. For many of us the "too big" doctrine is simply too prone to fail.

From a social perspective, it is not clear that Long-Term Capital, or any other hedge fund,

serves a sufficient social purpose to warrant government-directed protection. In one view,

hedge funds provide liquidity and stability in financial markets, allowing economies to finance the infrastructure and enterprises necessary to modernize. In another view, hedge funds have a narrower rationale: they're seen to be run-amok, casino-like enterprises, driven by greed with leveraged bets of such huge proportions they can influence global capital markets and even jeopardize the economic viability of individual sovereign states.

In the past decade, the American public's attention has been focused on institutions of finance and the development of sophisticated trading instruments such as derivatives. New fangled products can, in many instance, be helpful as hedges against risk, but as demonstrated by Long-Term Capital's failure, over-leveraging can produce destabilizing conditions for companies, as well as the general economy. While recognizing that there can be merit to utilizing modern financial instruments, what is needed is a return to the basics and an emphasis on the efforts and needs of ordinary people, as contrasted with a disproportionate emphasis on nihilistic insider games.

As a country, we are obligated to act promptly and non-ideologically. It is simply frail judgment to deny, for instance, the Cuban people humanitarian commerce in food and medicine. To ignore problems of potential famine in such diverse parts of the globe as Russia, North Korea, Indonesia and Sub-Saharan Africa is not the American way.

While isolationism is always at issue in our democracy, the American heritage involves a

heavy dose of compassionate internationalism. Consistent with the most caring dimension of the American foreign policy tradition Congress should support efforts through the World Bank and other development institutions to bolster already fragile safety nets for education, health and social protection in crisis-affected countries. Such initiatives should be designed to send a practical message about America's concern for the plight of average citizens around the globe -- not just government officials, captains of industry and problems of corrupted capital flows.

There are points where politics and economics intersect, and when political institutions

implode, as they have in Russia, economic consequences follow. The best and the brightest on Wall Street lost billions betting that Russia was "too nuclear" to fail. They didn't grasp that it was too corrupt to succeed and that it did little good for the West to transfer resources to Russia's Central Bank if it simply recycled them to a private banking system which served as a money-laundering network for insiders.

No nation-state can prosper if it lacks a place where people can save their money with

confidence and seek lending assistance with security. Russia, which is the land mass most

similar to our own, has been kept back for most of this century because of the Big "C" –

Communism – and is now being kept back because of the little "c" – corruption – which is likely to be more difficult to root out than Communism was in the first instance.

It is bewildering how, with all the attention in recent months being given to reforming the

"architecture" of the global financial system, no one is paying attention to universal values. But, honesty must prevail over corruption or no financial system will work. In fact, unless the point is made with regard to countries such as Russia that the problem isn't that market economics are wanting, but that corrupt market mechanisms are pervasive, the Russian people will never understand the lessons of the century. The old battleground in world affairs was Communism vs. Capitalism; the new one contrasts corrupted quasi-capitalist economies with non-corrupted ones; corruptocracies vs. free-market democracies.

What the Russian people – and those of so many developing countries – deserve is a chance to practice free market economics under, not above, the rule of law. If attention is paid, above all, to establishing honest, competitive institutions of governance and finance, virtually everything else will fall into place.

If it is true that foreign aid without trade is prescription for dependency rather than self-sufficiency, then so too it is true that aid without the development of a free enterprise psychology and legal infrastructure will be of fleeting significance. Unless laws are developed to protect property and provide incentives for entrepreneurship, many of the newly established states of the former Soviet Union will likely stagnate for decades with per capita GNP wallowing at the level of the world's least developed countries.

Nor should Russia alone be singled out. As Malaysia's embattled former Deputy Prime Minister and Finance Minister, Anwar Ibrahim, recently wrote in the Asian Wall Street Journal with respect to the Asian financial crisis, "many of our problems could have been avoided if there had been greater commitment to eradicating subsidies, monopolies, and favoritism." A new Asian renaissance, he wrote, "should encompass not only political transparency and better corporate governance, but also reforms to society and culture, and respect for human rights, the environment, and the independence of the judiciary. Without this commitment to these values, debate on resolving the Asian crisis may well turn out to be mere lip service."

There is an old saw that democracy can be talked to death; actually, this is only the case if money does the talking. All political systems are vulnerable to corruption, particularly if government and industry become intertwined.

From Aristotle to John Stuart Mill, from Marx to Schumpeter, social scientists have attempted to define types of political and economic systems. The international financial institutions today by charter and by organization too often pride themselves in not being systemically discriminatory out of an assumption that the goal is to help people whatever form of government their elites may have imposed. But the discrimination which can and should be made without equivocation is between governments that are corrupted and those that are not. It is simply indefensible for public funds to be used to pad private pockets.

With regard to the issue of corruption, the lessons are writ large: the best antidote to cultural corruption is a legal system where economic enterprise is decentralized and subject to as little financial control by the government as possible. The general level of corruption decreases as the degree of market competition increases. Free market systems are not only more efficient than statist models, but more honest.

From the public's perspective it must be understood that politicians are dangerous and that, kleptocracy aside, their most counterproductive weapon is protectionism. This is particularly true in finance. Any country that protects itself from foreign competition in finance injures itself and, in effect, emboldens corruption. Unilateral actions or international agreements to open those markets that are closed to Western-system financial institutions provide the best chance for corrupt systems to reform themselves. Their publics will, if given a chance, lead their leaders by saving where they are best protected and borrowing where they get the most competitive terms.

In conclusion, as the Banking Committee prepares to hold hearings in the next Congress regarding the future of Russia, I would make two policy suggestions to the international financial institutions: (a) they should invest greater resources in the development of sound intermediating financial systems in developing countries that are accountable to law; and (b) decentralize their own lending practices to borrowing countries, whether to individual regions (like Siberia) or provinces, or to creditworthy private sector actors, especially when capitals like Moscow are centers of corruption, rather than public accountability.

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