Contact: Rene Stulz, (614) 292-1970
[email protected]
Written by Jeff Grabmeier, (614) 292-8457
[email protected]
INTERNATIONAL BAILOUTS NOT NECESSARY FOR U.S. FINANCIAL SYSTEM
COLUMBUS, Ohio -- Despite arguments to the contrary, the major financial crises that struck countries like Brazil and Russia in recent years posed little risk to the U.S. financial system, according to new research.
The study found that economic meltdowns in Mexico, Korea, Russia and Brazil hurt those U.S. banks which invested most heavily in these economies, but barely affected other financial institutions. Huge financial bailouts of the countries also had little positive effect on U.S. banks except for the banks with the largest investments in the troubled countries.
The results suggest that these multi-billion dollar bailouts by the United States and the International Monetary Fund weren't necessary to protect the U.S. financial system, said Rene Stulz, co-author of the study and professor of finance at Ohio State's Fisher College of Business.
"Except possibly for the events at the end of August 1998 and the beginning of September 1998, we found no evidence to indicate the U.S. financial system was in any danger," Stulz said.
Stulz conducted the study with graduate students Bong-Chan Kho and Dong Lee. They will present the results next Saturday (Jan. 8, 2000) in Boston at a meeting of the American Economic Association.
For the study, Stulz and his colleagues compared how news of the crisis in each of the four countries affected stock values of major U.S. banks that were heavily invested in these economies, and the stocks of those banks that were not. Between 50 and 78 banks were surveyed for each crisis. The researchers also examined how news of major IMF bailouts affected these bank stock values.
"If the U.S. financial system was really at risk because of these financial meltdowns, we should see all banks suffering losses when news of each crisis became public," Stulz said. "But that wasn't the case. We found that banks that were heavily invested in the troubled countries suffered losses, as you would expect, but other banks were barely affected."
For example, in early September 1998 there was significant capital outflow from Brazil as news of the country's financial crisis became known. On Sept. 3, banks heavily invested in Brazil lost 4.57 percent of their value. Banks not involved in Brazil lost an insignificant 0.69 percent. (These figures take into account the general stock market movement that day.)
In general, analysis of the other countries' financial crises showed similar results, according to Stulz. "Our research shows that the market can distinguish between those banks that have a lot to lose because of a country's financial troubles, and those banks that are not in danger," he said. "The bottom line is that the markets did not think any of the adverse events we considered could have led to economically significant problems for U.S. banks in general."
In each of the four countries studied, the IMF stepped in as the economic troubles worsened and provided large bailouts. Many proponents argued that these bailouts were necessary to avoid threats to the financial system. If these fears were true, Stulz said, all banks should have benefited from the bailouts. But, again, that didn't happen. For example, on the day the IMF announced it would support a bailout of Brazil, heavily invested U.S. banks outperformed the stock market by 2.53 percent, while other banks did only 0.14 percent better.
Just how much did the IMF announcements benefit banks that invested heavily in Brazil? Stulz estimated that these banks increased in value by about $13.9 billion on three days associated with IMF announcements supporting a Brazilian bailout. "The big winners from the IMF bailouts were those banks that invested heavily in the affected countries," he said.
Not only were the IMF bailouts unnecessary for U.S. interests, they actually pose risks to the global financial system because they encourage banks to make risky loans in foreign countries, Stulz said. "Banks may find it optimal to take bigger gambles because, if they can expect IMF bailouts, they do not suffer as much if the gambles fail."
For comparison, the researchers also examined how U.S. banks reacted to another global financial crisis: the $3 billion meltdown last year of Long-Term Capital Management, a hedge fund. In this case, there was a private bailout of the firm; no public money was used.
Stulz said the economic significance of the LTCM crisis was actually much greater than the significance of the crises in Mexico, Korea, Russia or Brazil: U.S. banks which subsequently participated in the LTCM rescue lost 29 percent of their value between Aug. 27 and Sept. 4, 1998.
"But despite the magnitude of these losses, banks that were not involved with LTCM experienced no effect," Stulz said. "This shows that the market was perfectly capable of distinguishing between banks that were at risk and those that were not. There was no general bank crisis."
Stulz said there may be valid reasons to help countries like Brazil and Mexico when they suffer major financial meltdowns. However, protecting the U.S. financial system does not seem to be a good reason. "There is no basis for concern that markets react similarly across banks, ignoring their strengths and weaknesses, and that therefore banks have to be protected from markets," he said.
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