Don't cry for me Wall Street: financial amnesia again

The panic that is sweeping world financial markets seems to illustrate the memory loss that descends on market players. With Lehman Brothers now joining an illustrious list of distressed financial institutions such as Bear Stearns, Citigroup, UBS, Northern Rock and so on, one wonders if previous financial lessons have really ever been learned. History is replete with similar examples of financial excesses and unnatural exuberance, leading to bursting bubbles. While there are no lynch mobs pounding on the doors of the White House - yet - the latest panic on Wall Street does have some eerie parallels with the most spectacular financial meltdown of this decade and perhaps of the last half century - that of Argentina's financial and economic crisis of 2001-2002. For those who cannot remember, or who have developed financial amnesia, a slow-burning credit crunch and systematic run on Argentina's banks culminated in December 2001 with a whopping 70 per cent devaluation of the peso; the world's biggest ever sovereign debt default of US$14 billion (Dh51.4bn) in bonds; and to cap it all, a musical chair succession of five Argentine presidents in two weeks. The capital of Argentina, Buenos Aires, dubbed the "Paris of South America" for its elegance, became a nervous ghost town and mass riots broke out, with hungry mobs looting supermarkets and equally angry but well-dressed rioters in suits and neckties entering the Argentine congress and setting parts of it on fire. The economy went into free fall with 60 per cent unemployment and Argentina, which had been one of the world's richest five countries in the 1930s, was suddenly put on the terminally ill watchlist. In the next four years, the Argentine economy contracted by 20 per cent and the scope and duration of the recession rivalled the Great Depression of the 1930s, or any crises seen anywhere since. Could such a situation ever materialise in the US and other financially distressed markets? The endemic corruption and flagrant disregard for property rights that made Argentina's implosion so dramatic is not present in any of the major Western financial markets, yet the Argentine crisis does yield some parallels and cautionary tales that might be of use in this financial crisis. Like the subprime problem and continuing news of more blue-chip financial institutions revealing losses, the Latin American meltdown began with a genuine but controllable financial distortion that eventually got out of hand and developed into a much more serious crisis of confidence, and panic. As we know, nothing, but absolutely nothing, can stand up to panic, whatever soothing words are uttered. In Argentina's case, the main problem was a currency peg that over time had become overvalued by about 20 per cent. This was not worrying by itself, as the International Monetary Fund (IMF) was hailing Argentina only two years before the collapse as the world's best free market "reformer" of the 1990s. Everyone, including the IMF, was uniformly bewildered by what came next. Fundamentals were not enough to regain confidence, as once the Argentine public lost faith in their economy and their government's ability to control it, the country's fate was sealed. Panic engendered more panic. No amount of rescue packages, not even a staggering $40bn bailout led by the IMF and the US, was enough to turn matters around. Today, economic surveys reveal that three out of four Americans expect a recession and almost half foresee a depression, all of which are foreboding reminders of the power of self-fulfilling prophecies in economics. The tools available to governments - interest rate policies, discounted loans and cosmetic tax cuts - are simply not enough to stem panic once it takes root. Indeed, the subprime problem in the US may ultimately be remembered not for its technical details, but for the fact that it unmasked a much deeper lack of confidence, at home and abroad, in America's regulatory apparatus, financial system and government leadership. In times of trouble, people tend to look to their leadership for strength and direction. A crisis also represents an opportunity for an economy to correct itself. Argentina ultimately emerged from its depression with a much healthier economic model, free of the distortions that led to its collapse. The country is now, thanks to a boom in commodity prices, in its fifth straight year of eight per cent-plus growth. In the current financial crisis, the technical factors are arguably more important than the human ones. While Argentina's fundamental problems were currency and debt-related, America's reliance upon the housing boom to fuel broader economic growth in recent years was very unhealthy, and in the long run unsustainable. The gross overvaluation in the US housing market must fully unwind itself before the "normal" economic cycle can resume. The bad news for the US is that it could take many years. In the meantime, expect more painful news from leading financial institutions, all desperately seeking recapitalisation. Not many prizes will be given out for guessing where many will turn up to drum up the new capital injection. Dr Mohamed Ramady is a former banker and Visiting Associate Professor, Finance and Economics Department, at King Fahd University of Petroleum and Minerals, Saudi Arabia