Undue exuberance on the part of investors, when price-earning ratios grow beyond fundamentals, or on the part of bankers who failed to assess the impact of high interest rates on collateral or cash flows, would expose both the investor and the lender to asset losses. 17. Specifically, banks in Asia, having easier access to funds as a result of high global liquidity, were able to expand lending much more quickly and, thereby, incurred higher risks in their portfolios that they need to manage more soundly. Ironically, domestic banks may have been induced to move into more risky lending due to increased competition in the form of new entrants and financial intermediation. There is no question that they need to manage these new risks better. 18. There is also one distinguishing feature of the Asian turmoil. The debt problems have not been those of the public sector. On the contrary, the fiscal positions of Asian governments have by and large been quite sound. East Asia, excluding Japan, ran a fiscal surplus of $ billion BIS Review 109/1997  -4-  or 0.1% of GDP in 1996. The debt burden, in fact, has been largely one of private sector overborrowing. The resolution of the debt of the private sector makes the Asian problems quite different from the experience of the sovereign debt issues of the 1980s. 19. In essence, the Asian problem is the age-old question of efficient resource allocation.
That is, both current and future residents are willing to pay the tax cost of servicing this debt because of the benefits that they receive from the services supported by that debt. Now consider a different scenario – one in which the jurisdiction is borrowing to pay for a current year operating deficit. This kind of borrowing is inconsistent with running a balanced budget, which is in principle required in all but one state. But, as people in this room are well aware, states and localities can often find ways to “get around” balanced budget requirements if they are determined to do so. One example of this was New York City in the 1960s and early 1970s, where annual operating deficits were repeatedly financed with shortterm debt, until the fiscal crisis exploded in 1974–1975. The key distinction between these two types of borrowing is that in the former case an asset is producing services that help to offset the cost of the debt, but this is not so in the latter case. Indeed, using debt to finance current operating deficits is equivalent to asking future taxpayers to help finance today’s public services. When this occurs, it means that the fiscal surplus offered by the jurisdiction in the future will be diminished by the value of these additional debts. That is, in the future, the cost of servicing this debt will drive a wedge between the taxes paid by households and businesses, and the current services provided to them.