Israel's Central Banker on the Economic Crisis

Stanley Fischer may be thousands of miles from the epicenter of Wall Street's meltdown, but few people are better positioned to understand it. The 65-year-old former MIT economics professor supervised Ben Bernanke's doctoral thesis on the Great Depression. Later Fischer worked as a senior IMF official during the Asian financial crisis. Three years ago he moved to Israel after finance minister Benjamin Netanyahu persuaded him to leave his job at Citigroup and take over as the Jewish state's central banker. He spoke with NEWSWEEK's Kevin Peraino at his office in Jerusalem. Excerpts:

NEWSWEEK: What were the key lessons from Bernanke's research on the Great Depression?
Stanley Fischer: Ben has drawn two conclusions, which I think are right. The definitive [interpretation] when he was a student was that of [Milton] Friedman and [Anna] Schwartz, which was that the Fed didn't let the supply of money decline drastically [during the Great Depression]. Ben's thesis is: yes, but what really happened was that the credit mechanism collapsed. And it's clear from everything he's said that this emphasis on the credit system is still central to his thinking. And it happens to be correct. The second conclusion is that you've got to [ease the credit crunch] quickly. I'm sure nobody would say this in public, but if you make a few mistakes along the way, well, fine—keep going, fast.

Was it a mistake to let Lehman Brothers fail?
I think that'll be a big central question in the histories of this period.

What have been some of the other missteps so far?
There will be a question—and I'm as guilty as anybody—of what were we doing between July and August 2007 and now. There's also the issue of how you get the attention of the Congress. You can't go to them and say: I see a dark cloud on the horizon, and therefore I need $500 billion—give it to me because I'm worried. Part of the problem is that there were different views about what exactly needed to be done. A lot of people were saying that there should have been more focus on putting capital into the banks, but it's never the case that every economist is saying the same thing.

Where do you fall on that spectrum? Did you share the view of someone like Paul Krugman who was arguing for the government to take an equity stake in these banks?
I think it was clear that the government needed to inject capital into those banks. Whether it needed to take an equity stake immediately, or whether it wanted to put in something that gave it the option to take an equity stake later—that's a matter of judgment. But they had to get the money in, in quite significant amounts. [The risk is] that if the banks don't return to health in time, then presumably the government will find itself with very major stakes in a lot of banks. That will be kind of awkward.

Banks in Israel were only recently privatized. Will any need to be renationalized?
I don't think we're going to have to do it. But if the banking system gets into difficulties, then there's no question that the government will stand behind the banking system. I very much hope we don't get anywhere near that.

So far Israeli banks seem to be weathering the crisis fairly well.
Only one bank had any sizable holdings in [mortgage-backed securities] and subprime and so forth. And all the others didn't. Some of them for good reasons. And others because they weren't sufficiently integrated into the global market. They weren't very exposed abroad; they had pretty good diversification of their holdings in foreign banks. But the real reason was that our mortgages are very conservative instruments. At this time it happened to be a benefit. Most of the time Israelis complain like heck that they have to put down large down payments. Now that we're in this crisis, that turned out to be a very good thing.

Were you surprised to see Alan Greenspan acknowledge that some derivatives like credit-default swaps should have been better regulated?
I agree with that. [But] I'm concerned in this crisis that in a lot of things people will go too far. There are securitizations that have been very successful. The securitization of credit-card receivables has been working very well indeed. I don't think there's necessarily a problem with the securitization of mortgages. This European covered-bond system deals with some of the problems in securitization. In the securitizations in the United States, the risk is transferred to the buyer. In the covered-bond system, the risk stays with the seller, who is usually better able to deal with it.

You think securitizers should keep a portion of what they're selling?
Somebody has to have the incentive to understand the risk right. The natural place seems to be the originator.

In recent weeks, currency markets have seen a flight to the dollar and yen. Should the IMF be propping up battered emerging-market currencies?
We've just come off five years of the most rapid growth in a very long time. It's one of the benefits of globalization. Now we're seeing some of the negative sides. The fund should have more money and should help countries deal with the negative consequences of what's going on now. I'm very glad it's back in action.

Pakistan's president Asif Ali Zardari was complaining this week about IMF loan conditions. What lessons did you learn about excessive conditionality from your time at the IMF?
There were cases in the 1990s when the fund had too much conditionality on things that weren't essential. There was a period in the early parts of the program when the fund wanted fiscal contraction when the fiscal contraction probably wasn't necessary. So that was the lesson I learned. But you cannot have a program where you say: fine, we'll give them the money, and they're responsible people. Some of the countries do get into crises because they're pursuing the wrong policies. You've got to correct that.

Is this the end of the theory of "decoupling " ?
I think it was very unlikely that decoupling was [actually] happening. The decoupling view is based on the fact, by and large, if you look at the data on trade within Asia, intra-Asian trade has risen a great deal. And trade with the rest of the world is down. So there was a view that they're less dependent on the outside world. But then when you took into account what the trade is about, it was in many cases goods being produced for export to China to be put into goods which would then be exported to the United States. The other aspect is the financial connections are so much stronger than they used to be. It's implausible that a financial crisis of this magnitude wouldn't at some point have an impact.