By PETER BATE

The occasion was particularly poignant for the Latin American government officials gathered for the October seminar "Crisis and Contagion in Emerging Financial Markets," that was held at the IDB's Washington, D.C., headquarters during the annual joint meeting of the International Monetary Fund and the World Bank. The Latin American countries, widely regarded as blameless victims of the present crisis, nevertheless suffered a sudden and painful loss of credit following the near-collapse of Russia's financial system in September.

"We are facing the first real global financial crisis, in which emerging markets around the world are feeling the effect of contagion," said IDB President Enrique V. Iglesias at the opening of the conference. "We must explore the origins of this crisis, discuss what countries should do at an individual level in order to build up their defenses, and examine what the international community can do to help find global solutions to a global problem."

Iglesias noted that conversations were already underway between governments, international financial institutions and the private sector on how to address the effects of the crisis, which was punishing Latin American countries despite their decade-long economic reform efforts.

In introducing the issues, IDB Chief Economist Ricardo Hausmann said that Latin America's current credit plight constitutes a clear case of contagion, as there were neglible economic connections between this region and Russia. In August, that country chose to default on some of its debt, sparking panic in emerging markets around the globe.

In the ensuing selloff, Latin American countries found themselves shut out of the same capital markets that had lent eagerly to them since they rebounded from the 1995 Mexican crisis.

The swiftness of this contagion rekindled the debate over the liberalization of capital flows that began with the 1997 economic crises in East Asia. Should countries regulate investment inflows in order to prevent speculative bubbles from building up? Or should they concentrate on beefing up their banks to withstand sudden swings in market sentiment?

Ernest Stern, a managing partner of J.P. Morgan, the New York bank, and a former senior vice president of the World Bank, argued that this was not a crisis of emerging markets but rather a global crisis that had followed a global boom.

"The understanding of markets remains very imperfect," said Stern. "I think we have a crisis today that is fundamentally different from crises that occurred in a financial system that was smaller, more heavily based on bank lending instead of capital markets, and had fewer participants."

Stern recommended that developing countries build stronger financial buffers because in many cases their financial institutions were not robust enough or sufficiently supervised to participate in the modern capital markets and absorb such resources carefully.

World Bank Chief Economist Joseph Stiglitz observed that financial crises are becoming increasingly frequent and painful. At least 70 countries --industrialized as well as developing-- have suffered such upheavals over the past 25 years.

The crises in East Asia, however, shattered some of the tenets about these shocks, he added. Economic models for predicting financial disasters did not single out the Asian "tigers" as especially vulnerable. Their financial disclosure standards were about average, suggesting that a supposed lack of transparency was not the triggering cause. Moreover, some of these countries had not experienced an economic downturn in three decades, so volatility was not an issue.

"What we do know is that there is sufficient economic justification for doing something," Stiglitz said. "If you believe that there ought to be someone involved in the bailout business, then you have to believe that there ought to be interventions to stop the events that lead to it."

He argued that financial crises are systematically related to financial market liberalization, and that the likelihood of such episodes can be reduced by having better regulations. Preventive measures should go beyond strengthening capital adequacy standards for financial institutions to setting restrictions on risky investments, he said. To buttress his argument, Stiglitz pointed out that Thailand, after dropping the rules it kept against real estate speculation in the 1980s, wound up with a bubble that eventually burst and wrecked its financial system.

International institutions, he suggested, could play a role in advising countries to adopt sound policies and in persuading investors that such restraints on capital flows do not signal hostility to investments but simply a desire to avoid risks "that are not compensated by adequate benefits."

Other panelists voiced support for taxation or market-based controls of capital inflows. José Antonio Ocampo, director general of the U.N. Economic Commission for Latin America and the Caribbean and a former finance minister of Colombia, defended the reserve requirements imposed on short-term foreign investments in his own country and in Chile. He also called for establishing commodities stability funds, such as Colombia's coffee fund, Chile's copper fund and Venezuela's planned oil fund, which were designed to cushion the effects of steep drops or spikes in prices of those countries' key exports.

"Crisis prevention is a task of boom periods, and instruments of this sort must be designed to manage them," he added.

Michael Gavin, a former lead research economist at the IDB who recently joined the Warburg Dillon Read investment bank, presented a paper he co-authored with Hausmann that set forth a series of measures Latin American governments could take--and, in fact, which a few have already taken--to meet three basic objectives in order to weather international shocks: they must be solvent, they must be liquid, and their policies must inspire confidence.

While many of their recommendations for fiscal and banking policies ran along the lines of widely accepted best practices, such as running very small deficits or even modest fiscal surpluses during good times or avoiding short-term debt, Gavin staked out a provocative position on monetary and exchange rate policy. He based his argument on observations of Argentina and Mexico, two countries with similar fiscal policies that were also the worst hit by the 1995 "tequila" crisis. Looking at how these countries have fared during the recent financial turbulence, he found that in Argentina, a country with a rigid currency board, interbank interest rates were less than half of those in Mexico, which has a flexible exchange rate.

"If there are any casualties in the conventional wisdom about exchange rate management, it's the belief that flexible exchange rates allow the latitude to lower interest rates during periods of crisis," he said.

Speaking for Argentina, which has successfully implemented several of the best practices enumerated in Gavin's and Hausmann's paper, Finance Undersecretary Miguel Kiguel stressed his government's efforts to strengthen its banking sector immediately after the 1995 "tequila" crisis, when Argentine banks suffered a run on deposits comparable to the U.S. panic of the 1930s.

The "vodka" crisis unleashed by Russia prompted the Argentine government to seek support from the multilateral banks to bolster a standby liquidity fund it had arranged with foreign lenders long before the most recent bout of instability in global financial markets.

Regarding the role multilateral development banks could play in this scenario, Hausmann noted that institutions like the IDB are often asked to show concrete results for their efforts to help borrowing countries develop their economies. But in terms of containing the social costs of financial volatility by protecting people's livelihoods, creating precautionary arrangements may be more important than more traditional projects.

"One might say that we are not structured to prevent houses from burning down but rather to send some blankets after the fire is put out. I think that precautionary measures that stop houses from catching fire are very much what we should be working on," he said.