The Odor Across the Oder

What's gone wrong in Eastern Europe.

To the global recession, add an emerging market meltdown. This time Southeast Asia and Latin America are ceding the dishonors to Eastern Europe. The old Soviet bloc shot up this decade. But then the credit crunch hit and capital fled, and it has spiraled down fast.

Three countries have already gone hat in hand to the International Monetary Fund, and more may be on the way. The lesson isn't about market failure or the downside of open borders for capital. It's about the importance of sound economic policy. From far away, the region east of the Oder River blends into a single space of collapsing living standards. But there is more than one Eastern Europe.

The Baltics and Balkans succumbed to the same bubblenomics as house-happy Central California or Iceland. Double-digit growth in Latvia, Lithuania and Estonia was fueled by debt and short-term capital inflows. Now these gains are being reclaimed, with GDP slated to fall by double digits in the Baltic states this year. The scene of the crash looks familiar. Residential mortgage debt as a share of GDP in Latvia and Estonia climbed, respectively, to 33.7% and 36.3% -- worryingly high because a lot is denominated in foreign currency, though still not as high as Iceland's 121%.

The government in Latvia, a regional banking hub, fell last week after the IMF imposed austerity measures. Standard & Poor's downgraded its debt to junk; Romania is the other noninvestment grade member of the European Union. In Russia, Vladimir Putin spooked investors with his assault on property rights, and the collapse in oil prices did the rest last year. The Moscow stock market fell further than any other in the world, straining companies that borrowed heavily overseas. For now, Russia has deep enough reserves to avoid a repeat of its 1998 default-devaluation.

Ukraine isn't as fortunate. It suffered when prices for its chief export (steel) fell while its chief energy input (natural gas) rose. Though a vibrant democracy, Ukraine isn't blessed with a mature political class able to put its economy on stable footing. The IMF has stepped in there, as it has in Hungary.

Elsewhere more virtuous behavior has partially shielded countries with stronger fundamentals. The Czech Republic and Poland avoided the worst of easy-money mania and attracted capital for direct investment, often in export industries, that can't flee at the first hint of trouble. Their economies have made the transition from communism to a market economy built on the rule of law.

But in a global downturn, they're also seeing growth fall and unemployment rise. The Polish zloty has dropped 15% against the euro this year, the hardest hit of the non-euro EU currencies. The Czech koruna is down as well on (by most accounts, exaggerated) fears about mortgage debt and current account difficulties. Tainted by association with an ugly neighborhood, the Poles and Czechs now better realize that safety from currency attacks can only come with the euro.

The EU needs to keep close watch, what with Western European bank exposure to the region at $730 billion. On Sunday, the European Union will discuss ways to prop up weakened financial systems and get credit flowing. (Sounds familiar to an American.) The bloc's bright idea is to double funding for the IMF, which can help with emergency cash as long as it leaves its antigrowth ideas in Washington.

After the global boom, the bust is hitting all -- but not equally. The worst affected in Eastern Europe repeated mistakes made in Asia and Latin America in previous crises. It's a painful, but potentially useful, lesson.