Compare the 1997 Asian financial crisis with the subprime crisis

Résumé du document

The subprime crisis was triggered by an expectation of defaults of payments on subprime mortgages in the US. It is an on-going crisis that has already led to the free fall of the US housing prices, billions of losses by banks, and generally speaking a slow-down (maybe a recession) of the American economy. The impact of the crisis has already been big enough so as to influence all the major capital markets of the world. On the other side, the 1997 Asian financial crisis was a major financial crisis that hit most of south-East Asia and Japan, also referred to as the East Asian currency crisis. There were fears that the crisis would grow through financial contagion, but it affected the world economy only relatively (afterwards investors were reluctant to lend money to developing countries, leading to a meltdown of these economies). Although we do not know exactly how bad the current crisis is going to be, we can say that both crises are serious. We will describe the main characteristics of the two crises and then compare them.

Extraits

[...] Japan suffered too, but the country was facing its own long-term economic problems. Until 1997 the Asian developing countries received a very large amount of international investments, and their governments maintained high interest rates in order to attract investors with a high ROE rate. The consequence of this policy was a flow of money and investments, followed by a tremendous surge in assets prices (notably in real estate). South East Asian countries had growth rates between 8 and 12% during the 1980's and 1990's, thus getting the attention of economists that coined this phenomenon the “Asian economic miracle”. [...]

[...] There was therefore an abundance of loans at low prices, and traditional investments had such low returns that investors were led to lend money to more risky individuals/ businesses. The expansionary monetary policy was such that a liquidity shortage seemed impossible. The same happened in Thailand were the market players did not consider the possibility of scarce money. In both cases the abundance of liquidity led to lax credit standards (no one seems to care to much if people / businesses will be able to meet their payments since liquidity is so abundant). Moreover, both crises saw a burst of a real estate bubble. [...]

[...] The securitization of illiquid assets thanks to complex financial products transferred the troubles of the mortgage bond market to the rest of the financial system. This move from traditional banking practices towards more innovative techniques spread the risk of insolvency across a much wider group, reducing the level of risk of each individual. The problem is the actors on the markets felt insecure when they realized that credit risk was so widespread it was impossible to identify with certainty who ever hold the risks and who was facing losses. [...]

[...] In the end the governments allowed their currency to float, provoking bankruptcies of many businesses whose currency-denominated liabilities rose dramatically. Among the global consequences, investors were reluctant after the episode to lend money to developing countries, which experienced a slow-down after 1997. The shock on the global economy also reduced the oil prices (to a currently unbelievable level of per barrel ) causing financial troubles in the OPEC countries but also the 1998 Russian crisis. These two crises clearly have characteristics in common; however we will explain why they are essentially different. [...]

[...] China might also have had an impact on the difficulty these countries were facing, since it became at that time a more competitive economy, making it harder for the latter countries to export. South East Asian countries had a strong currency whereas the Chinese currency was depreciated relative to the U.S$. As a consequence Western buyers would turn their heads to China. Coming back to the causes of the Asian crisis, it appears that the very large quantity of credits available in these economies generated extremely high assets prices. The bubble inevitably burst, leading the borrowers to default on debts obligations. [...]