Study of Financial Crisis

DISSERTATION REPORT ON DIAGNOSTIC STUDY ON FINANCIAL CRISIS WITH SPECIAL REFERENCE TO SOUTH EAST ASIAN CRISIS, RUSSIAN CRISIS & SUB-PRIME CRISIS

Submitted towards the partial fulfillment of MBA in International Business (2007-09)

Faculty Guide: Dr. Ajit Mittal

Submitted By: Priyanka Mahajan MBA-IB 2007-09 A1802007345

AMITY INTERNATIONAL BUSINESS SCHOOL UTTAR PRADESH, NOIDA

CERTIFICATE OF COMPLETION

This is to certify that the dissertation report on "Diagnostic study on financial crisis with special reference to South East Asian Crisis, Russian Crisis & Sub-Prime Crisis" prepared by Priyanka Mahajan, Roll No. A1802007345 of MBA-IB(2007-09) batch is her genuine effort under my guidance and supervision.

___________________________
Dr. Ajit Mittal (Faculty Guide)

_______________
Priyanka Mahajan

ACKNOWLEDGEMENT
2

It’s an immense pleasure to express my sincere and humble gratitude to my mentor and faculty guide Dr. Ajit Mittal, for his guidance, continuous support and cooperation, to make this dissertation/project a great success.

I would also like to thank all those persons who have directly or indirectly helped me in successful completion of my dissertation.

Priyanka Mahajan

PREFACE

3

There is a bit difference between the theoretical and practical knowledge. But the practical practice is based on theoretical concept. In every study theoretical concept is essential to have to apply it in practical scenario. In MBA-IB also, class room studies are not sufficient to develop healthy managerial and administrative skill for the future managers. So, practical training is the essential element to fill up the gap between theory and practice.

This dissertation provided me with an opportunity to do a diagnostic study of major financial crises. It helped me to understand their causes, their outcomes and similarities/differences among them. Starting from consulting journal, surfing internet for latest details, carrying out a diagnostic study, I have gained a considerable understanding of the topic by the end of the dissertation.

A sincere effort has been made in the report to present my viewpoints on the dissertation topic and enough literature has been derived from various sources, which have been acknowledged in the references/bibliography.

Priy anka Mahajan

ABSTRACT

4

This dissertation encompasses a diagnostic study on financial crises with special reference to Sub-Prime Crisis, Russian Crisis and South East Asian crisis. The purpose of this study is to diagnose ad compare the various financial crises. The crisis problem is one of the dominant macroeconomic features of our age. Currency and banking crises were chronic problems not just in the 1990s but in the preceding years as well, including the present scenario. Their importance suggests questions like the following: Are crises growing more frequent? Are they becoming more disruptive? Are economies taking longer to recover? These are fundamentally historical questions, which can be answered only by comparing the present with the past. In this dissertation I have concentrated on the following dimensions: diagnosing the reasons for the three financial crises taken into account, analyzing and comparing the three crises, finding any similarities among them (nature, depth and causes) and commenting on the steps taken to overcome them.

INDEX

5

TOPIC

PAGE NO.

1. MAJOR FINANCIAL CRISES OF THE WORLD: AN INTRODUCTION 6

2. CRISIS FINANCIAL FRAMEWORK

22

3. LITERATURE REVIEW

30

4. METHODOLOGY

43

5. OBJECTIVE

43

6. DATA ANALYSIS

44

7. FINDINGS & CONCLUSION

68

8. REFERENCES

70

MAJOR FINANCIAL CRISES OF THE WORLD: AN INTRODUCTION
6

“The Chinese use two brush strokes to write the word 'crisis'. One brush stroke stands for danger; the other for opportunity. In a crisis, be aware of the danger-but recognize the opportunity.” -John F. Kennedy

“In a time of crisis we all have the potential to morph up to a new level and do things we never thought possible.” -Stuart Wilde

There is no precise definition of “financial crisis,” but a common view is that disruptions in financial markets rise to the level of a crisis when the flow of credit to households and businesses is constrained and the real economy of goods and services is adversely affected. The term financial crisis is applied broadly to a variety of situations in which some financial institutions or assets suddenly lose a large part of their value. In the 19th and early 20th centuries, many financial crises were associated with banking panics, and many recessions coincided with these panics. Other situations that are often called financial crises include stock market crashes and the bursting of other financial bubbles, currency crises, and sovereign defaults. Following are the various types of financial crisis. TYPES OF FINANCIAL CRISIS:

7

BANKING CRISIS

WIDER ECONOM I-C CRISIS

TYPES

SPECULA -TIVE BUBBLES & CRASHES

INTERNA -TIONAL FIANCIA L CRISIS

Banking crises

8

When a bank suffers a sudden rush of withdrawals by depositors, this is called a bank run. Since banks lend out most of the cash they receive in deposits, it is difficult for them to quickly pay back all deposits if these are suddenly demanded, so a run may leave the bank in bankruptcy, causing many depositors to lose their savings unless they are covered by deposit insurance. A situation in which bank runs are widespread is called a systemic banking crisis or just a banking panic. A situation without widespread bank runs, but in which banks are reluctant to lend, because they worry that they have insufficient funds available, is often called a credit crunch. Examples of bank runs include the run on the Bank of the United States in 1931 and the run on Northern Rock in 2007. The collapse of Bear Stearns in 2008 has also sometimes been called a bank run, even though Bear Stearns was an investment bank rather than a commercial bank.

Speculative bubbles and crashes Economists say that a financial asset exhibits a bubble when its price exceeds the present value of the future income (such as interest or dividends that would be received by owning it to maturity). If most market participants buy the asset primarily in hopes of selling it later at a higher price, instead of buying it for the income it will generate, this could be evidence that a bubble is present. If there is a bubble, there is also a risk of a crash in asset prices: market participants will go on buying only as long as they expect others to buy, and when many decide to sell the price will fall. However, it is difficult to tell in practice whether an asset's price actually equals its fundamental value, so it is hard to detect bubbles reliably. Some economists insist that bubbles never or almost never occur.

9

Well-known examples of bubbles (or purported bubbles) and crashes in stock prices and other asset prices include the Wall Street Crash of 1929, the crash of the dot-com bubble in 2000-2001, and the now-deflating United States housing bubble (2008).

International financial crises When a country that maintains a fixed exchange rate is suddenly forced to devalue its currency because of a speculative attack, this is called a currency crisis or balance of payments crisis. When a country fails to pay back its sovereign debt, this is called a sovereign default. While devaluation and default could both be voluntary decisions of the government, they are often perceived to be the involuntary results of a change in investor sentiment that leads to a sudden stop in capital inflows or a sudden increase in capital flight. Several currencies that formed part of the European Exchange Rate Mechanism suffered crises in 1992-93 and were forced to devalue or withdraw from the mechanism. Another round of currency crises took place in Asia in 1997-98. Many Latin American countries defaulted on their debt in the early 1980s. The 1998 Russian financial crisis resulted in a devaluation of the ruble and default on Russian government bonds.

Wider economic crises A downturn in economic growth lasting several quarters or more is usually called a recession. An especially prolonged recession may be called a depression, while a long period of slow but not necessarily negative growth is sometimes called economic stagnation. Since these phenomena affect much more than the financial system, they are not usually considered financial crises per se. But some 10

economists have argued that many recessions have been caused in large part by financial crises. One important example is the Great Depression, which was preceded in many countries by bank runs and stock market crashes. The sub-prime mortgage crisis and the bursting of other real estate bubbles around the world are widely expected to lead to recession in the U.S. and a number of other countries in 2008. Nonetheless, some economists argue that financial crises are caused by recessions instead of the other way around. Also, even if a financial crisis is the initial shock that sets off a recession, other factors may be more important in prolonging the recession. In particular, Milton Friedman and Anna Schwartz argued that the initial economic decline associated with the crash of 1929 and the bank panics of the 1930s would not have turned into a prolonged depression if it had not been reinforced by monetary policy mistakes on the part of the Federal Reserve, and Ben Bernanke has acknowledged that he agrees.

CAUSES AND CONSEQUENCES OF FINANCIAL CRISIS:

11

FRAUD

LEVERAGE ASSET-LIABILITY MISMATCH

UNCERTAINTY AND HERD BEHAVIOUR

RECESSIONARY EFFECTS

REGULATORY FAILURES

CONTAGION

STRATEGIC COMPLEMENTARITIES IN FINANCIAL MARKET

Strategic complementarities in financial markets

12

It is often observed that successful investment requires each investor in a financial market to guess what other investors will do. George Soros has called this need to guess the intentions of others 'reflexivity’. Similarly, John Maynard Keynes compared financial markets to a beauty contest game in which each participant tries to predict which model other participants will consider most beautiful. Furthermore, in many cases investors have incentives to coordinate their choices. For example, someone who thinks other investors want to buy lots of Japanese yen may expect the yen to rise in value, and therefore has an incentive to buy yen too. Likewise, a depositor in IndyMac Bank who expects other depositors to withdraw their funds may expect the bank to fail, and therefore has an incentive to withdraw too. Economists call an incentive to mimic the strategies of others strategic complementarity. It has been argued that if people or firms have a sufficiently strong incentive to do the same thing they expect others to do, then self-fulfilling prophecies may occur. For example, if investors expect the value of the yen to rise, this may cause its value to rise; if depositors expect a bank to fail this may cause it to fail. Therefore, financial crises are sometimes viewed as a vicious circle in which investors shun some institution or asset because they expect others to do so.

Leverage Leverage, which means borrowing to finance investments, is frequently cited as a contributor to financial crises. When a financial institution (or an individual) only invests its own money, it can, in the very worst case, lose its own money. But when it borrows in order to invest more, it can potentially earn more from its investment, but it can also lose more than all it has. Therefore leverage magnifies the potential returns from investment, 13

but also creates a risk of bankruptcy. Since bankruptcy means that a firm fails to honor all its promised payments to other firms, it may spread financial troubles from one firm to another. The average degree of leverage in the economy often rises prior to a financial crisis. For example, borrowing to finance investment in the stock market became increasingly common prior to the Wall Street Crash of 1929.

Asset-liability mismatch Another factor believed to contribute to financial crises is asset-liability mismatch, a situation in which the risks associated with an institution's debts and assets are not appropriately aligned. For example, commercial banks offer deposit accounts which can be withdrawn at any time and they use the proceeds to make long-term loans to businesses and homeowners. The mismatch between the banks' short-term liabilities (its deposits) and its long-term assets (its loans) is seen as one of the reason bank runs occur (when depositors panic and decide to withdraw their funds more quickly than the bank can get back the proceeds of its loans). Likewise, Bear Stearns failed in 2007-08 because it was unable to renew the short-term debt it used to finance long-term investments in mortgage securities. In an international context, many emerging market governments are unable to sell bonds denominated in their own currencies, and therefore sell bonds denominated in US dollars instead. This generates a mismatch between the currency denomination of their liabilities (their bonds) and their assets (their local tax revenues), so that they run a risk of sovereign default due to fluctuations in exchange rates.

14

Uncertainty and herd behavior Many analyses of financial crises emphasize the role of investment mistakes caused by lack of knowledge or the imperfections of human reasoning. Behavioral finance studies errors in economic and quantitative reasoning. Psychologist Torbjorn K A Eliazonhas also analyzed failures of economic reasoning in his concept of 'œcopathy'. Historians, notably Charles Kindleberger, have pointed out that crises often follow soon after major financial or technical innovations that present investors with new types of financial opportunities, which he called "displacements" of investors' expectations. Early examples include the South Sea Bubble and Mississippi Bubble of 1720, which occurred when the notion of investment in shares of company stock was itself new and unfamiliar, and the Crash of 1929, which followed the introduction of new electrical and transportation technologies. More recently, many financial crises followed changes in the investment environment brought about by financial deregulation, and the crash of the dot com bubble in 2001 arguably began with "irrational exuberance" about Internet technology. Unfamiliarity with recent technical and financial innovations may help explain how investors sometimes grossly overestimate asset values. Also, if the first investors in a new class of assets (for example, stock in "dot com" companies) profit from rising asset values as other investors learn about the innovation (in our example, as others learn about the potential of the Internet), then still more others may follow their example, driving the price even higher as they rush to buy in hopes of similar profits. If such "herd behavior" causes prices to spiral up far above the true value of the assets, a crash may become inevitable. If for any reason the price briefly falls, so that investors realize that further

15

gains are not assured, then the spiral may go into reverse, with price decreases causing a rush of sales, reinforcing the decrease in prices.

•

Regulatory failures

Governments have attempted to eliminate or mitigate financial crises by regulating the financial sector. One major goal of regulation is transparency: making institutions' financial situation publicly known by requiring regular reporting under standardized accounting procedures. Another goal of regulation is making sure institutions have sufficient assets to meet their contractual obligations, through reserve requirements, capital requirements, and other limits on leverage. Some financial crises have been blamed on insufficient regulation, and have led to changes in regulation in order to avoid a repeat. For example, the Managing Director of the IMF, Dominique Strauss-Kahn, has blamed the financial crisis of 2008 on 'regulatory failure to guard against excessive risk-taking in the financial system, especially in the US'. Likewise, the New York Times singled out the deregulation of credit default swaps as a cause of the crisis. However, excessive regulation has also been cited as a possible cause of financial crises. In particular, the Basel II Accord has been criticized for requiring banks to increase their capital when risks rise, which might cause them to decrease lending precisely when capital is scarce, potentially aggravating a financial crisis. • Fraud

Fraud has played a role in the collapse of some financial institutions, when companies have attracted depositors with misleading claims about their investment strategies, or have

16

embezzled the resulting income. Examples include Charles Ponzi's scam in early 20th century Boston, the collapse of the MMM investment fund in Russia in 1994, the scams that led to the Albanian Lottery Uprising of 1997, and, allegedly, the collapse of Madoff Investment Securities in 2008. Many rogue traders that have caused large losses at financial institutions have been accused of acting fraudulently in order to hide their trades. Fraud in mortgage financing has also been cited as one possible cause of the 2008 subprime mortgage crisis; government officials stated on Sept. 23, 2008 that the FBI was looking into possible fraud by mortgage financing companies Fannie Mae and Freddie Mac, Lehman Brothers, and insurer American International Group.

Contagion Contagion refers to the idea that financial crises may spread from one institution to another, as when a bank run spreads from a few banks to many others, or from one country to another, as when currency crises, sovereign defaults, or stock market crashes spread across countries. When the failure of one particular financial institution threatens the stability of many other institutions, this is called systemic risk. One widely-cited example of contagion was the spread of the Thai crisis in 1997 to other countries like South Korea. However, economists often debate whether observing crises in many countries around the same time is truly caused by contagion from one market to another, or whether it is instead caused by similar underlying problems that would have affected each country individually even in the absence of international linkages.

Recessionary effects 17

Some financial crises have little effect outside of the financial sector, like the Wall Street crash of 1987, but other crises are believed to have played a role in decreasing growth in the rest of the economy. There are many theories why a financial crisis could have a recessionary effect on the rest of the economy. These theoretical ideas include the 'financial accelerator', 'flight to quality' and 'flight to liquidity', and the Kiyotaki-Moore model. Some 'third generation' models of currency crises explore how currency crises and banking crises together can cause recessions.

List of Some Major Financial Crisis:  1929 : Wall Street crash: great depression  1973–1974: stock market crash  1980s: Latin American debt crisis, beginning in Mexico  1989-91: United States Savings & Loan crisis  1990s: Collapse of the Japanese asset price bubble  1992-93: Speculative attacks on currencies in the European Exchange Rate Mechanism  1994-95: 1994 economic crisis in Mexico: speculative attack and default on Mexican debt  1997-98: Asian Financial Crisis: devaluations and banking crises across Asia  1998: 1998 Russian financial crisis: devaluation of the ruble and default on Russian debt  2000: Dot-Com bubble crash  2001-02: Argentine economic crisis (1999-2002): breakdown of banking system

18

 2008: Global financial crisis and USA, Europe: spread of the U.S. subprime mortgage crisis.

We will be confining our study to:  Financial crisis of 1997-98: South East Asian Financial Crisis  Financial crisis of 1998: Russian Financial crisis  Financial crisis of 2008: Global Financial crisis

A brief introduction to these financial crises is as follows:

•

1997-98 South East Asian financial crisis

The Asian financial crisis started with the devaluation of Thailand’s Bath, which took place on July 2, 1997, a 15 to 20 percent devaluation that occurred two months after this currency started to suffer from a massive speculative attack and a little more than a month after the bankruptcy of Thailand’s largest finance company, Finance One. This first devaluation of the Thai Baht was soon followed by that of the Philippine Peso, the Malaysian Ringgit, the Indonesian Rupiah and, to a lesser extent, the Singaporean Dollar. This series of devaluations marked the beginning of the Asian financial crisis. A second sub-period of the currency crisis can be identified starting in early November, 1997 after the collapse of Hong Kong’s stock market (with a 40 percent loss in October). This sent shock waves that were felt not only in Asia, but also in the stock markets of Latin America (most notably Brazil, Argentina and Mexico). In addition to these stock markets, were those of the developed countries (e.g. the U.S. experienced its largest point

19

loss ever in October 27, 1997, which amounted to a 7 percent loss). These financial and asset price crises also set the stage for this second sub-period of large currency depreciations. This time, not only the currencies of Thailand, the Philippines, Malaysia, Indonesia and Singapore were affected, but those of South Korea and Taiwan also suffered. In fact, the sharp depreciation of Korea’s Won beginning in early November added a new and more troublesome dimension to the crisis given the significance of Korea as the eighth largest economy in the world; the magnitude of the depreciation of its currency which took place in less than two months; and the Korean Central Bank’s success in maintaining the peg ever since the Thai’s first devaluation (i.e. the “nominal anchor” of the largest of the Asian Tigers was suddenly lost). In addition, the other important component of this second sub-period: the complete collapse of the Indonesian Rupiah that started at about the same time.

•

1998 Russian financial crisis

The Russian financial crisis (also called "Ruble crisis") hit Russia on 17 August 1998. It was triggered by the Asian financial crisis, which started in July 1997. During the subsequent decline in world commodity prices, countries heavily dependent on the export of raw materials were among those most severely hit. Petroleum, natural gas, metals, and timber accounted for more than 80% of Russian exports, leaving the country vulnerable to swings in world prices. Oil was also a major source of government tax revenue. Declining productivity, an artificially high fixed exchange rate between the ruble and foreign currencies to avoid public turmoil, and a chronic fiscal deficit were the background to the meltdown.

20

Up to late 1997, the sales of ruble denominated discount instruments and coupon bonds, known as GKO and OFZ, by the government were successful. In 1998, however, the government began facing difficulties selling ruble denominated debt due to adverse domestic political developments, weak commodity prices, and global economic events. Hence, the government decided to replace the ruble denominated debt into US dollar denominated Eurobonds. The growing burden of borrowing had raised concerns about
Russia's default on its treasury bills as pressures on debt, equity, and exchange markets decreased the investors’ confidence.

•

2008 Sub-prime crisis

In US, borrowers are rated either as 'prime' - indicating that they have a good credit rating based on their track record - or as 'sub-prime', meaning their track record in repaying loans has been below par. Loans given to sub-prime borrowers, something banks would normally be reluctant to do, are categorized as sub-prime loans. Typically, it is the poor and the young who form the bulk of sub-prime borrowers. In roughly five years leading up to 2007, many banks started giving loans to sub-prime borrowers, typically through subsidiaries. They did so because they believed that the real estate boom, which had more than doubled home prices in the US since 1997, would allow even people with dodgy credit backgrounds to repay on the loans they were taking to buy or build homes. Government also encouraged lenders to lend to sub-prime borrowers, arguing that this would help even the poor and young to buy houses.

Since the risk of default on such loans was higher, the interest rate charged on sub-prime loans was typically about two percentage points higher than the interest on prime loans. 21

This, of course, only added to the risk of sub-prime borrowers defaulting. The repayment capacity of sub-prime borrowers was in any case doubtful. The higher interest rate additionally meant substantially higher EMIs than for prime borrowers, further raising the risk of default. Further, lenders devised new instruments to reach out to more sub-prime borrowers. The housing boom in the US started petering out in 2007. One major reason was that the boom had led to a massive increase in the supply of housing. Thus, house prices started falling. This increased the default rate among sub-prime borrowers, many of whom were no longer able or willing to pay to buy a house that was declining in value. Since in home loans in the US, the collateral is typically the home being bought, this increased the supply of houses for sale while lowering the demand, thereby lowering prices even further and setting off a vicious cycle. That this coincided with a slowdown in the US economy only made matters worse. Estimates are that US housing prices have dropped by almost 50% from their peak in 2006 in some cases. The declining value of the collateral means that lenders are left with less than the value of their loans and hence they have to book losses.

CRISIS FINANCIAL FRAMEWORK

Russian Crisis Financial Framework: Prior to the culmination of the economic crisis, the government-issued GKO bonds with the interest on matured obligations being paid off using the proceeds of newly issued obligations.

22

Declining productivity, an artificially high fixed exchange rate between the ruble and foreign currencies to avoid public turmoil, and a chronic fiscal deficit were the background to the meltdown. Two external shocks, the Asian financial crisis that had begun in 1997 and the following declines in demand for (and thus price of) crude oil and nonferrous metals, also impacted Russian foreign exchange reserves. A political crisis came to a head in March when Russian president Boris Yeltsin suddenly dismissed Prime Minister Viktor Chernomyrdin and his entire cabinet on March 23. Yeltsin named Energy Minister Sergei Kiriyenko, aged 35, as acting prime minister On May 29, Yeltsin appointed Boris Fyodorov - Head of the State Tax Service. The growth of internal loans could only be provided at the expense of the inflow of foreign speculative capital, which was attracted by very high interest rates: In an effort to prop up the currency and stem the flight of capital, in June Kiriyenko hiked GKO interest rates to 150%. The situation was worsened by irregular internal debt payments. Despite government efforts, the debts on wages continued to grow, especially in the remote regions. By the end of 1997, the situation with the tax receipts was very tense, and it had a negative effect on the financing of the major budget items (pensions, communal utilities, transportation etc). A $22.6 billion International Monetary Fund and World Bank financial package was approved on July 13 to support reforms and stabilize the Russian market by swapping out an enormous volume of the quickly maturing GKO short-term bills into long-term Eurobonds. On May 12, 1998 Coal miners went on strike over unpaid wages, blocking the Trans-Siberian Railway. By August 1, 1998 there were approximately $12.5 billion in unpaid wages owed to Russian workers. On August 14, the exchange rate of the Russian ruble to the US dollar was still 6.29. Despite the bailout, July monthly interest payments on Russia’s debt rose to a figure 40 percent greater than its monthly tax collections. 23

Additionally, on July 15, the State Duma dominated by left-wing parties refused to adopt most of government anti-crisis plan so that the government was forced to rely on presidential decrees. At the time, Russia employed a "floating peg" policy toward the ruble, meaning that the Central Bank at any given time committed that the ruble-to-dollar (or RUR/USD) exchange rate would stay within a particular range. If the ruble threatened to devalue outside of that range (or "band"), the Central Bank would intervene by spending foreign reserves to buy rubles. For instance, during approximately the one year prior to the Crisis, the Central Bank committed to maintain a band of 5.3 to 7.1 RUR/USD meaning that it would buy rubles if the market exchange rate threatened to exceed 7.1 rubles per dollar. The inability of the Russian government to implement a coherent set of economic reforms led to a severe erosion in investor confidence and a chain-reaction that can be likened to a run on the Central Bank. Investors fled the market by selling rubles and Russian assets (such as securities), which also put downward pressure on the ruble. This forced the Central Bank to spend its foreign reserves to defend the ruble, which in turn further eroded investor confidence and undermined the ruble. It is estimated that between October 1, 1997 and August 17, 1998, the Central Bank spent approximately $27 billion of its U.S. dollar reserves to maintain the floating peg. It was later revealed that about $5 billion of the international loans provided by the World Bank and International Monetary Fund were stolen upon the funds' arrival in Russia on the eve of the meltdown. On August 13, 1998, the Russian stock, bond, and currency markets collapsed as a result of investor fears that the government would devalue the ruble, default on domestic debt, or both. Annual yields on ruble denominated bonds were more than 200 percent. The 24

stock market had to be closed for 35 minutes as prices plummeted. When the market closed, it was down 65 percent with a small number of shares actually traded. From January to August the stock market had lost more than 75 percent of its value, 39 percent in the month of May alone.

South-East Asian Crisis Financial Framework: Until 1997, Asia attracted almost half of the total capital inflow from developing countries. The economies of Southeast Asia in particular maintained high interest rates attractive to foreign investors looking for a high rate of return. As a result the region's economies received a large inflow of money and experienced a dramatic run-up in asset prices. At the same time, the regional economies of Thailand, Malaysia, Indonesia, Singapore, and South Korea experienced high growth rates, 8-12% GDP, in the late 1980s and early 1990s. This achievement was widely acclaimed by financial institutions including the IMF and World Bank, and was known as part of the "Asian economic miracle". At the time of the mid-1990s, Thailand, Indonesia and South Korea had large private current account deficits and the maintenance of fixed exchange rates encouraged external borrowing and led to excessive exposure to foreign exchange risk in both the financial and corporate sectors. In the mid-1990s, two factors began to change their economic environment. As the U.S. economy recovered from a recession in the early 1990s, the U.S. Federal Reserve Bank began to raise U.S. interest rates to head off inflation. This made the U.S. a more attractive investment destination relative to Southeast Asia, which had attracted hot money flows through high short-term interest rates, and raised the value of the U.S. dollar, to which many Southeast Asian nations' currencies were pegged, thus 25

making their exports less competitive. At the same time, Southeast Asia's export growth slowed dramatically in the spring of 1996, deteriorating their current account position.

Thailand: From 1985 to 1996, Thailand's economy grew at an average of over 9% per year, the highest economic growth rate of any country at the time. From 1978 until 2 July 1997, the baht was pegged at 25 to the dollar. On 14 May and 15 May 1997, the Thai baht was hit by massive speculative attacks. On 30 June 1997, Prime Minister Chavalit Yongchaiyudh said that he would not devalue the baht. This was the spark that ignited the Asian financial crisis as the Thai government failed to defend the baht, which was pegged to the U.S. dollar, against international speculators. Thailand's booming economy came to a halt among massive layoffs in finance, real estate, and construction. The baht devalued swiftly and lost more than half of its value. The baht reached its lowest point of 56 units to the US dollar in January 1998. The Thai stock market dropped 75%. Finance One, the largest Thai finance company until then, collapsed. The Thai government was eventually forced to float the Baht, on 2 July 1997.

Indonesia: In June 1997, Indonesia seemed far from crisis. Unlike Thailand, Indonesia had low inflation, a trade surplus of more than $900 million, huge foreign exchange reserves of more than $20 billion, and a good banking sector. But a large number of Indonesian corporations had been borrowing in U.S. dollars. During the preceding years, as the rupiah had strengthened respective to the dollar, this practice had worked well for these 26

corporations; their effective levels of debt and financing costs had decreased as the local currency's value rose. In July 1997, when Thailand floated the baht, Indonesia's monetary authorities widened the rupiah trading band from 8% to 12%. The rupiah suddenly came under severe attack in August. On 14 August 1997, the managed floating exchange regime was replaced by a free-floating exchange rate arrangement. The rupiah dropped further. The IMF came forward with a rescue package of $23 billion, but the rupiah was sinking further among fears over corporate debts, massive selling of rupiah, and strong demand for dollars. The rupiah and the Jakarta Stock Exchange touched a historic low in September. Indonesia's long-term debt was eventually downgraded to 'junk bond'.

South Korea: Macroeconomic fundamentals in South Korea were good but the banking sector was burdened with non-performing loans as its large corporations were funding aggressive expansions. During that time, there was a haste to build great conglomerates to compete on the world stage. Many businesses ultimately failed to ensure returns and profitability. The Korean conglomerates, more or less completely controlled by the government, simply absorbed more and more capital investment. Eventually, excess debt led to major failures and takeovers. For example, in July 1997, South Korea's third-largest car maker, Kia Motors, asked for emergency loans. In the wake of the Asian market downturn, Moody's lowered the credit rating of South Korea from A1 to A3, on 28 November 1997, and downgraded again to B2 on 11 December. That contributed to a further decline in Korean shares since stock markets were already bearish in November. The Seoul stock exchange

27

fell by 4% on 7 November 1997. On 8 November, it plunged by 7%, its biggest one-day drop to that date. And on 24 November, stocks fell a further 7.2% on fears that the IMF would demand tough reforms. In 1998, Hyundai Motor took over Kia Motors. Samsung Motors' $5 billion dollar venture was dissolved due to the crisis, and eventually Daewoo Motors was sold to the American company General Motors (GM). The South Korean ‘won’, meanwhile, weakened to more than 1,700 per dollar from around 800. In Korea, the crisis is also commonly referred to as the IMF Crisis.

Sub-prime Crisis Financial Framework: The crisis began with the bursting of the United States housing bubble and high default rates on "sub-prime" and adjustable rate mortgages (ARM), beginning in approximately 2005–2006. Government policies and competitive pressures for several years prior to the crisis encouraged higher risk lending practices. Further, an increase in loan incentives such as easy initial terms and a long-term trend of rising housing prices had encouraged borrowers to assume difficult mortgages in the belief they would be able to quickly refinance at more favorable terms. However, once interest rates began to rise and housing prices started to drop moderately in 2006–2007 in many parts of the US, refinancing became more difficult. Defaults and foreclosure activity increased dramatically as easy initial terms expired, home prices failed to go up as anticipated, and ARM interest rates reset higher. Foreclosures accelerated in the United States in late 2006 and triggered a

28

global financial crisis through 2007 and 2008. During 2007, nearly 1.3 million U.S. housing properties were subject to foreclosure activity, up 79% from 2006. Financial products called mortgage-backed securities (MBS), which derive their value from mortgage payments and housing prices, had enabled financial institutions and investors around the world to invest in the U.S. housing market. Major Banks and financial institutions had borrowed and invested heavily in MBS and reported losses of approximately US$435 billion as of 17 July 2008. The liquidity and solvency concerns regarding key financial institutions drove central banks to take action to provide funds to banks to encourage lending to worthy borrowers and to restore faith in the commercial paper markets, which are integral to funding business operations. Governments also bailed out key financial institutions, assuming significant additional financial commitments. Effects on global stock markets due to the crisis have been dramatic. Between 1 January and 11 October 2008, owners of stocks in U.S. corporations had suffered about $8 trillion in losses, as their holdings declined in value from $20 trillion to $12 trillion. Losses in other countries have averaged about 40%. Losses in the stock markets and housing value declines placed further downward pressure on consumer spending.

29

LITERATURE REVIEW

The following is the article written by Ms. Prerna Katiyar and her views were posted on Nov 2, 2008 in Economic Times.

THIS DAY THAT YEAR Oct 24, 1929, saw The Great Depression creeping in the biggest economy of the world. It’s the play of destiny that one of the greatest falls of Sensex too happened on the same day, this year. Prerna Katiyar elaborates on what’s common, and what’s not, between the two crises BUT such are life diaries, as they say. Just when the confidence had started sneaking back in the markets and the underlying sentiment was that the worst may be behind us, the stocks took an unprecedented turn for the worse in the past few days and parallels are already being drawn between the current times and the days of the Great Depression. So let’s see if history is repeating itself or it’s just a play of destiny. 30

WHAT’S COMMON? Apart from the common dates—the most distressing parallel is the assets bubble formed in both the eras. If it was stocks that had shot to ridiculous levels in the 1920s in US, the housing dominated the scene recently. In the Indian context, both real estate and stocks had shot to astronomical levels in the recent past. From 1921 to 1929, there was a stock market boom in the US, just like we had here in the five-year Bull Run until the trend reversed from January. While Dow was at 63 during the bad times of 1921 and rallied to 386 in September 1929 — or a jump of more than six times in eight years; Sensex was around 3,000 in 2003, and hit 21,000 in January 2008, seven times in five years). Easy money available due to relax credit norms, euphoria among investors and playing on margin in the stock market (with only 10% ‘downpayment’, you get) did its part to fuel the ascent. What was also common was the feeling of ecstasy among investors — old and new — that the markets will only head north leading to the unprecedented rise — and the fall of the stocks. Also, the exceptional moves taken by the central banks failed to cheer the market, both during the Great Depression and now. Whether it was the creation of Reconstruction Finance Corporation (RFC) in 1932, or the $700-billion bailout package by the US — all have nearly failed to re-inflate the economy.

WHAT’S NOT? The unemployment levels we see today in US are much more comforting than the days of the Great Depression. It was as high as 25% during 1930s and today, stands around 5%, which is something to cheer about, in a way. 31

Also remarkably different is the proactive role the central banks are taking now (and that may be partly due to the experience from the Depression itself, and partly because they have new tool to handle the crisis) compared to the initial somewhat lazy response by the Fed during the depression era. A new phenomenon that has emerged is the ‘coupling effect’ that has come to play in the recent years. The US sneeze, indeed, gives jitters to India — and else where — as has been seen by the Indian markets behaviour in the recent past. It is this international cooperation and linkages that made most central banks lowering interest rates last week to save the ‘world economy’ from a near credit freeze.

CAN CAN! What government needs to do is provide more liquidity by their discount windows, especially to smaller firms who lack all the Cs — cash, credit and credibility, increase solvency for the banking system so they continue to do lend and provide required capital to industries that will keep the supply of goods and employment at normal pace. And keep the interest rates low to encourage borrowing and restore investors’ confidence. Though the government and the RBI are already on the track and have done their part to give a leg up to the market, by steadily bring-ing down the rates, allaying fears by frequent clarifications, easing investment norms and lowering the growth target to keep the expectations realistic — it remains to be seen what would do the magic to give the markets — and the economy — the much-needed kiss of life.

The following is the article written by Mr. Robert J Samuelson, (Source: Ebscohost, Published: Newsweek; 13th October, 2008) 32

IS THIS CRISIS A REPLAY OF 1929? Watching the slipping economy and Congress's epic debate over the Treasury's unprecedented $700 billion financial bailout, it is impossible not to wonder whether this is 1929 all over again. Even sophisticated observers invoke the comparison. Martin Wolf, the chief economic commentator for the Financial Times, began a recent column: "It is just over three score years and ten since [the end of] the Great Depression." What's frightening is not any one event but the prospect that things are slipping out of control. Panic--political as well as economic--is the enemy. There are parallels between then and now; but there are also big differences. Now, as then, Americans borrowed heavily before the crisis--in the 1920s, for cars, radios and appliances; in the past decade, for homes or against inflated home values. Now, as then, the crisis caught people by surprise and is global in scope. But unlike then, the federal government is now a huge part of the economy (20 percent vs. 3 percent in 1929) and its spending--for Social Security, defense, roads--provides greater stabilization. Unlike then, government officials have moved quickly, if clumsily, to contain the crisis. We need to remind ourselves that economic slumps--though wrenching and disillusioning for millions--rarely become national tragedies. Since the late 1940s, the United States has suffered 10 recessions. On average, they've lasted 10 months and involved peak monthly unemployment of 7.6 percent; the worst (those of 1973--75 and 1981--82) both lasted 16 months and had peak unemployment of 9.0 percent and 10.8 percent, respectively. We are almost certainly in a recession now; but joblessness, 6.1 percent in September, would have to rise spectacularly to match post-World War II highs.

33

The stock market tells a similar story. There have been 10 previous bear markets, defined as declines of at least 20 percent in the Standard & Poor's 500 Index. The average decline was 31.5 percent; those of 1973--74 and 2000--02 were nearly 50 percent. By contrast, the S&P's low point so far (Monday, Sept. 29) was 29 percent below the peak reached in October of 2007. The Great Depression that followed the stock market's collapse in October 1929 was a different beast. By the low point in July 1932, stocks had dropped almost 90 percent from their peak. The accompanying devastation--bankruptcies, foreclosures, bread lines--lasted a decade. Even in 1940, unemployment was almost 15 percent. Unlike postwar recessions, the Depression submitted neither to self-correcting market mechanisms nor government policies. Why? Capitalism's inherent instabilities were blamed--fairly, up to a point. Over borrowing, overinvestment and speculation chronically govern business cycles. Herbert Hoover was also blamed for being too timid--less fairly. In fact, Hoover initially expanded public works to combat the slump. The real culprit was the Federal Reserve. Depression scholarship changed forever in 1963 when economists Milton Friedman and Anna Schwartz argued, in a highly detailed account, that the Fed had unwittingly transformed an ordinary, if harsh, recession into a calamity by permitting a banking collapse and a disastrous drop in the money supply. From 1929 to 1933, two fifths of the nation's banks failed; depositor runs were endemic; the money supply (basically, cash plus bank deposits) declined by more than a third. People lost bank accounts; credit for companies and consumers shriveled. The process of economic retrenchment fed on itself and overwhelmed the normal channels of recovery. These mechanisms included surplus inventories being sold so companies could reorder; 34

strong companies expanding as weak competitors disappeared; high debts being repaid so borrowers could resume normal spending. What we see now is a frantic effort to prevent a repetition of this destructive chain reaction by which a disintegrating financial system compounds the economic downturn. It's said that the $700 billion bailout passed by Congress will rescue banks and other financial institutions by having the Treasury buy their suspect mortgage-backed securities. In reality, the Treasury is bailing out the Fed, which has already--through various channels--lent financial institutions roughly $1 trillion against myriad securities. The law's increase in federal deposit insurance from $100,000 to $250,000 aims to discourage panicky bank withdrawals (nearly three quarters of deposits will now be insured, up from almost two thirds before). In Europe, governments have taken similar actions; last week, Ireland guaranteed its banks' deposits. The cause of the Fed's timidity in the 1930s remains a matter of scholarly dispute. Economist Barry Eichengreen of the University of California, Berkeley, suggests a futile defense of the gold standard; Allan Meltzer of Carnegie Mellon University blames the flawed "real bills" doctrine that, in practice, limited the Fed's lending to besieged banks. Either way, Fed chairman Ben Bernanke--a student of the Depression--understands the error. The Fed's massive lending and the congressional bailout both aim to prop up the financial system and avoid a ruinous credit contraction. This doesn't mean the economy won't get worse. It will. The housing glut endures. With unemployment rising, cautious consumers have curbed spending. Economies abroad are slowing, hurting U.S. exports. Banks and other financial institutions will suffer more losses. But these are all normal symptoms of recession. Our real vulnerability is a highly complex and interconnected global financial system that might resist rescue and revival. 35

The Great Depression resulted from the perverse mix of a weak economy and government policies that magnified the weakness and that were only partially neutralized by the New Deal. If we can avoid a comparable blunder, the great drama of these recent weeks may prove blessedly misleading.

The following is the article written on 19th August, 2008 on http://english.pravda.ru/

RUSSIA’S FINANCIAL CRISIS OF 1998 PLOTTED BY IMF As it turns out, the default, which hit Russia ten years ago, was not merely a consequence of the ungifted economic policy of the Russian government during the second half of the 1990s. The devaluation of the Russian ruble occurred because of the efforts taken by the International Monetary Fund, which triggered the massive economic crisis in Russia nationwide and impoverished the majority of Russians in an instant. “The weak position of the federal budget became the main reason of the black August in 1998. In the summer of 1998 the Finance Ministry could fund only a half of its spending with the help of taxes. The other half was funded at the expense of borrowings. When markets stopped lending money to the ministry, the federal budget was unable to function properly,” Sergei Aleksashenko, who took the position of the first deputy chairman of the Bank of Russia in 1998, said. The government should have taken serious measures in the economic policy of the nation in 1996. Mr. Aleksashenko stated that he was surprised to hear incumbent Finance Minister of Russia, Aleksei Kudrin, saying that the crisis of 1998 was mainly caused because of IMF’s actions.

36

“I was very surprised to hear yesterday’s statement from Finance Minister Kudrin, who did not say a word about the budgetary policy and the weakness of Russia 's budget during the period of the crisis. Moreover, I was surprised to hear Mr. Kudrin laying the blame for the crisis on the IMF. If the minister said what he really thouhgt then it means that our government had not learned any lesson from the events that happened ten years ago,” Sergei Aleksashenko said. Kudrin laid the blame for the crisis on the Russian government too. The minister said that the crisis had been predetermined with low gold and forex reserves. However, the minister said that the International Monetary Fund was also guilty of the financial crisis in Russia in 1998, RIA Novosti reports. If the IMF had increased the Russian reserves by ten or 20 billion dollars within the framework of its coordinated aid program, the financial collapse would not have happened. As a result, the Russian government declared default on August 17, 1998 being unable to abide by its obligations. The current economic situation in Russia has something in common with that of 1998. It is worthy of note that oil prices have dropped down to $112.5 per barrel from over $150. Russia’s debt has undergone a significant change, though. Russia as a state appeared to be the major debtor in 1998. The corporate debt was negligibly small. Nowadays, Russia’s foreign debt makes up $40 billion, whereas Russian companies owe some $400 billion in total. The former chairman of the Moscow department of the International Monetary Fund, Martin Gilman, stated that every member of the Russian government, who was involved in the decision-making process ten years ago, played a big role in the crisis.

37

The economic crisis of 1998 became a result of certain decisions, the official believes, although bad luck was also involved. Mr. Gilman said that even world’s biggest men of genius would have faced difficulties if they had attempted to solve Russia’s problems in the 1990s. The official described the default of 1998 as the price which Russia had to pay to evolve from its old system to the new globalized economy. “It was the price which Russia paid for moving forward,” the former chairman of the IMF in Moscow said.

The following research paper is by Abbigail J. Chiodo and Michael T. Owyang (Source:
Ebscohost, Published: Nov 2002, Federal Reserve Bank of St. Louis)

A Case Study of a Currency Crisis: The Russian Default of 1998 THE RUSSIAN DEFAULT: A BRIEF HISTORY After six years of economic reform in Russia, privatization and macroeconomic stabilization had experienced some limited success. Yet in August 1998, after recording its first year of positive economic growth since the fall of the Soviet Union, Russia was forced to default on its sovereign debt, devalue the ruble, and declare a suspension of payments by commercial banks to foreign creditors. What caused the Russian economy to face a financial crisis after so much had been accomplished? This section examines the sequence of events that took place in Russia from 1996 to 1998 and the aftermath of the crisis.

1996 and 1997 Optimism and Reform: 38

In April 1996, Russian officials began negotiations to reschedule the payment of foreign debt inherited from the former Soviet Union. The negotiations to repay its sovereign debt were a major step toward restoring investor confidence. On the surface, 1997 seemed poised to be a turning point toward economic stability. • • The trade surplus was moving toward a balance between exports and imports Relations with the West were promising: the World Bank was prepared to provide expanded assistance of $2 to $3 billion per year and the International Monetary Fund (IMF) continued to meet with Russian officials and provide aid. • Inflation had fallen from 131 percent in 1995 to 22 percent in 1996 and 11 percent in 1997 • • Output was recovering slightly. A narrow exchange rate band was in place keeping the exchange rate between 5 and 6 rubles to the dollar • And oil, one of Russia’s largest exports, was selling at $23 per barrel—a high price by recent standards. (Fuels made up more than 45 percent of Russia’s main export commodities in 1997.)

In September 1997, Russia was allowed to join the Paris Club of creditor nations after rescheduling the payment of over $60 billion in old Soviet debt to other governments. Another agreement for a 23-year debt repayment of $33 billion was signed a month later with the London Club. Analysts predicted that Russia’s credit ratings would improve, allowing the country to borrow less expensively. Limitations on the purchase of government securities by nonresident investors were removed, promoting foreign

39

investment in Russia. By late 1997, roughly 30 percent of the GKO (a short-term government bill) market was accounted for by nonresidents. The economic outlook appeared optimistic as Russia ended 1997 with reported economic growth of 0.8 percent.

Revenue, Investment and Debt: Despite the prospects for optimism, problems remained. On average, real wages were less than half of what they were in 1991, and only about 40 percent of the work force was being paid in full and on time. Per capita direct foreign investment was low, and regulation of the natural monopolies was still difficult due to unrest in the Duma, Russia’s lower house of Parliament. Another weakness in the Russian economy was low tax collection, which caused the public sector deficit to remain high. The majority of tax revenues came from taxes that were shared between the regional and federal governments, which fostered competition among the different levels of government over the distribution. According to Shleifer and Treisman (2000), this kind of tax sharing can result in conflicting incentives for regional governments and lead them to help firms conceal part of their taxable profit from the federal government in order to reduce the firms’ total tax payments. In return, the firm would then make transfers to the accommodating regional government. This, Shleifer and Treisman suggest, may explain why federal revenues dropped more rapidly than regional revenues. Also, the Paris Club’s recognition of Russia as a creditor nation was based upon questionable qualifications. One-fourth of the assets considered to belong to Russia were in the form of debt owed to the former Soviet Union by countries such as Cuba, Mongolia, and Vietnam. Recognition by the Paris Club was also based on the old, completely arbitrary official Soviet exchange rate of approximately 0.6 rubles to the dollar (the market exchange rate at the time was 40

between 5 and 6 rubles to the dollar). The improved credit ratings Russia received from its Paris Club recognition were not based on an improved balance sheet. Despite this, restrictions were eased and lifted and Russian banks began borrowing more from foreign markets, increasing their foreign liabilities from 7 percent of their assets in 1994 to 17 percent in 1997. Meanwhile, Russia anticipated growing debt payments in the coming years when early credits from the IMF would come due. Policymakers faced decisions to decrease domestic borrowing and increase tax collection because interest payments were such a large percentage of the federal budget. In October 1997, the Russian government was counting on 2 percent economic growth in 1998 to compensate for the debt growth. Unfortunately, events began to unfold that would further strain Russia’s economy; instead of growth in 1998, real GDP declined 4.9 percent.

The following is the article published on 17th July, 2008 in Money Management (Source: Ebscohost)

ASIAN FINANCIAL CRISIS CONTINUES TO BITE AN Australian Treasury report has found that 11 years after the Asian financial crisis, investment in East Asian economies hits not recovered. The report, 'Investment in East Asia since the Asian financial crisis' found that despite economic conditions in Asia having "vastly improved" since the crisis, "investment has continued to languish". "This is despite improved economic conditions and strong underlying investment needs typical for developing economies," the Treasury report found.

41

Private, corporate and public investment levels in the region have all fallen since the crisis, with a key contributing factor being the "the apparent deterioration in 'institutional factors', such as regulation and governance". "Another possible explanation for weak investment relates to greater competition from China and the associated diversion of investment," the report said. "It has also been suggested that the crisis triggered a fundamental reassessment of risk by investors in emerging Asia." "This experience [of the crisis] led to increased investor wariness, which continues to linger despite improving economic conditions in the region." The writers of the report found that while the rapid rise in investment prior to the crisis was "speculative and of poor quality", they believed those cyclical factors should have receded by now. "Yet investment continues to he lower than suggested by the fundamentals." The good news is that domestic and regional reforms are strengthening the investment environment, but there is concern that East Asia's future economic growth may be impaired by the slow investment growth. "This underscores the need for continued domestic and regional initiatives to further strengthen the investment environment," the report said. East Asia includes Indonesia, Thailand, the Philippines, Malaysia, Korea, Taiwan, Singapore and Hong Kong. The authors of the report were Elisha Houston, Julia Minty and Nathan Dal Bon from the International Economy Division at the Australian Treasury.

METHODOLOGY

42

In this diagnostic study, three financial crises namely Sub-prime crises, Russian financial crises and South East Asian crisis have been studied and analyzed. Their causes, role of various organizations and steps taken to overcome them have been studied. Data for a study can be collected through primary and secondary sources. For this diagnostic study, the source of data is secondary. Various secondary sources (like internet, journals, articles, etc) have been utilized to extract the data. Data & literature derived from various sources have been acknowledged in the references section.

OBJECTIVES • To compare the three crises and find out the similarities among them as regards their nature, causes and impact. • To study and analyze the measures taken to overcome them.

DATA ANALYSIS

43

CAUSES OF SOUTH EAST ASIAN CRISIS: Several factors—both domestic and external—probably contributed to the dramatic deterioration in sentiment by foreign and domestic investors. The domestic factors are as follows: • A buildup of overheating pressures, evident in large external deficits and inflated property and stock market values. • The prolonged maintenance of pegged exchange rates, in some cases at unsustainable levels, which complicated the response of monetary policies to overheating pressures and which came to be seen as implicit guarantees of exchange value, encouraging external borrowing and leading to excessive exposure to foreign exchange risk in both the financial and corporate sectors. • Lack of enforcement of prudential rules and inadequate supervision of financial systems, coupled with government-directed lending practices that led to a sharp deterioration in the quality of banks' loan portfolios. • Problems resulting from the limited availability of data and a lack of transparency, both of which hindered market participants from taking a realistic view of economic fundamentals. • Inadequate supervision of financial institutions and lack of adequate disclosure by the corporate world further worsened the situation. Weak governments lacked the political autonomy or will to enact the deflationary policies necessary to reduce current account deficits and domestic asset bubbles. They also contributed to the 44

cronyism and ethical problem that encouraged over borrowing, over lending, and over investment in the private corporate sector as well as in state projects, and • Problems of governance and political uncertainties, which worsened the crisis of confidence, fueled the reluctance of foreign creditors to roll over short-term loans, and led to downward pressures on currencies and stock markets.

External factors also played a role, and many foreign investors suffered substantial losses: • International investors had underestimated the risks as they searched for higher yields at a time when investment opportunities appeared less profitable in Europe and Japan, owing to their sluggish economic growth and low interest rates; • Overvalued exchange rates tied to an appreciating U.S. dollar led to large current account deficits and inadequate or declining long-term capital inflows. This resulted in heavy dependence on short-term external debt and the depletion of foreign exchange reserves. • The Opening up of Capital Account led to local financial institutions over borrowing more from foreign sources. All this made currency devaluation inevitable and attracting speculators eager to benefit from it. Borrowed Short-Term funds were invested in the Stock market and in Real Estate. • The overall quality of investments declined with the fall in investor confidence which was a result of bad news that the export market had slowed down.

45

•

Since several exchange rates in East Asia were pegged to the U.S. dollar, wide swings in the dollar/yen exchange rate contributed to the buildup in the crisis through shifts in international competitiveness that proved to be unsustainable (in particular, the appreciation of the U.S. dollar from mid-1995, especially against the yen, and the associated losses of competitiveness in countries with dollar-pegged currencies, contributed to their export slowdowns in 1996–97 and wider external imbalances).

•

International investors—mainly commercial and investment banks—may, in some cases, have contributed, along with domestic investors and residents seeking to hedge their foreign currency exposures, to the downward pressure on currencies.

CAUSES OF RUSSIAN CRISIS The most immediate and direct causes are the government's financial imbalances and Russian fiscal policies that have made Russia very vulnerable to the vagaries of the global financial markets. The less direct but deeper causes concern the incomplete restructuring of the Russian economy that has left a large part of the economy non-monetized and run by barter, thus making it difficult to resolve the imbalances. Immediate Cause: Government Fiscal Imbalances • The Russian government has run persistently high budget deficits. While general government expenditures (that is, expenditures of the federal and regional governments, plus extra-budget expenditures) have declined, some areas of public

46

spending have not been adequately controlled. The government has not been able to cover its expenditures with revenues. • From 1995 and until 1998 the government had financed much of its budget deficit by borrowing in capital markets and issuing treasury bills, known by the Russian acronym GKOs, and bonds. On the upside, borrowing allowed the government to dramatically reduce inflation from a peak annual rate of 2,500% in 1992, to around 11% by the end of 1997. However, the low inflation rate may be superficial given that many state employees are not being paid and parts of the economy have increased bartering and have relied on other non-monetary means of payment such as inter-enterprise debt. • Russian government had to offer high yields on its treasury bills and bonds in order to attract the necessary capital. As a result, the borrowing added a new and heavy debt service burden to the Russian budget. Debt service expenditures have accounted for more than 30% of total Russian expenditures. In 1997 and the beginning of 1998, Russian treasury bill rates were averaging more than 25% per annum. Adjusting for inflation would make the real interest rate around 10%. During the late part of May and beginning of June 1998, the Russian government had to boost interest rates on bonds and bills even higher. • Most Russian domestic debt was short-term with an average maturity of around 11 months. That meant the debt had to be constantly rolled over, making the Russian government highly vulnerable to short-term fluctuations of capital markets. About 1/3 of the debt is held by foreign investors.

47

•

Government also has not been able to rein in subsidies to agriculture, the residents of the far northern regions, and the oil and gas industries. It also has not adequately dealt with social payments to the aged, disabled, and others who require a financial safety net.

•

The increasing burden of debt service made it difficult, if not impossible to address other budgetary priorities. Payments to workers, soldiers, pensioners, and contractors were deferred, building up arrears. Now Russia has not been able to pay banks and other investors who hold the government debt, which has created the current crisis.

•

Russian government survived financially, until recently, by accruing ever growing debt and government nonpayment of fiscal obligations to workers, soldiers, and others. These practices masked the weaknesses in the government's ability to rein in subsidies and raise revenues. It managed to continue as long as investors were willing to renew short-term debt.

•

Asian financial crisis of 1997 and other factors created uncertainty in emerging capital markets on the part of investors, and slumping oil prices made hard currency revenues scarcer, bringing the crisis to a head.

Fundamental Problem: The Tax Regime and the "Virtual Economy" The growth in government financial imbalances and borrowing practices largely explain the suddenness of the current financial crisis in Russia. But how Russia got to this point of

48

vulnerability analysts explain by citing more fundamental problems with Russian economic policy and economic structure. • One such problem has been the inability of the Russian government to collect revenues adequate to match expenditures. Many analysts and Russia's Western creditors have pointed to Russia's tax regime as being inefficient and a factor in the lack of sufficient tax revenues. The Russian system has consisted of some 200 different types of taxes at various levels of government (federal, regional and local) making administration of the regime unduly burdensome. The governments have frequently changed regulations on implementing the tax regime, making compliance even more burdensome. In addition, the governments have granted tax exemptions to favored sectors and enterprises reducing the potential revenue. Analysts have pointed out that the division of tax authority among the various levels of government has been unclear and conflicts have erupted making tax administration and compliance arduous. Importantly, the government has not had the resources, such as a sufficient number of tax inspectors, to administer tax collection. Some experts suggest that even if Russia manages to reform its tax regime, fundamental problems with the structure of the economy will prevent the government from attaining fiscal balance. In a recent study, two experts, Clifford Gaddy and Barry Ickes, describe and analyze what they call Russia's "virtual economy." This economy is one in which barter, bills of exchange, and other nonmonetary means of exchange have largely replaced currency. According to the article, more than 50% of payments among all industrial enterprises in Russia are

49

conducted by barter. In 1997, the Russian federal government received 40% of its tax revenues in the form of non-monetary forms of payment. Such a payments system is inherently inefficient and, as the authors point out, has led to masking of the true value of output which tends to be substantially below what prices indicate. In terms of public finance, the "virtual economy" makes tax collection difficult and leads to unrealistic government projections of revenue and expenditures. • Other structural problems include the administrative relationship between the federal government in Moscow and the regional and local governments. Confusion and conflict arise among them over control of assets and tax authority. The problems also include how to deal with the so-called oligarchies, the group of individuals that have amassed a great deal of wealth and who control the major banks and enterprises.

CAUSES OF SUB-PRIME CRISIS: The sub-prime crisis can be attributed to a number of factors pervasive in both housing and credit markets, factors which emerged over a number of years. Causes proposed include the inability of homeowners to make their mortgage payments, poor judgment by borrowers and/or lenders, speculation during the boom period, risky mortgage products, financial products that distributed and perhaps concealed the risk of mortgage default, monetary policy, and international trade imbalances.

•

Ups & downs in the housing market

50

Low interest rates and large inflows of foreign funds created easy credit conditions for a number of years prior to the crisis, fueling a housing market boom and encouraging debtfinanced consumption. The USA home ownership rate increased from 64% in 1994 (about where it had been since 1980) to an all-time high of 69.2% in 2004. Sub-prime lending was a major contributor to this increase in home ownership rates and in the overall demand for housing, which drove prices higher. While housing prices were increasing, consumers were saving less and both borrowing and spending more. Starting in 2005, American households have spent more than 99.5% of their disposable personal income on consumption or interest payments. This credit and house price explosion led to a building boom and eventually to a surplus of unsold homes, which caused U.S. housing prices to peak and begin declining in mid2006. Easy credit, and a belief that house prices would continue to appreciate, had encouraged many sub-prime borrowers to obtain adjustable-rate mortgages. Borrowers who found themselves unable to escape higher monthly payments by refinancing began to default. As more borrowers stopped paying their mortgage payments, foreclosures and the supply of homes for sale increased. This placed downward pressure on housing prices, which further lowered homeowners' equity. The decline in mortgage payments also reduced the value of mortgage-backed securities, which eroded the net worth and financial health of banks. This vicious cycle led to the crisis.

•

Speculation

51

Speculation in residential real estate has been a contributing factor. During 2006, 22% of homes purchased (1.65 million units) were for investment purposes, with an additional 14% (1.07 million units) purchased as vacation homes. During 2005, these figures were 28% and 12%, respectively. In other words, a record level of nearly 40% of homes purchases were not intended as primary residences. Housing prices nearly doubled between 2000 and 2006. While homes had not traditionally been treated as investments subject to speculation, this behavior changed during the housing boom. For example, one company estimated that as many as 85% of condominium properties purchased in Miami were for investment purposes. Media widely reported condominiums being purchased while under construction, then being sold for a profit without the seller ever having lived in them. Some mortgage companies identified risks inherent in this activity as early as 2005, after identifying investors assuming highly leveraged positions in multiple properties.

•

High-risk mortgage loans and lending/borrowing practices

Lenders began to offer more and more loans to higher-risk borrowers, including illegal immigrants. Sub-prime mortgages amounted to $35 billion (5% of total originations) in 1994, 9% in 1996, $160 billion (13%) in 1999, and $600 billion (20%) in 2006. A study by the Federal Reserve found that the average difference between sub-prime and prime mortgage interest rates (the "sub-prime markup") declined from 280 basis points in 2001, to 130 basis points in 2007. In other words, the risk premium required by lenders to offer a sub-prime loan declined. This occurred even though the credit ratings of sub-prime borrowers, and the characteristics of sub-prime loans, both declined during the 2001–2006 period, which should have had the opposite effect. 52

In addition to considering higher-risk borrowers, lenders have offered increasingly risky loan options and borrowing incentives. One high-risk option was the "No Income, No Job and No Assets" loans, sometimes referred to as “Ninja loans”. Another example is the interest-only adjustable-rate mortgage (ARM), which allows the homeowner to pay just the interest (not principal) during an initial period. Still another is a "payment option" loan, in which the homeowner can pay a variable amount, but any interest not paid is added to the principal.

•

Securitization practices

Securitization, combined with investors’ desire for mortgage-backed securities (MBS), and the high ratings formerly granted to MBS by rating agencies, meant that mortgages with a high risk of default could be originated almost at will, with the risk shifted from the mortgage issuer to investors at large. As the borrowers failed to make payments, the value of such securities declined which eroded the value of the investment.

•

Inaccurate credit ratings

Credit rating agencies have given investment-grade ratings to CDO and MBS based on sub-prime mortgage loans. These high ratings were believed justified because of risk reducing practices, including over-collateralization (pledging collateral in excess of debt issued), credit default insurance, and equity investors willing to bear the first losses. However, there are also indications that some involved in rating sub-prime related securities knew at the time that the rating process was faulty.

53

High ratings encouraged investors to buy securities backed by sub-prime mortgages, helping finance the housing boom. The reliance on agency ratings and the way ratings were used to justify investments led many investors to treat securitized products as equivalent to higher quality securities.

•

Policies of Central Banks

Central banks manage monetary policy and may target the rate of inflation. They have some authority over commercial banks and possibly other financial institutions. A contributing factor to the rise in house prices was the Federal Reserve's lowering of interest rates early in the decade. From 2000 to 2003, the Federal Reserve lowered the federal funds rate target from 6.5% to 1.0%. This was done to soften the effects of the collapse of the dot-com bubble and of the September 2001 terrorist attacks, and to combat the perceived risk of deflation. The Federal Bank believed that interest rates could be lowered safely primarily because the rate of inflation was low; it disregarded other important factors. Richard W. Fisher, President and CEO of the Federal Reserve Bank of Dallas, said that the Federal Bank's interest rate policy during the early 2000s was misguided, because measured inflation in those years was below true inflation, which led to a monetary policy that contributed to the housing bubble.

•

Inflow of funds due to trade deficits

54

Between 1996 and 2004, the USA current account deficit increased by $650 billion, from 1.5% to 5.8% of GDP. Financing these deficits required the USA to borrow large sums from abroad, much of it from countries running trade surpluses, mainly the emerging economies in Asia and oil-exporting nations. Hence, large and growing amounts of foreign capital flowed into the USA to finance its imports. These funds reached the USA financial markets. Foreign governments supplied funds by purchasing USA Treasury bonds and thus avoided much of the direct impact of the crisis. USA households, on the other hand, used funds borrowed from foreigners to finance consumption or to bid up the prices of housing and financial assets. Financial institutions invested foreign funds in mortgage-backed securities. USA housing and financial assets dramatically declined in value after the housing bubble burst.

55

Comparative Table of the causes of the three Major Financial Crises:

Causes

Asian Crisis

Russian Crisis

Sub-prime Crises

Declining productivity

Outcome

Cause, leading to the crisis

Outcome

Current Account/Fiscal Deficit

Leading to large inflows of funds

Leading to large inflows of funds

Leading to large inflows of funds

Asian financial Crisis

X

One of the causes

X

Decline in foreign exchange reserves

Leading to erosion of investors’ confidence Leading to decline in foreign exchange reserves Leading to fall in the value of assets

Leading to erosion of investors’ confidence Leading to decline in foreign exchange reserves Leading to fall in the value of assets

X

Fixed Exchange Rate System

X

Erosion of Investors’ confidence

Leading to fall in the value of assets Leading to dramatic changes in assets prices

Uncontrolled utilization of large inflows of funds

Leading to dramatic Leading to dramatic changes in assets changes in assets prices prices

Credit crunch

Leading to fall in the value of assets

Leading to fall in the value of assets

Leading to fall in the value of assets

Boom and bust in housing/assets prices

Outcome, due to credit crunch

Outcome, due to credit crunch

One of the causes leading to mortgage crisis

56

ROLE OF INTERNATIONAL ORGANISATIONS
ASIAN FINANCIAL CRISIS: IMF’s role in financial crisis The IMF is charged with safeguarding the stability of the international monetary system. Thus, a central role for the IMF in resolving the Asian financial crisis was clear, and has been reaffirmed by the international community in various multilateral fora. The IMF's priority was also clear: to help restore confidence to the economies affected by the crisis. IMF’s immediate response to the crisis In pursuit of its immediate goal of restoring confidence in the region, the IMF responded quickly by: • Helping the three countries most affected by the crisis-Indonesia, Korea, and Thailand-arrange programs of economic stabilization and reform that could restore confidence and be supported by the IMF; • Approving in 1997 some SDR 26 billion or about US$35 billion of IMF financial support for reform programs in Indonesia, Korea, and Thailand, and spearheading the mobilization of some US$77 billion of additional financing from multilateral and bilateral sources in support of these reform programs. In July 1998, committed assistance for Indonesia was augmented by an additional US$1.3 billion from the IMF and an estimated US$5 billion from multilateral and bilateral sources; and • Intensifying its consultations with other members both within and outside the region that were affected by the crisis and needed to take policy steps to ward off the contagion effects, although not necessarily requiring IMF financial support. 57

The IMF's immediate efforts to re-establish confidence in the affected countries included: • • A temporary tightening of monetary policy to stem exchange rate depreciation; Concerted action to correct the weaknesses in the financial system, which contributed significantly to the crisis; • Structural reforms to remove features of the economy that had become impediments to growth (such as monopolies, trade barriers, and nontransparent corporate practices) and to improve the efficiency of financial intermediation and the future soundness of financial systems; • • Efforts to assist in reopening or maintaining lines of external financing; and The maintenance of a sound fiscal policy, including through providing for rising budgetary costs of financial sector restructuring, while protecting social spending. Once the severity of the economic downturn in the affected countries became clear, fiscal policy was oriented toward supporting economic activity and expanding the social sector safety net. Forceful, far-reaching structural reforms are at the heart of all the programs, marking an evolution in emphasis from many of the programs that the IMF has supported in the past, where the underlying country problem was imbalances reflecting inappropriate macroeconomic policies. Because financial sector problems were a major cause of the crisis, the centerpiece of the Asian programs has been the comprehensive reform of financial systems. While tailored to the needs of individual countries, in all cases the programs have arranged for:

58

•

The closure of unviable financial institutions, with the associated write down of shareholders' capital;

• • •

The recapitalization of undercapitalized institutions; Close supervision of weak institutions; and Increased potential for foreign participation in domestic financial systems.

To address the governance issues that also contributed to the crisis, the reform of the financial systems is being buttressed by measures designed to improve the efficiency of markets, break the close links between business and governments, and ensure that the integration of the national economy with international financial markets is properly segmented. Transparency is being increased, both as regards economic (on external reserves and liabilities in particular) and fiscal data, and in the financial and corporate sectors. The reform efforts have been invaluably aided by the World Bank, with its focus on the structural and sectoral issues that underpin the macroeconomy, and the Asian Development Bank (ADB), with its regional specialization. The IMF's Interim Committee reviewed and endorsed the overall strategy adopted by the international community in dealing with the Asian crisis at the 1998 Bank-Fund Annual Meetings in October. Additional Measures Taken by the IMF in Response to the Crisis In addition to the IMF's first line of response-assisting in the design of the programs and providing financial resources for their support-the following steps have also been taken: • The Executive Board made use of the accelerated procedures established under the emergency financing mechanism and the exceptional circumstances clause3 to 59

meet the exceptional needs of the member countries in terms of approval time and access. • The Supplemental Reserve Facility (SRF) was created, for the special circumstances of members experiencing exceptional balance of payments difficulties owing to a large short-term financing need resulting from a sudden loss of market confidence. • The coordination of the IMF with the other international financial institutions, notably the World Bank and the Asian Development Bank, and with bilateral donors was intensified, to muster truly international support for the affected countries' economic reform programs. • A strengthened level of dialogue between the IMF and a variety of constituencies in the program countries was initiated, including consultations with labor groups and extensive contacts with the press and the public. • The IMF programs have been associated with coordinated efforts between international creditor banks and debtors in the affected countries to resolve the severe private sector financing problems at the heart of the crisis, and the IMF has provided support to this process as appropriate. Thailand reached an early understanding on debt roll-over with key Japanese creditor banks in August 1997. Talks between Korea and a group of foreign creditor banks on the voluntary restructuring of short-term debt began in late December 1997 and were finalized in March 1998. In June 1998, Indonesia and a steering committee of its foreign bank creditors agreed on a framework for the voluntary restructuring of interbank debt, trade credit, and corporate debt. 60

•

IMF member countries have attained new levels of transparency through the release to the public of the letters of intent describing their programs of economic reform. With the permission of the respective authorities of Indonesia, Korea, and Thailand, the IMF has posted the letters of intent on the IMF website so that details of the programs are readily available to all interested parties. Korea and Thailand have also issued Public Information Notices (PINs), a relatively new means for countries to make known to the public the views of the IMF Executive Board on national economic policies. All three countries are subscribers to the IMF Special Data Dissemination Standard (SDDS), and Indonesia and Thailand have established hyperlinks from the IMF Dissemination Standards Bulletin Board (DSBB) to their respective national economic and financial data.

•

Ad hoc measures have been taken as necessary, including the appointment of former IMF Deputy Managing Director Prabhakar Narvekar as a Special Advisor to the Indonesian authorities; the establishment of resident representative posts in Korea and Thailand (and the expansion of the existing post in Indonesia); and various activities through the IMF's newly opened Asia and Pacific Regional Office.

•

The IMF has been responding to the requests it has received from its members, from its own Interim Committee and from multilateral fora such as the Group of Seven and the Group of Twenty-Four nations, to investigate aspects related to the financial crisis, from the role of hedge funds, to promoting financial sector soundness and strengthening the architecture of the international monetary system.

61

Amid the urgent need for a concerted international response to the crisis situation, the great uncertainty in Asia, and the unexpectedly virulent financial contagion, the IMFsupported programs have, as would be expected, come under scrutiny from a wide range of commentators, and a healthy debate is taking place. The IMF has undertaken and made public a rigorous, albeit preliminary, internal review of the design and early experiences with IMF-supported programs in Indonesia, Korea, and Thailand, in part to contribute to this debate. However, some criticisms of the programs are based on fundamental misunderstandings about the IMF's response to events in Asia.

•

RUSSIAN CRISIS: 1997-98

In July-August 1998 the Russian government appealed to the international financial community for assistance. After significant deliberations the IMF on July 13 announced agreement on a new package of $17 billion in new credits. The package included new loans totaling $11.6 billion from the IMF, $4.0 billion from the World Bank, and $1.5 billion from Japan. The credits were scheduled to be distributed through 1999. Combined with committed but undistributed IMF credits of $5.6 billion, the package was to provide Russia with $22.6 billion. The IMF subsequently turned over to Russia $4.8 billion as the first tranche from the package. But the IMF had ceased making further payments (the second tranche was scheduled to be delivered on September 15) because of the Russian government's failure to meet the conditions of the loans. In late October "anti-crisis plan" was implemented to stabilize the economy. The plan included subsidies for the production of food, medicines, and other goods considered critical to the population; more strictly controlling the activities of the so-called natural 62

monopolies-- natural gas, electricity, and rail; imposing controls on using and holding foreign currencies; restructuring the banking sector and the tax system; and reducing the volume of wage and pension arrears. Many analysts and the IMF had criticized the budget as based on unrealistic assumptions : an annual inflation rate of 30%; an exchange rate of 20R/$1; cooperation in getting foreign debt rescheduled (the budget includes only $9.5 billion for debt servicing out of $17.5 billion that is due). Perhaps most critically, the IMF continued to withhold funding because it viewed the Russian government's plan and budget unworkable. Many believe that the default, which hit Russia ten years ago, was not merely a consequence of the ungifted economic policy of the Russian government during the second half of the 1990s. The devaluation of the Russian ruble occurred because of the efforts taken by the International Monetary Fund, which triggered the massive economic crisis in Russia nationwide and impoverished the majority of Russians in an instant. They believe that if IMF had increased the Russian reserves by ten or 20 billion dollars within the framework of its coordinated aid program, the financial collapse would not have happened. The weak position of the federal budget became the main reason of the black August in 1998. In the summer of 1998 the Finance Ministry could fund only a half of its spending with the help of taxes. The other half was funded at the expense of borrowings. When markets stopped lending money to the ministry, the federal budget was unable to function properly.

63

•

STEPS TAKEN TO OVERCOME SUB-PRIME CRISIS:

Various actions have been taken since the crisis became apparent in August 2007. In September 2008, major instability in world financial markets increased awareness and attention to the crisis. Various agencies and regulators, as well as political officials, began to take additional, more comprehensive steps to handle the crisis.

•

Legislative and regulatory responses: o Federal Reserve Bank lowered the target for the Federal funds rate from 5.25% to 2%, and the discount rate from 5.75% to 2.25%. o Undertaken, along with other central banks, open market operations to ensure member banks remain liquid. These are effectively short-term loans to member banks collateralized by government securities. o Used the Term Auction Facility (TAF) to provide short-term loans to banks. The Fed increased the monthly amount of these auctions throughout the crisis, raising it to $300 billion by November 2008, up from $20 billion at inception. A total of $1.6 trillion in loans to banks were made for various types of collateral by November 2008. o In November 2008, the Federal Bank announced the $200 billion Term Asset-Backed Securities Loan Facility (TALF). This program supported the issuance of asset-backed securities (ABS) collateralized by loans related to autos, credit cards, education, and small businesses. This step was taken to offset liquidity concerns.

64

o In November 2008, the Federal Bank announced a $600 billion program to purchase the MBS of the GSE, to help lower mortgage rates. o On 31 March 2008, an expansion of the Federal Bank's regulatory powers was proposed, that would expand its jurisdiction over non-bank financial institutions, and its authority to intervene in market crises. o Responding to concerns that lending was not properly regulated, the House and Senate are both considering bills to further regulate lending practices. o Economic Stimulus Act of 2008: On 13 February 2008, Former President George Bush signed into law an economic stimulus package costing $168 billion, mainly taking the form of income tax rebate checks mailed directly to taxpayers. Checks were mailed starting the week of 28 April 2008. o On 18 September 2008, UK regulators announced a temporary ban on short-selling the stock of financial firms.

•

Government bailouts of financial firms: o In October 2008, the Australian government announced that it would make AU$4 billion available to non-bank lenders unable to issue new loans. After discussion with the industry, this amount was increased to AU$8 billion. o In November 2008, the U.S. government announced it was purchasing $27 billion of preferred stock in Citigroup, a USA bank with over $2 trillion in assets, and warrants on 4.5% of its common stock. The preferred stock

65

carries an 8% dividend. This purchase follows an earlier purchase of $25 billion of the same preferred stock using TARP funds. o AIG received an $85 billion emergency loan in September 2008 from the Federal Reserve which AIG is expected to repay by gradually selling off its assets. In exchange, the Federal government acquired a 79.9% equity stake in AIG.

•

Emergency Economic Stabilization Act of 2008

The U.S. Federal government announced a plan, requiring Congressional approval, to purchase from financial institutions large amounts of mortgage backed securities (MBS) and collateralized debt obligation (CDO) backed by sub-prime mortgages. The estimated cost of this plan was at least $700 billion. The plan also banned short-selling the stocks of financial firms. On 1 October 2008, the U.S. Senate approved an amended version of the plan, which was ratified by the House on October 3 and immediately signed into law by Former President George Bush. After the law was passed, the U.S. Treasury instead primarily used the first $350 billion of bailout funds to buy preferred stock in banks instead of troubled mortgage assets.

•

Hope Now Alliance

Former President George W. Bush announced a plan to voluntarily and temporarily freeze the mortgages of a limited number of mortgage debtors. A refinancing facility was also created. These actions are part of the Hope Now Alliance, an ongoing collaborative effort between the US Government and private industry to help certain sub-prime borrowers.

66

FINDINGS & CONCLUSION

While each financial crisis, no doubt, is distinct in some aspects, they also share striking similarities, in the run-up of asset prices, in debt accumulation, in growth patterns, and in current account deficits. While in the case of the United States (sub-prime crisis), new unregulated or lightly regulated financial entities have come to play a much larger role in

67

the financial system, undoubtedly enhancing stability against some kinds of shocks, but possibly increasing vulnerabilities against others. Technological progress has advanced, cutting down the cost of transacting in financial markets and broadening the list of instruments. Nevertheless, the quantitative and qualitative parallels to earlier financial crises (Asian & Russian crises) are worthy of note. The earlier crises (Asian & Russian) were more or less related to currency, i.e. the exchange rate system, whereas sub-prime US crisis is related to credit creation and boom & bust in housing prices. From the study conducted above, we can find and conclude that the Asian & the Russian crisis were somewhat similar, the former being one of the causes of the latter. The common reasons for both the crises were pegged exchange rate system, current account deficits leading to higher inflows of capital and erosion of investors’ confidence due to falling GDP and failure to pay debts. Their outcomes were also similar - falling GDP, fall in the value of investment assets (crash in stock market), devaluation of currency, rise in unemployment, decline in housing prices and IMF’s financial support to strengthen the situation. Whereas, the sub-prime crisis is concerned, the causes for the same were somewhat different from the other two crises. The main causes of the sub-prime crisis were housing boom & bust, high risk sub-prime loans, securitization of such loans and inaccurate ratings of such loans. Although some causes were similar like speculation and inflows of funds, the basic nature of the sub-prime crisis is different from the other two, in the sense that the other two are currency crisis and the sub-prime crisis is high risk mortgage crisis.

68

Outcomes of sub-prime crisis include fall in the value of investment assets, devaluation of currency of various countries, fall in per-capita income, loss of employment and changes in policies (similar to basic outcome of a financial crises). IMF played a major role in taking measures to overcome the Asian financial crises, its measures include timely financial support, reforms, programs and policies to restore investors’ confidence, to facilitate refinancing to strengthen the economy and to correct the weaknesses in financial structure. In case of Russian crises, IMF & World Bank, initially, announced financial support to facilitate the Russian government overcome the crunch position, but IMF later seized the second installment of the financial support due to non-conformance of the conditions by the Russian government. While in case of sub-prime crises, the measures to overcome crisis include various legislative and regulatory measures, financial bailouts by US government and hope new allowance set up by the Former President George W Bush. So, after analyzing the data we can conclude that the Asian crisis & the Russian crisis were similar in nature but the Sub-prime mortgage crisis was different from the other two. Although the outcomes were somewhat similar, the causes of sub-prime were different from the causes of the other two crises.

REFERENCES

Articles & Journals:  Ebscohost

69

o “A Case Study of a Currency Crisis: The Russian Default of 1998 ” A Research Paper by Abbigail J. Chiodo and Michael T. Owyang (Nov 2002,
Federal Reserve Bank of St. Louis)

o “Is the 2007 U.S. Sub-Prime Financial Crisis So Different? An International Historical Comparison” by Carmen M. Reinhart & Kenneth S. Rogoff. “Is This Crisis A Replay of 1929?” An Article by Mr. Robert J Samuelson (Newsweek, 13th October, 2008) o “Asian Financial Crisis Continues To Bite” Published in Money Management (17th July, 2008)

 Economic Times “This Day That Year” An article by Ms. Prerna Katiyar, Nov 2, 2008

 “The Russian Financial Crisis: Why was Ruble Devaluation accompanied by the Sovereign Debt Crisis?” May 2005, Open Economy Institute and International College of Economics and Finance, State University – Higher School of Economics, Moscow, Russia

Internet:  http://en.wikipedia.org/wiki/Financial_crisis  http://en.wikipedia.org/wiki/Asian_financial_crisis  http://en.wikipedia.org/wiki/Sub-prime_mortgage_crisis

70

 http://en.wikipedia.org/wiki/1998_Russian_financial_crisis  http://economictimes.indiatimes.com  http://www.fas.org/man/crs/crs-asia2.htm  http://www.imf.org/External/np/exr/facts/asia.htm  http://www.frbsf.org/econrsrch/wklyltr/wklyltr98/el98-24.html  http://www.twnside.org.sg/title/chan-cn.htm  http://www.ifg.org/imf_asia.html  http://www.globalissues.org/print/article/32  http://www.acus.org/new_atlanticist/financial-crisis-what-doesnt-kill-us-makes-usstronger  http://english.pravda.ru/russia/history/19-08-2008/106148-financial_crisis-0

71