This dissertation presents a comparison of two recent crises which are Asian financial crisis in 1997 and US Subprime mortgage crisis in 2007. The study is based on reviewing from previous papers and journals on the origins of each crisis, their effects and how regulators react afterwards. The study also examine 3 factors that are considered have led to the crises, compared these factors between 4 sample countries US, UK, Thailand and South Korea.
Chapter 1: Introduction
The subprime mortgage crisis in 2007 was started by a large number of defaults of payments on subprime mortgages in US. It led to the rapid fall of US housing markets, bankruptcies of many large institutions and small-medium enterprises. Not only that, it even impacted many other countries in the world, leading to financial crisis and recession. All the major capital markets were affected by this crisis.
The Asian financial crisis in 1997 was the major crisis happened to Asia where South-East Asia was hit hardest. The crisis started due to the loss of investors' confidence in the Asian market. It first started in Thailand then developed contagious effects on other Asia countries, led to large amount of capital was withdrawn from the market.
Although two crises happened 10 years apart from each other, both have had serious impacts on many financial markets.
The primary project question of the study is: What are the similarities between the Asian Financial crisis of 1997 and the US Subprime crisis and what can be done to avoid similar predicaments in the future?
The aim of the project is to analyse two financial crises, examining correlations between how they occurred, in order to develop indictors to avoid future crises. The project will concentrate on comparing the two crises in term of current account balance, interest rates, GDP growth per capita and equity prices before and after each crisis.
The organisation of the dissertation is as following. Next section is the literature review which will present the causes of the two crises that have been presented in past articles, journals or working papers by many authors and readers. Not only the origins of the crisis, it will also present the policy and regulator responses after the crises. From those, I will give my comparison of two crises based on the literature written in this section. Chapter 3 is Methodology and Data which will give a description on how I select my data to do the comparison between and what methodology I use to present these data. Chapter 4 is the analysis on the data collected and compares my analysis with what have been found in previous papers or journals. At last, conclusion will be presented in chapter 6, with my answer if there is any similarity between the two crises and what can be done in the future to prevent them from happening again.
Chapter 2: Literature Review
Subprime crisis 2007
Origin of the crisis
Causes of the subprime crisis can contain many factors distributive in housing and credit markets, factors which had been going on for a number of years. According to Milne (2009), the causes include "maturity mismatch", "rapid credit growth", "deterioration in standards of loan assessment" and also lost of investors' confidence. We will look at these causes, together with others found by other authors in this section.
Due to global imbalances, US have seen a large inflow of foreign funds coming in the last several years. It helped to increase the availability of financing in US which led to easy credit conditions, banks were more willing to lend to borrower with low credit score. In few years before the crisis, banks and financial institutions offered more and more loans to low credit borrowers who were very high-risk. In 2006, subprime mortgages amounted up to 60% of total originations. The mortgage qualification guidelines started to change. For example, proof of income and employment were no longer needed. Borrowers just needed to prove that they had money in their bank account. The guidelines got looser and looser, produce more and more mortgages and securities.
Moreover, US remained low interest rates for number of years prior to the crisis. Federal Reserve, who acts as central bank in United States, set very low interest rates from 2000 to 2004. From figure 1 below, we can see that from 2000 to July 2004, the federal fund rate was getting lower and lower to 1%. This was due to the fear of deflation that was caused by the dot-com bubble and the terrorist attacks in 2001. In 2006, Fisher (2006) mentioned that due to poor date, the real federal fund rate was lower and held longer than it should have been, led to policy that increase the homeowner speculation activity. From July 2004 to 2006, the federal fund rate was raised significantly to 5.25%. That made adjustable-rate mortgage interest rate became higher and more expensive for homeowners. As the interest rate got higher, the housing prices became lower which led to the deflating of the housing bubble.
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Figure : Fed Funds Rate & Mortgage Rates 2001 - 2008, Source: US Federal Reserve
The two factors above had helped the housing market to boom and encourage debt-finance consumption. Number of mortgages increased, in which subprime lending was a major part. As subprime mortgage was easier to borrow, demand for housing increased and led to higher housing prices. The increase in demand for housing also drove building boom. That eventually led to surplus in supply of houses in US, housing prices peaked and began to decline in mid-2006. Borrowers who could not make payment for their mortgages found it more difficult to refinance once housing prices fell. As the result, borrowers started to default on their mortgages. Housing prices continued to fall and value of mortgage-backed securities reduced due to the increase in mortgage payment.
In the traditional mortgage model, banks originated a loan to the borrower and retain the credit risk. With the coming of securitisation, the traditional model had changed. Banks packed these mortgages into mortgage backed securities, or often called collateralised debt obligations (CDO). These securities were then sold to hedge funds and investment banks that will generate huge returns from them. Securitisation meant that banks did not need to hold the mortgages until maturity. So by selling the mortgages, banks were able to get more funds, which mean they could issue more loans. That could be the reason why there was an increase in number of mortgages, instead of increase in credit quality of mortgages. However, it would only work if housing price did not fall. In mid-2006, when housing prices started to decline, borrowers began to default on their mortgages. As the result, value of MBS also decreased. The securitisation makers started to close down in beginning 2007 and nearly shut down in 2008. Investors stopped buying MBS so banks could not get any source of funds. Therefore, banks and other financial institution who originated mortgages could not help subprime borrowers to refinance or lend second mortgages. That was one of the effects of the crisis.
Another causes contributed to the crisis was the failure of government and central bank policies. The Securities and Exchange Commission (SEC) and Alan Greenspan confessed failure in allowing investment banks to self-regulate (Labaton, 2008). In 2004, the SEC loosened up capital rules; let banks determine level of risk of investments by themselves. Many banks had taken this opportunity to raise their leverage ratio. Figure : Leverage Ratios for Major Investment Banks below shows us how 5 major investment banks had increased their leverage ratios significantly since 2004. The higher their leverage ratios, the more exposure they are to risk of mortgage backed securities losses.
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Figure : Leverage Ratios for Major Investment Banks
The boom and burst of shadow banking system was also a key factor of the subprime crisis. Shadow banking system involves banks and financial institutions that do not accept deposits. Hence they are different from depository banks and cannot be regulated like depository banks. These banks are usually very high leverage as they are not regulated to keep enough capital to cover their borrowing and lending. These shadow institutions represent maturity mismatch risk as mentioned earlier as they use short-term funds to invest in long-term assets. One of these long-term assets was mortgage backed securities which saw a decline in value during the crisis. Because shadow institutions rely heavily on short-term funds, they will have to keep finding new loans to refinance their operations. When the mortgage backed securities dropped in value and housing market went down in 2007, these institutions could not obtain new funds to finance themselves. This led to the collapse of Bear Stearns and Lehman Brothers, two examples of shadow institutions, in 2008.
Another factor contributing to the crisis was the balance of payment. From Figure below, it was easily seen that USA was experiencing a long period of rising in current account deficit. Current account deficit is often resulted by imports are higher than exports or savings are higher than investments. One year before the crisis started, current account deficit was nearly 6% of total GDP. Countries with currency pegged to US dollar, in order to maintain the system and prevent their currency appreciating, they have to buy US dollar and save in foreign exchange reserves. The biggest buyer of US dollar was China. In order to maintain its exports competitiveness, China has to keep their currency value low. As it was pegged to US dollar and with US being the biggest consumer, China had to pour capital into US, resulting current account deficits. However, in order to maintain the balance of payments, US must run a capital account surplus by the same amount as current account deficits, means they will have to increase their imports or domestics investments. In anyway, the increasing of availability of funds from abroad had made it easier for individuals for financial institutions to borrow. Individuals would borrow to invest in properties while financial institutions used loans to invest in mortgage backed securities. After the housing bubble bursts, the US housing and financial assets went down significantly (Economist, 2009)
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Figure : US Current Account or Trade Deficit: Dollars and % GDP
Policy and regulation responses
Before the crisis happened, FSA operated in "old-style" where FSA only intervened in the market when it observed that there were clearly problems and risks had occurred. This "old-style" was more retroactive way in intervening in the market when what we needed was prevention before anything could happen. Firms did not have a clear guideline of where to stop before making mistakes, therefore, although unintentionally, they would make mistakes along the way. In order to minimising mistakes and failures made by firms, FSA needed to be more proactive in their approach by be more prudent in supervising and having better quality analysis. In order to have more prudential supervision, FSA has changed their approach to be more proactive. According to John Pain (2010), FSA now:"
Undertake more extensive business model analysis
Make judgements, on the judgements of senior management
Act quickly and decisively
Proactively look to influence outcomes, not merely react to events
Apply a greater depth of analytical rigour
Back up the intensive supervision with credible deterrence when standards are not met"
This approach of intensive supervision is risk-based, which means the regularity of the supervision or risk assessment will depend on how much the firm or sector is exposed to risk.
In the speech by Richard Sutcliffe( 2010), he stated that the Capital Requirements Directive CRD2 proposals were intended at improving the:"
quality of firms' capital by establishing clear EU-wide criteria for assessing the eligibility of 'hybrid' capital to be counted as part of a firm's overall capital;
management of large exposures by restricting a firm's lending beyond a certain limit to any one party;
risk management of securitisation, including a requirement to ensure that a firm does not invest in a securitisation unless the originator retains an economic interest of at least 5%;
supervision of cross-border banking groups by establishing 'colleges of supervisors' for banking groups that operate in multiple EU countries;
Operation of the CRD by amending various technical provisions to correct unintended errors or to introduce additional clarity sought by stakeholders since the implementation of the original CRD." (Sutcliffe, 2010)
There were also changes in CRD 3 to show international developments and keep up the agreements by the BCBS. The changes included:"
higher capital requirements for re-securitisations to make sure that firms take proper account of the risks of investing in such complex financial products;
Strengthening capital requirements for the trading book to ensure that a firm's assessment of the risks connected with its trading book better reflects the potential losses from adverse market movements in the kind of stressed conditions that have been experienced recently." (Sutcliffe, 2010)
Changes in CRD 4 contain a significant reform package to:"
raise the quality, consistency and transparency of the capital base;
strengthen the risk coverage of the capital framework;
introduce a leverage ratio as a supplementary measure to the Basel II risk-based framework;
introduce a series of measures to promote the build-up of capital buffers in good times; and
introduce a global minimum liquidity standard for internationally active banks." (Sutcliffe, 2010)
In US, the subprime mortgage crisis affected many banks and financial institutions, even the biggest one. The first US government's response was to bailout these institutions through a fiscal stimulus package (Kenc & Dibooglu, 2010). When crisis happened, government's bailouts were always advised, especially with "too big to fail" firms. Otherwise, it would create greater loss of confidence in the financial system. As the reason, the US government had paid around $700 billion to bailout some of the failed institutions such as Fannie Mae and Freddie Mac.
The Federal Reserve's first response was cutting the rate they lend to depository banks in August 2007. Following that, in September 2007, easy monetary policy was started by the Federal Open Market Committee, began by lowering the Federal Funds rate by 50 basis points. By Spring 2008, the federal funds rate was reduced by 325 basis points (Bernanke, 2009). According to Bernanke (2009), compared with responses in the past, "this policy response stands out as exceptionally rapid and proactive".
A second strategy employed through the Federal Reserve was to increase the deposit insurance for financial institutions. Such a move is argued to better the decision to close a financial institution "with less social hardship and less consequential political fuss" (Goodhart 2008, p. 352). Further this would lead to early detection of institutions that are at the risk of failure thus informing early action to prevent the effect from spreading to the entire sector and the economy (Weiss & Larson 2008). This however could also be subject to moral hazard challenges and agency related issues where the deposit insurance provides regulators (agents of the taxpayer) with an incentive to ignore problems of insured entities that are at a risk of insolvency (Hanc n.d). This means that the financial institutions also do have a role to play in ensuring the stability of the financial system to withstand economic downfalls.
Other responses include the introducing of the Housing and Economic Recovery Act of 2008 in order to repair confidence in mortgage markets. The Act includes introducing new Federal Housing Finance Agency with greater power and authority in controlling and supervising 14 housing GSEs and 12 Federal Home Loan Banks (Housing and Economic Recovery Act of 2008, 2008)
Asian Financial crisis 1997
Origin of the crisis
The Asian financial crisis started in Thailand in July 1997, when Thailand announced to float the Thai baht after a long period of pegging to the US dollar exhaustively. The collapse of Thai baht led to the drop in value of many other currencies in the same region such as Malaysian ringgit, Philippine peso and Indonesian rupiah (Appendix 1). This led to pressure being put on Taiwan dollar, South Korean won, Singaporean dollar and Hong Kong dollar (Appendix 1). In order to cope with the pressure, governments from these countries had to sell dollars they were holding to buy countries own currencies. These countries also raised their interest rate in expectation of preventing currency speculation and attracting more foreign investment (Nanto, 1998)
Pegged exchange rate
The initial cause that led to the crisis was the pegged exchange rates system where most of the affected countries had their currencies pegged with the US dollar. This system was initially beneficial to the countries involved. Pegged exchange rate system will provide certainty and reduce exchange rate risk for exporting to and importing from US or countries in dollar area. The exchange rates would only change if there were any changes in US dollar. Therefore, if there were any changes in these countries' economic situation, it would not reflected by the exchange rates as governments only allowed their exchange rates to change within a certain limit. However, these benefits are only effective if the level of currency speculative activity is low. The collapse of Thai baht was an example of how damaging the pegged exchange rate system could do to a country's economy. Since 1987, Thailand had been able to maintain a stable exchange rate for Thai baht in relative to US dollar. With the growing of crop exports at a rate of 12% per year and US economic aid during the Vietnam War, Thai economy was injected with large amount of capital. In 1984, as inflation rose, it led to the decrease of Thai exports. Thai government had to repegged Thai baht at a lower exchange rate to ensure the competitiveness of their exports. However, problem only started in 1996 and 1997 when US started to recover from recession in early 1990s. The US Federal Reserve Bank decided to raise the interest rate to attract more foreign investments. This had diverted foreign investments from South East Asian countries to US and helped to raise the value of US dollar. This meant countries with currencies pegged to US dollar also appreciated. Therefore, their exports were more expensive to non-dollar importers. Furthermore, at the same time, Japanese yen, which was not fixed to US dollar, was depreciating in value and hence, Japanese exports became more attractive than South East Asian. The two problems had subsequently led to rising in trade and current account deficits in these South East Asian countries. Thailand, at that time, was one amongst these countries with the highest current account deficit and trade deficit. Thailand current account deficit and trade deficit were 8.08% and 6.65% of GDP respectively (World Databank). Currency speculators who anticipated the Thai baht would continue to fall would sell the currency in the forward market with expectation that they would be able to buy with lower price in the future. This had put a downward pressure on Thai government to intervene and maintain the currency exchange within limitation. It meant that they had to use US dollar in their foreign reserves to buy their own currency to bring up its value. Thai government also had raised interest rate up, expecting to attract foreign investments and bring capital into the country. However, speculator kept selling the baht forward to put pressure on the baht's value. In July 1997, after a string of speculative attacks and using $33 billion in foreign exchange, Thai government announced to float Thai baht, no longer pegging it with US dollar. As mentioned before, the collapse of Thai baht led to the collapse of other currencies. As mentioned before, this led to pressure being put on other countries including South Korea. South Korean's external balance already started to go deteriorate in late 1996. By the time the crisis started in Thailand, South Korean had high level of external debt, which had risen swiftly after years of current account deficits. Investors started to lose confidence in South Korea's financial market outlook and withdrew funds from South Korea. The government was unable to attract more funds from abroad or extend maturity of loans. The balance of payment problem led to financial problem as domestic stock price drop dramatically and exchange rate depreciated (Kim, 2000)
Lending and borrowing practices
The other problem lied in banks and financial institutions' lending and borrowing practices in Asia. According to Nanto (1998), companies in Asia raised capital mainly by borrowing, rather than issuing shares. Since late 1980s and early 1990s, we can see from Error: Reference source not found that many Asian countries had expericed high growth rate. Especially Four Asian Tigers which are Singapore, South Korea, Hong Kong and Taiwan were highly developed and had rapid growth GDP and living standard. At that time, Japan was experiencing stagflation and European countries were in recession, Asian countries became attractive destination for foreign investors with high interest rates and stable economies. Hence, many of them had diverted their capital from Japan and Europe to Asian countries. Large amount of capital inflows was poured into Asia. Until the crisis started, nearly half of total capital inflow into developing countries went to Asia.
This resulted a booming period in banking sector in Asia. However, banks and financial institutions in the region were not monitored and controlled tightly by the government. There was no regulation or limitation in amount bank can borrow or lend. Therefore, they had borrowed excessively from abroad and then lent at a high interest rate to businesses and consumers at home country. By early 1990s, Thailand banks made huge profit from the economy by charging borrowing interest rate 4% higher than depositing rate. As business cultures in Asia depends strongly in relationship and connection, businesses that have strong relationship or connection with banks or government will have better access to financing. Therefore, loans were given out because of relationship, not by assessing business plans or loan applications, net value of the projects or credibility. There was no risk assessment and banks only looked at how much profit they could get. This is applied to South Korean case where large amount of support and subsidised loans were given to chaebols, a form of business conglomerate which operates internationally and is very powerful. This resulted high amount of capital was concentrated in particular industries, made the economy more exposure to shock.
Many banks and businesses in Asia also had caused trouble by relying too heavily on short term funding, mostly loans with maturity of one year or less, for long term projects. In Figure : Short term debt June 1997 (as % of Total Reserves), South Korean, Thailand and Indonesia, main countries that were affected by the crisis, had very high amount of short term debts in June 1997, especially South Korean with short term debt amounted around 200% of total reserves. In the American Economic Association in 1998, South Korean was criticised for removing regulations and restrictions on these short term borrowing that contributed to the crisis (Uchitelle, 1998).
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Figure : Short term debt June 1997 (as % of Total Reserves)
In Thailand, a large proportion of these short term borrowings were used for real estate investment. This sector was claimed to be non-productive because it did not product any tradable goods or services that could be sold internationally to generate exports. Hence it would deteriorate capital account and balance of trade. Kim (2000) also argued these short term loans if to be invested in real estate development would fall before making enough profits to repay the debt. In most cases, if banks or businesses keep getting new loans, they will be able to roll over these old loans that have matured. Hence, there will be no financial problem occurs. However, in the long run, this high ratio of short term debts to total reserves made these countries vulnerable to a potential run on their currencies (Radelet & Sachs, 1998). As mentioned before, after recovering from early 1990s crisis, US Federal Reserve raised their interest rate to attract foreign investments. They also limit their lending to Asian countries. Loans became more difficult to get. Businesses and banks were unable to refinance their debts or obtain new ones. Even lending between bank and bank was difficult at that time due to illiquidity.
Policy and regulator responses
In December 3, 1997, the IMF and other international financial institutions agreed to use $58.4 billion to bailout and reform Indonesia, Thailand South Korea. Out of $58.4 billion, G-7 countries reserved $23.4 billion that would only be available if the initial $35 billion contributed by the IMF and other institutions was not enough.
Also IMF had tightened monetary policy in these countries. They did not do it all at the same time but execute in different countries at different period of time. This was to prevent the depreciation of these countries' exchange rates and prevent it turn into spiral inflation. This monetary policy would be effective until the markets recover and confidence is restored.
In all IMF's responses to the crisis, restructuring the financial sector was amongst the most needed. In order to do that, IMF had:
closed insolvent financial institutions to prevent further losses;
recapitalised of potentially viable financial institutions;
closed central bank supervision of weak financial institutions; and
strengthened the financial supervision and regulation, to prevent the crisis from happening again, restore the health of financial institutions and bring supervision and regulation up to international standards.
(IMF, 2000)
The IMF (2000) also addressed the need for restructuring corporate debt in order to bring back the healthy financial system. The reforms include:"
efforts to shield poor and vulnerable sections of society from the worst of the crisis, by deepening and widening social safety nets and (notably in Indonesia) devoting substantial budgetary resources to increasing subsidies on basic commodities such as rice;
measures to increase transparency in the financial, corporate, and government sectors; and
steps to improve the efficiency of markets and increase competition." (IMF, 2000)
Similarities of two crises
The first similarity between Asian financial crisis 1997 and Subprime mortgage crisis 2007 that can easily be seen is a period of significant economic growth before the crisis started (Allen & Snyder, 2009). The booming period led to investors' high confidence in the economies so they injected a large amount of capital in these countries. This resulted in large debts were acquired by firms and individuals to finance their investments. In both crises, it usually led to risk of maturity mismatch as firms and individuals tended to use short term borrowings to finance long term projects. So even though significant economic growth did not stimulate these crises, it led to other factors that cause them.
Another cause that was similar in both crises is poor government policies and regulations. The poor government policies were demonstrated in the Asian financial crisis including the relaxed regulations on short term borrowings, let the markets rely too heavily on short term loans to fund long term projects and increase their risk of maturity mismatch; borrowing and lending practices were too concentrated in well-connected businesses, make the capital not diversify and less available to other small and medium firms. In the subprime crisis, government regulations were not tight in controlling businesses' risk, allowing firms to model their risk themselves which led them to take more risks than they could. Also they allowed sub-prime mortgage borrowers to receive mortgages that were significantly more than what these borrowers could afford, led to high proportion of defaulted mortgages when the market was in trouble.
Another cause that was similar in both the Asian financial crisis and the global financial crisis was the poor accounting reports that were provided by the financial services firms. In the Asian financial crisis, there was a "lack of standardisation in the accounting practices which impacted the reliability and comparability of financial information" and thus helped fuel the drivers of the financial crisis (Lin & Chen, 2000). In the global financial crisis, the unclear accounting treatment of the financial derivatives and the varied approaches to how these were presented in the balance sheets of the financial services firm led to the failure of different agencies to understand the impact of these derivatives on the financial stability of the firms (Hutchinson, 2009). In both the Asian financial crisis and the global financial crisis, the inadequacy of the financial reports to 'paint a true picture' of the financial soundness and stability of the corporations and the financial services firms was a key influence to the financial crises experienced.
In terms of the effects of the crises, the main similarities that could be seen in both the Asian financial crisis and the global financial crisis include: the drop in property and asset prices; the withdrawal of funds available in the market; the increase in volatility of the stock markets and the co-integration of the market. In Asia, these two effects of decreasing property and asset prices and withdrawing of foreign funds in the market (Pilbeam, 2001) were immediately seen following the start of the crisis in Thailand. These were also seen in the global financial crisis with the drop in property and asset prices further exacerbating the situation of the financial services firms that relied on the prices of these properties as collateral for various instruments. There was also an immediate lack of liquidity in the market as the investor funds dried up thus resulting in some firms being unable to find financing to offset the drop in collateral requirements.
There was also a marked volatility in the Asian stock prices and a co-integration of the market following the Asian financial crisis (Girard & Rahman, 2002). News events easily impacted the market resulting in large swings in the stock prices of public firms. The co-integration of the market had a contagion effect with the impact in one of the countries resulting in an impact in the other countries in the Asian financial crisis. This was similarly seen in the global financial crisis with stock markets having large volatilities and markets being affected by the contagion effect.
While there were similarities in the effects of the financial crises, there were also differences. The main difference that can be noted was that while there was a global effort to make wholesale changes to the financial services sector as a result of the global financial crisis, this was not similarly evident in the Asian financial crisis. The aftermath of the Asian financial crisis still shows some countries continuing with their pre-Asian financial crisis approach thus fuelling the possibility of another financial crisis (Liu, 2000). In contrast, the efforts of the G20 since the global financial crisis have been focused in instituting reforms that would prevent further occurrences of the global financial crisis. The focus has been on increasing corporate governance and risk management, improving regulation in the financial services sector, and managing the 'risks and rewards' that are in place in the financial services sector.
Chapter 3: Methodology & Data
The title of this project involves a large number of data that can be used to compare both crises. As there is a limitation of amount of time and work that can be spent, I narrow it to main 4 indicators: current account balance, interest rate, GDP growth per capita and S&P Global Equity Indices.
The two crises affected many countries in the world. Asian crisis 1997 affected mainly Indonesia, South Korea and Thailand. China, India, Taiwan, Singapore, Brunei and Vietnam were also slightly affected as the demand and confidence of Asian economic situation were dropped. The subprime crisis 2007 started in US but had global effects on many European and developing countries. As mentioned before that due to limitation of the project, we will only look at 4 sample countries from the 2 crises. For Asian crisis 1997, I choose South Korea and Thai land, which were two countries that were most affected by the crisis. For subprime crisis 2007, I choose US and UK which are two largest financial centres in the world.
Data is collected mainly from World Databank by The World Bank and International Financial Statistics by The International Monetary Fund.
Chapter 4: Analysis and Findings
Current account balance
From Figure : South Korea current account balance 1992 - 1997 (World Databank) below, we can see that, all four countries in our comparison were having a significant amount of current account deficit one year before the crisis happened. Especially South Korea, there had been a substantial increase in current account deficit from 1995 to 1996, from -$8.6 billion to -$23.2 billion. Compare with previous years before the crisis, the increase in current account deficit had never been this big. As mentioned in the literal review, this was due to the slow down of export and loss of competitiveness in export price which led to significant reduction in trade deficit. On the year of crisis, the current account balance dropped back to the same level as 1995.
Figure : South Korea current account balance 1992 - 1997 (World Databank)
Although Thailand did not experience the same situation as South Korea on the year before the crisis happened, the country also saw an increase in current account deficit from $13.5 billion to $14.6 billion. Comparing with other countries in the same region, we can see from Table that Thailand had consistently had current account deficits ranging from -5.08% to -8.08% since 1990. Also according to the table, Thailand was one of the countries that had highest current account deficit for most of the time. This was due to Thailand's balance of trade deficit. From Table , for 5 years before the crisis, their imports were too high compared with their exports. Thailand GDP growth had always been above from 1992 to 1995 so high value in imports was expected. On the year of the crisis, the current account deficit went down dramatically to only $3 billion.
Now looking at current account balance of US and UK in the period 5 years before the crisis happened, we can see that both countries have similar pattern as Thailand and South Korean. Both US and UK have consistently had current account deficit in the 5-year pre-crisis period and on the year the crisis happened. However, on the year of crisis, the current account deficits went down but insignificantly.
Figure : Current Account Balance (% of GDP) Comparison looks at comparison of current account balance as percentage of GDP between US - UK and South Korea - Thailand. We can see US - UK current account balances reacted different to South Korea - Thailand ones. There was still a large capital inflow into 2 countries US and UK; on the other hand, South Korea and Thailand experienced a large withdrawal of funds by foreign investors. In the 2 years after the crisis, South Korea and Thailand current account balances went into surplus while US and UK current account balances still did not change significantly
Figure : Current Account Balance (% of GDP) Comparison
Interest rates
In the Figure : Real Interest Rates (%) Comparison following, we can see that 5 year before each crisis, both set of countries' interest rates followed the same increasing trend. It was clearly stated in the literature above as it was period when both US-UK and South Korea-Thailand attracted large amount of foreign capital inflows. However, again, after the crisis happened, interest rates in US-UK went down while South Korea-Thailand interest rates rose. This is matched with literature review above. Two pair of countries' governments had different responses to the crisis. US-UK government lowered the interest rates in the view that it was indicator of economic weakness (Bernanke, 2009), whereas, South Korea and Thailand tried to raise interest rates to attract more capital inflows.
Figure : Real Interest Rates (%) Comparison
GDP per capita growth
Chapter 5: Conclusion
The events of the recent financial crisis unearthed the inefficiencies of the financial intermediaries to self-regulate and create a functional financial system. Among the causes of the financial crisis imprudent practices such as lack of risk insights and limited rationality in the banking institutions dominated (Rötheli, 2010). Whereas the market environment prior to crises allowed for risk appetite; prudence practice demanded the existence of stable risk management systems to safeguard against pitfalls (Kirkpatrick, 2009). Lack of such risk averseness in the corporate institutions' framework; led to failures in many intermediaries some of which were held in high repute in the society (Weiss & Larson 2008). Secondly; a promoter of imprudence in financial institutions has been remuneration trends that are not pegged on the entity's performance thus deterring managerial attention to potential risks (Kirkpatrick 2009).
With such indications of inability to institute effective internal controls with regard to risks; external control of financial institutions is necessary. Such control could for instance be offered through the stock exchange and strengthening of regulatory institutions (Rötheli 2010). Further strengthening of accounting procedures to deter classification of significant liabilities under the off-balance sheet events that conceal the real state of affairs at the company would better the process of detecting failures early (Rötheli 2010). Finally the monetary policy and other government strategies need to be continually reviewed to reflect changes in the market thus avoid promoting imprudence among the financial intermediaries (Rötheli 2010).
