Financial crisis from theory to experiences in east asia crisis (1997 1998) and the great recession (2007 2008)

Financial crises have historically had devastating effects on the economies involved. Recognizing the significance of the financial crisis research, our paper analyzes the financial crisis in the context of previous national experience and economic theory and draws some valuable key takeaways. A variety of the crisiss aspects, namely its concept, signs, types, causes and consequences, are discussed to define what a financial concept is. With the usage of qualitative research methods and theoretical analysis, our report has shed light on two notable financial crises: the 1997 1998 East Asian financial crisis and the financial crisis in 2008, as well as the policies introduced by the government to tackle the crisis and the lessons noted to minimize these mistakes. It should be noted that policies have been crucial in preventing the crisis from evolving into a more complex one while not acting alone but in conjunction with other measures to lessen the impact of the financial crises.

FOREIGN TRADE UNIVERSITY FACULTY OF BANKING AND FINANCE



-INTERNATIONAL FINANCE REPORT

FINANCIAL CRISIS: FROM THEORY TO

EXPERIENCES IN EAST ASIA CRISIS (1997 - 1998)

AND THE GREAT RECESSION (2007 - 2008)

Instructor: Assoc Prof Mai Thu Hien

Group:

Ha Noi, June 2023

FOREIGN TRADE UNIVERSITY FACULTY OF BANKING AND FINANCE



-INTERNATIONAL FINANCE REPORT

FINANCIAL CRISIS: FROM THEORY TO

EXPERIENCES IN EAST ASIA CRISIS (1997 - 1998) AND THE GREAT RECESSION (2007 - 2008)

GROUP:

– CLASS: TCHE414

Table of Contents

ABSTRACT 1

INTRODUCTION 2

LITERATURE REVIEW 3

Chapter 1: Overview of Financial Crisis 3

1.1 Definition 3

1.2 Causes of financial crises 3

1.3 Types of financial crises 3

1.4 Explaining the consequences of financial crises 4

Chapter 2: Financial Crisis Theories 5

2.1 Minsky's Theory of Financial Crisis: 5

2.2 Marxist’s Theory of Financial Crisis 6

RESEARCH DIRECTION AND STRUCTURE 7

METHODOLOGY 8

DISCUSSION 9

Chapter 3: Asian Financial Crisis (1997-1998) 9

3.1 Overviews and aspects of The Asian Financial Crisis 9

3.2 How do the governments and central banks respond? 13

Chapter 4: The Great Recession (2007-2009) 14

4.1 Overviews and aspects of The Great Recession 14

4.2 Government Intervention in Response to The Great Recession 16

Chapter 5: Lessons for Crisis Prevention and Recommendation for Crisis

21 5.1 Lesson for Crisis Prevention 21

5.2 Recommendation for Crisis Resolution 21

LIMITATION AND CONCLUSION 24

Limitation 24

Conclusion 24

REFERENCE 26

Financial crises have historically had devastating effects on the economiesinvolved Recognizing the significance of the financial crisis research, our paperanalyzes the financial crisis in the context of previous national experience andeconomic theory and draws some valuable key takeaways A variety of the crisis'saspects, namely its concept, signs, types, causes and consequences, are discussed todefine what a financial concept is With the usage of qualitative research methods andtheoretical analysis, our report has shed light on two notable financial crises: the 1997-

1998 East Asian financial crisis and the financial crisis in 2008, as well as the policiesintroduced by the government to tackle the crisis and the lessons noted to minimizethese mistakes It should be noted that policies have been crucial in preventing thecrisis from evolving into a more complex one while not acting alone but in conjunctionwith other measures to lessen the impact of the financial crises

Financial crisis is increasingly essential in countries going into a recession, andfailing to meet the demand for money The economy, sociology, and politics of eachnation and each region have all been significantly impacted by it as it has suckednumerous nations into its vortex Unfortunately, the most severe financial crises arecurrently affecting developing nations, including Haiti, South Africa, and Afghanistan,all of which have long-standing financial problems Developing countries are prone tofinancial crises due to limited trade and fluctuations in income Recent years havewitnessed more severe and complex financial crises, including the Mexico crisis in

1994, the Asian financial crisis in 1997, the Argentina crisis in 2001, and the GreatDepression of 2008-2009 These crises bring both challenges and opportunities forthose who are proactive

During a financial crisis, asset prices plummet, individuals and businessesstruggle to repay debts, and financial institutions face liquidity shortages This crisis isoften accompanied by panic or bank runs, where investors hastily sell assets orwithdraw funds from banks due to concerns about asset devaluation

Financial crises can be caused by various factors such as unexpected humanbehavior, systemic failures, risk-taking opportunities, regulatory deficiencies, orcontagious diseases

LITERATURE REVIEW Chapter 1: Overview of Financial Crisis

1.1 Definition

A financial crisis or economic crisis is defined as a sudden loss in the value ofnumerous monetary assets such as real estate and stocks, which may lead to aneconomic collapse

Following the 1929 Wall Street Crash, the globe experienced its largestfinancial crisis This crisis resulted in widespread bank collapse in the United Statesand the interwar recession The Great Crash (1929) by John Kenneth Galbraith statedthat the economy on the edge of the Great Depression was so unstable that it was onlywaiting for something to trigger the catastrophe It doesn't really matter what triggeredthe occurrence; it could have been anything

1.2 Causes of financial crises

It is difficult to summarize the entire literature on crisis causes or drivers, buttwo large groups can be distinguished: studies linking financial crises tomacroeconomic instability (current account imbalances, public deficit growth, etc.),and studies viewing financial nuisances as a feature of financial systems However,determining their underlying causes remains a challenge

1.3 Types of financial crises

However, financial crises tend to have different forms, formats, andcharacteristics, which means that studying the determinants of financial crises can bebiased when we rely only on a single definition of financial crisis Reinhart and Rogoff(2009b) describe two types of crises: those classified using strictly quantitativedefinitions and those dependent largely on qualitative and judgmental analysis Thefirst group mainly consists of currency and sudden stop crises, whereas the secondgroup contains debt and banking crises Regardless, theories attempting to explaincrises have a major influence on definitions

a Currency crisis

A currency crisis, also known as an exchange rate crisis or a balance ofpayments crisis, occurs when currency speculation causes a sharp devaluation of thelocal currency or creates a situation in which foreign responsible authorities mustprotect their currency by raising interest rates or spending large amounts of foreignexchange reserves

b Sudden stop crisis

A sudden stop (or capital account or balance of payments crisis) is described as

a significant (and often unexpected) reduction in foreign capital inflows or a sharp

reversal in aggregate capital flows to a country, most likely occurring concurrentlywith a sharp rise in its credit spreads Because these are measurable variables, theylend themselves to the use of quantitative methodologies.

c Debt crisis

A debt crisis occurs when a country is unable to repay its government debt Acountry might suffer a debt crisis when its government's tax revenues are less than itsexpenditures for an extended period of time

d Banking crisis

This is the situation that occurs when customers withdraw money from the bank

at the same time Because banks lend the majority of the deposits, it will be difficultfor banks to be able to fulfill their debts if customers withdraw money at the sametime Massive withdrawals may cause a bank to fail, leading many customers to losetheir deposits, unless they are covered by deposit insurance If the massivewithdrawals continue, a systemic banking crisis will ensue It is also possible that theaforementioned phenomenon is not common, but credit interest rates are raised (tomobilize capital) due to concerns about budget shortfalls At this time, it is the banksthat will become the cause of the economic crisis Several banking crises, for example,are also sudden stop episodes and currency crises

1.4 Explaining the consequences of financial crises:

a Stresses in the financial system, failure of financial firms, panic in financial markets

The manifestation of the financial crisis and the global economic recessionfrequently causes serious macro effects, such as broken macro balances, high andgalloping inflation, currency devaluation, exchange rate fluctuations in the direction ofdevaluation, an increase in the public debt burden, the stock market collapsing,property prices in countries plummeting, many businesses, banks and financialinstitutions failing, and job losses Employment and unemployment increased, millionsplunged into poverty, social instability and strife arose, riots and wars emerged

It is clear that the global economic downturn and financial crisis have hadcatastrophic repercussions Fascism emerged in the 1930s as a result of the globaleconomic crisis and recession that lasted from 1929 to 1933, which also served as theprimary driver of the disastrous Second World War Many regimes have crumbled andmany economies have dissolved as a result of this crisis and the Second World War.Due to the interconnected business relationships between the two countries' bankingsystems during the globalization era, the US subprime debt crisis of 2007—which wasbrought on by banks' easy credit policies and real estate investment organizations—was the precursor to the global economic crisis of 2008 This crisis appeared when aseries of large financial institutions collapsed one after another, especially thebankruptcy of Lehman Brothers Bank This is the bank that just a year earlier was

rated as the best real estate investment bank in the US After Lehman Brothers Bankare other big banks, such as Bradford and Bingley (UK), HypoReal Estate (Germany),Fortis (Belgium), Dexia (France), Yamamoto Life (Japan) In 2008, 22 banks wentinto commercial bankruptcy in the US (of which the top of the list of these ill-fatedfinancial entities is Washington Mutual with total assets of 307 billion USD) In thethird quarter of 2008 alone, 171 banks were on the "problem" list, the highest levelsince 1995.

b Spillovers to other countries

Following the collapse of the US financial institution Lehman Brothers inSeptember 2008, financial tensions reached their height This, along with a number ofother financial institutions that failed or came close to failing at that time, caused apanic in financial markets all around the world Due to uncertainty over who would bethe next financial institution to fail and the exposure each institution had to subprimeand other troubled loans, investors started to withdraw their money from banks andinvestment funds all around the world As a result of everyone trying to sell at onceand many institutions being unable to secure new financing, financial markets becamechaotic As confidence fell, businesses and households both were far less eager toinvest and spend As a result, the United States and some other economies fell intotheir deepest recessions since the Great Depression

Chapter 2: Financial Crisis Theories

2.1 Minsky's Theory of Financial Crisis:

Hyman Minsky's financial crisis theory was developed in the context of adomestic economy With the 2008 Financial Crisis, the Financial InstabilityHypothesis (FIH) has grown in importance

Essentially, Minsky contends that stability is destabilizing and that the internaldynamics of a system can be solely responsible for market failures According to theFIH, the level of profits determines system behavior, and thus aggregate profits equalaggregate investment plus the government deficit According to Minsky, banks act asprofit-making institutions with an incentive to increase lending, which undermines theeconomy's stability Debt is important in determining system behavior, so Minskyexamines three distinct income-debt relations for economic units Minskydistinguishes three stages of lending: Hedge, Speculative, and Ponzi

Banks and borrowers are cautious during the Hedge stage, where the initial loanand interest can be repaid As a result, the economy at this point is likely to be seekingand containing equilibrium

Following this, the Speculative period begins, during which confidence in thebanking system grows Loans are made to people who can only afford to pay theinterest

The borrower cannot afford to pay the principal or interest on the loans in thefinal stage of the FIH, known as the Ponzi stage.

As a consequence, the three stages of the FIH suggest that, over long periods ofprosperity, economies tend to gravitate toward economic structures that increasinglyrely on risky loans, rather than the financial structure of stability in the initial stage.According to Minsky's FIH, the transition to instability will inevitably result in afinancial crash

Minsky's work on the FIH has become increasingly popular in recent years,owing primarily to the Great Recession, demonstrating the accuracy of Minsky'spredictions

2.2 Marxist’s Theory of Financial Crisis:

According to Marx, crises are caused by overproduction of capital andcommodities, and overproduction is caused by the contradiction between thedevelopment of social productive powers and capitalist production relationships Acrisis is thus the emergence of capitalism's contradictions and the limits to capital'sdevelopment (which are inherent in capital itself)

According to Marx, capitalist society is distinguished by a long-term tendencyfor profit rates to fall This tendency, as well as the countervailing factors discussed byMarx, are extremely helpful in understanding the current crisis The crisis that began

in 2007 thus became a genuine, globalized crisis that destroyed capital on a globalscale, which Marx believes is required to restore profits and restart accumulation,along with the destruction of the means of production

In conclusion, Marx's theory demonstrates that a capitalist economy alwaystends to lose profit, resulting in a monopolistic market with low wages

RESEARCH DIRECTION AND STRUCTURE

The Financial Crisis is a major concern for economies all over the world As aresult, experts are constantly stating their views on the financial crisis, its explanations,theories, causes, consequences, and policy responses

However, it was difficult to find synthesized research that provided anoverview of the Financial Crisis, as well as the limitations of response policies andlessons learned from these crises

As a result, this research will first recall the financial crisis foundationknowledge and some theories, then provide a broad picture of two representative crisisperiods, the Asian Financial Crisis (1997-1998) and The Great Recession (2007-2009),analyze the root causes and consequences of these crises, show in detail the policiesimplemented in response to these crises, and finally go over the lessons learned fromthe Financial Crisis

The structure of this paper's discussion section includes three main sections:

 In the first and second sections, we will briefly discuss the causes of the AsianFinancial Crisis and the Great Recession, their impact on the Asian and US economiesduring the Great Recession, and the consequences of these crises on the economy andpolicy interventions for each of the above-mentioned crises

 In the third section, the experience from financial crises in global situations will

be summarized, and some recommendations for crisis prevention and resolution will

be made

The main objective of this study is to learn from two financial crises in history:the East Asian financial crisis (1997-1998) and the Great Recession (2007-2008) byanalyzing causes and consequences in order to avoid and quickly overcome similarcrises in the future

To achieve this goal, the main methodology of this paper is qualitative researchwith theoretical analysis We use the case study approach to analyze the symptoms,effects, and responses in chronological order to understand how the economy responds

to such crises The information and data in this study were gathered from crediblesources such as Google Scholar, scientific magazines, the government informationgate, and well-known Finance and Banking textbooks

DISCUSSION Chapter 3: Asian Financial Crisis (1997-1998)

3.1 Overviews and aspects of The Asian Financial Crisis

3.1.1 Causes of the Asian financial crisis:

3.1.1.1 Internal causes:

 The creation of an economic bubble:

The collapse of currency exchange rates and the hot money bubble led to theemergence of the Asian Financial Crisis, which began in Thailand in July 1997 andspread throughout East and Southeast Asia This crisis had a severe impact on thevalue of currencies, as well as stock markets and other assets in numerous countries inthe region

In the late 1980s and early 1990s, numerous Southeast Asian countries such asThailand, Singapore, Malaysia, Indonesia, and South Korea experienced remarkableeconomic expansion, with their GDP increasing by 8% to 12% This was famouslyknown as the "Asian economic miracle" (Asian Financial Crisis, 2022) However, thisachievement came with a considerable risk The growth in these countries wasprimarily fueled by export expansion and foreign investment, which channeled moneyinto financial and securities markets, causing a steep increase in asset prices andprompting companies to borrow heavily This resulted in current account deficits, aswell as policies that encouraged borrowing in foreign currencies and fixed exchangerates, leading to government exposure to foreign exchange risks

A significant outflow of capital led to a depreciation of currencies in Asiancountries The Thai government was the first to exhaust its foreign currency reserves

to maintain its exchange rate, which resulted in the floating of the baht Subsequently,the value of the baht dropped dramatically, and the same phenomenon occurred inother Asian countries shortly after

 Enforcement of an inflexible exchange rate regime:

In an attempt to attract foreign investment and maintain stability, Thailandadopted a fixed exchange rate regime pegging its currency, the Thai baht, to the USdollar in 1997 However, this policy made the country heavily reliant on foreigninvestment, and when investors started pulling out their funds, the Thai governmentcouldn't sustain the exchange rate due to insufficient foreign currency reserves As aresult, the government was forced to abandon the fixed exchange rate and let the bahtfloat freely on July 2, 1997 The abrupt devaluation of the baht caused a financialpanic in Thailand, which ultimately spread to other Asian countries, leading to theAsian Financial Crisis

Other emerging economies in Asia also adopted a flexible exchange rate regime

by pegging their currencies to the US dollar while relaxing foreign exchange controls.This move attracted foreign capital inflows and created more investment opportunities.However, the large inflows created exchange rate disparities, causing currencycollapses and reduced competitiveness compared to other countries These factorscontributed to the conditions that caused the Asian Financial Crisis

 The weakness of the banking and financial system:

The weakness of the banking and financial system in Asian countries was one

of the primary causes of the 1997 Asian Financial Crisis Many Asian countries hadalso maintained fixed exchange rates, which put pressure on their central banks tomaintain large reserves of foreign currency This created a dependence on short-termcapital inflows to fund current account deficits, leaving these countries exposed tosudden changes in investor sentiment The combination of these factors ultimately led

to the collapse of the banking and financial system in many Asian countries, triggering

a severe economic crisis that took several years to recover from The close relationshipbetween the government, banks, and businesses aimed at achieving development goalsand projects set by the state resulted in ineffective financial control and evaluationinstitutions This made the information often mixed or limited, leading to major risks

in the domestic financial sector Banks had invested heavily in bubbles such as realestate and faced interest rate and exchange rate risks on debt obligations, making thefinancial system vulnerable to shocks Additionally, the outflow of capital from theregion due to the recovery of the US economy and the emergence of China as acommodity exporter exacerbated the crisis, causing the value of local currencies toplummet and putting further pressure on the state banks

3.1.1.2 External causes:

 Capital flow liberalization:

International capital movement is a crucial aspect of international economictransactions, allowing for the movement of production factors and capital types across

markets During this period, the United States economy experienced a resurgence,leading to a rise in USD interest rates and making financial investment returns in the

US more attractive Additionally, China emerged as a significant commodity exporter,which created competition for traditional Southeast Asian exporters such as Thailandand Malaysia Consequently, capital outflows from Southeast Asian countries wereredirected towards China and the US, resulting in a decline in their foreign currencyreserves Moreover, the exchange rate fixated policy added pressure to the state banks

 Speculation attacks:

International financial speculators had targeted the currencies of East Asiancountries, causing them to depreciate despite efforts by central banks and internationalaid Furthermore, certain Western financial entities have utilized their influence todevalue these currencies, bolster the US dollar, and exert pressure on these countries toalter their economic and political systems

3.1.2 Consequences of Asian Financial Crisis:

The Asian Financial Crisis had a severe impact on several countries in theregion, including Indonesia, Thailand, Malaysia, South Korea, and the Philippines.These countries experienced sharp declines in their currency exchange rates, stockmarkets, and asset prices, leading to a significant drop in their GDPs In fact, from

1996 to 1997, Indonesia saw a 43.2% decrease in nominal GDP per capita, whileThailand's dropped by 21.2%, Malaysia's by 19%, South Korea's by 18.5%, and thePhilippines' by 12.5% Although Hong Kong, Mainland China, Singapore, and Japanwere also affected, their economies suffered a lesser extent

The Asian financial crisis resulted in the end of a long period of rapid economicgrowth that relied heavily on foreign capital from developing countries in the region