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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: Submitted By:

Dr. Ajit Mittal Priyanka Mahajan

MBA-IB 2007-09

A1802007345

AMITY INTERNATIONAL BUSINESS SCHOOL

UTTAR PRADESH, NOIDA


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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

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Its 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

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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

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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

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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

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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:

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Banking crises

WIDERECONOM

I-C

CRISIS

INTERNA

-TIONALFIANCIA

L CRISIS

SPECULA

-TIVEBUBBLES

&

CRASHES

BANKING

CRISIS

TYPES

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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.

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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

economicstagnation. Since these phenomena affect much more than the financial

system, they are not usually considered financial crises per se. But some

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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. Thesub-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:

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Strategic complementarities in financial markets

FRAUD

LEVERAGE

ASSET-LIABILITY MISMATCH

UNCERTAINTY AND HERD BEHAVIOUR

STRATEGIC COMPLEMENTARITIES IN FINANCIAL MARKET

REGULATORY FAILURES

RECESSIONARY EFFECTS

CONTAGION

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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 othersstrategic 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,

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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.

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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 'copathy'.

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

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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

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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

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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

19731974: 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

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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 Thailands 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 Thailands 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 Kongs 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

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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 Koreas 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 Banks

success in maintaining the peg ever since the Thais 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.

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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.

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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.

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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 Russias debt rose to a figure 40 percent greater than its monthly tax collections.

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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

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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

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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

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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

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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

20052006. 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 20062007 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

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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.

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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.

Its the play of destiny that one of the greatest falls of Sensex too happened on the

same day, this year.

Prerna Katiyar elaborates on whats common, and whats 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 al-

ready being drawn between the current times and the days of the Great Depression. So

lets see if history is repeating itself or its just a play of destiny.

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WHATS COMMON?

Apart from the common datesthe 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% down-

payment, 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.

WHATS 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.

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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)

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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.

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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;

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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.

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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 19 th August, 2008 on http://english.pravda.ru/

RUSSIAS 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 IMFs actions.

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I was very surprised to hear yesterdays 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.

Russias 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, Russias

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.

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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 worlds biggest men of

genius would have faced difficulties if they had attempted to solve Russias 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:

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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 Russias largest exports, was selling at $23 per barrela high

price by recent standards. (Fuels made up more than 45 percent of Russias 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 Russias 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

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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, Russias

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 Clubs 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

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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 Russias economy; instead of growth in

1998, real GDP declined 4.9 percent.

The following is the article published on 17 th 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.

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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

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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

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CAUSES OF SOUTH EAST ASIAN CRISIS:

Several factorsboth domestic and externalprobably 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

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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.

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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 199697 and wider external

imbalances).

International investorsmainly commercial and investment banksmay, 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

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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.

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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

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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 non-

monetary means of exchange have largely replaced currency. According to the

article, more than 50% of payments among all industrial enterprises in Russia are

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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

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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 debt-

financed 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 mid-

2006. 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

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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 20012006

period, which should have had the opposite effect.

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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.

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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

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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.

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

Causes Asian Crisis Russian CrisisSub-prime

Crises

Declining productivity OutcomeCause, leading to

the crisisOutcome

Current Account/FiscalDeficit

Leading to largeinflows of funds



Asian financial Crisis X One of the causes X

Decline in foreignexchange reserves

Leading to erosionof investorsconfidence

Leading to erosionof investorsconfidence

X

Fixed Exchange RateSystem

Leading to declinein foreign exchange

reserves

Leading to declinein foreign exchange

reservesX

Erosion of Investorsconfidence

Leading to fall inthe value of assets



Uncontrolled utilizationof large inflows of funds

Leading to dramaticchanges in assets

prices

Leading to dramaticchanges in assets

prices

Leading todramatic changesin assets prices

Credit crunchLeading to fall inthe value of assets



Boom and bust inhousing/assets prices

Outcome, due tocredit crunch

Outcome, due tocredit crunch

One of the causesleading to

mortgage crisis

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ROLE OF INTERNATIONAL ORGANISATIONS

ASIAN FINANCIAL CRISIS:

IMFs 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 reaffirme

study of financial crisis

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