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 Class: Group: Ha Noi, June 2023 TCHE414 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 INTRODUCTION LITERATURE REVIEW Chapter 1: Overview of Financial Crisis 1.1 Definition 1.2 Causes of financial crises 1.3 Types of financial crises 1.4 Explaining the consequences of financial crises .4 Chapter 2: Financial Crisis Theories 2.1 Minsky's Theory of Financial Crisis: .5 2.2 Marxist’s Theory of Financial Crisis .6 RESEARCH DIRECTION AND STRUCTURE METHODOLOGY DISCUSSION Chapter 3: Asian Financial Crisis (1997-1998) 3.1 Overviews and aspects of The Asian Financial Crisis 3.2 How 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 ABSTRACT 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 crisis's 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 19971998 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 INTRODUCTION Financial crisis is increasingly essential in countries going into a recession, and failing to meet the demand for money The economy, sociology, and politics of each nation and each region have all been significantly impacted by it as it has sucked numerous nations into its vortex Unfortunately, the most severe financial crises are currently affecting developing nations, including Haiti, South Africa, and Afghanistan, all of which have long-standing financial problems Developing countries are prone to financial crises due to limited trade and fluctuations in income Recent years have witnessed 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 Great Depression of 2008-2009 These crises bring both challenges and opportunities for those who are proactive During a financial crisis, asset prices plummet, individuals and businesses struggle to repay debts, and financial institutions face liquidity shortages This crisis is often accompanied by panic or bank runs, where investors hastily sell assets or withdraw funds from banks due to concerns about asset devaluation Financial crises can be caused by various factors such as unexpected human behavior, systemic failures, risk-taking opportunities, regulatory deficiencies, or contagious 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 of numerous monetary assets such as real estate and stocks, which may lead to an economic collapse Following the 1929 Wall Street Crash, the globe experienced its largest financial crisis This crisis resulted in widespread bank collapse in the United States and the interwar recession The Great Crash (1929) by John Kenneth Galbraith stated that the economy on the edge of the Great Depression was so unstable that it was only waiting for something to trigger the catastrophe It doesn't really matter what triggered the 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, but two large groups can be distinguished: studies linking financial crises to macroeconomic 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, and characteristics, which means that studying the determinants of financial crises can be biased when we rely only on a single definition of financial crisis Reinhart and Rogoff (2009b) describe two types of crises: those classified using strictly quantitative definitions and those dependent largely on qualitative and judgmental analysis The first group mainly consists of currency and sudden stop crises, whereas the second group contains debt and banking crises Regardless, theories attempting to explain crises have a major influence on definitions a Currency crisis A currency crisis, also known as an exchange rate crisis or a balance of payments crisis, occurs when currency speculation causes a sharp devaluation of the local currency or creates a situation in which foreign responsible authorities must protect their currency by raising interest rates or spending large amounts of foreign exchange 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 concurrently with a sharp rise in its credit spreads Because these are measurable variables, they lend themselves to the use of quantitative methodologies c Debt crisis A debt crisis occurs when a country is unable to repay its government debt A country might suffer a debt crisis when its government's tax revenues are less than its expenditures 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 difficult for banks to be able to fulfill their debts if customers withdraw money at the same time Massive withdrawals may cause a bank to fail, leading many customers to lose their deposits, unless they are covered by deposit insurance If the massive withdrawals continue, a systemic banking crisis will ensue It is also possible that the aforementioned phenomenon is not common, but credit interest rates are raised (to mobilize capital) due to concerns about budget shortfalls At this time, it is the banks that 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 recession frequently causes serious macro effects, such as broken macro balances, high and galloping inflation, currency devaluation, exchange rate fluctuations in the direction of devaluation, an increase in the public debt burden, the stock market collapsing, property prices in countries plummeting, many businesses, banks and financial institutions failing, and job losses Employment and unemployment increased, millions plunged into poverty, social instability and strife arose, riots and wars emerged It is clear that the global economic downturn and financial crisis have had catastrophic repercussions Fascism emerged in the 1930s as a result of the global economic crisis and recession that lasted from 1929 to 1933, which also served as the primary driver of the disastrous Second World War Many regimes have crumbled and many economies have dissolved as a result of this crisis and the Second World War Due to the interconnected business relationships between the two countries' banking systems during the globalization era, the US subprime debt crisis of 2007—which was brought 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 a series of large financial institutions collapsed one after another, especially the bankruptcy 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 Bank are other big banks, such as Bradford and Bingley (UK), HypoReal Estate (Germany), Fortis (Belgium), Dexia (France), Yamamoto Life (Japan) In 2008, 22 banks went into commercial bankruptcy in the US (of which the top of the list of these ill-fated financial entities is Washington Mutual with total assets of 307 billion USD) In the third quarter of 2008 alone, 171 banks were on the "problem" list, the highest level since 1995 b Spillovers to other countries Following the collapse of the US financial institution Lehman Brothers in September 2008, financial tensions reached their height This, along with a number of other financial institutions that failed or came close to failing at that time, caused a panic in financial markets all around the world Due to uncertainty over who would be the next financial institution to fail and the exposure each institution had to subprime and other troubled loans, investors started to withdraw their money from banks and investment funds all around the world As a result of everyone trying to sell at once and many institutions being unable to secure new financing, financial markets became chaotic As confidence fell, businesses and households both were far less eager to invest and spend As a result, the United States and some other economies fell into their 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 a domestic economy With the 2008 Financial Crisis, the Financial Instability Hypothesis (FIH) has grown in importance Essentially, Minsky contends that stability is destabilizing and that the internal dynamics of a system can be solely responsible for market failures According to the FIH, the level of profits determines system behavior, and thus aggregate profits equal aggregate investment plus the government deficit According to Minsky, banks act as profit-making institutions with an incentive to increase lending, which undermines the economy's stability Debt is important in determining system behavior, so Minsky examines three distinct income-debt relations for economic units Minsky distinguishes three stages of lending: Hedge, Speculative, and Ponzi Banks and borrowers are cautious during the Hedge stage, where the initial loan and interest can be repaid As a result, the economy at this point is likely to be seeking and containing equilibrium Following this, the Speculative period begins, during which confidence in the banking system grows Loans are made to people who can only afford to pay the interest The borrower cannot afford to pay the principal or interest on the loans in the final stage of the FIH, known as the Ponzi stage As a consequence, the three stages of the FIH suggest that, over long periods of prosperity, economies tend to gravitate toward economic structures that increasingly rely 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 a financial 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's predictions 2.2 Marxist’s Theory of Financial Crisis: According to Marx, crises are caused by overproduction of capital and commodities, and overproduction is caused by the contradiction between the development of social productive powers and capitalist production relationships A crisis is thus the emergence of capitalism's contradictions and the limits to capital's development (which are inherent in capital itself) According to Marx, capitalist society is distinguished by a long-term tendency for profit rates to fall This tendency, as well as the countervailing factors discussed by Marx, 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 global scale, 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 always tends 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 a result, 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 an overview of the Financial Crisis, as well as the limitations of response policies and lessons learned from these crises As a result, this research will first recall the financial crisis foundation knowledge and some theories, then provide a broad picture of two representative crisis periods, 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 policies implemented in response to these crises, and finally go over the lessons learned from the 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 Asian Financial Crisis and the Great Recession, their impact on the Asian and US economies during the Great Recession, and the consequences of these crises on the economy and policy 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 Chapter 4: The Great Recession (2007-2009) 4.1 Overviews and aspects of The Great Recession The 2007–2008 financial crisis, or Global Financial Crisis (GFC), was a severe worldwide economic crisis that occurred in the early 21st century The crisis was caused by the subprime mortgage-backed securities crisis, which spread to mutual funds, pension, and the corporations that owned these securities, resulting in extensive national and worldwide consequences In this part, we are going to show our findings on the root causes of the Great Recession based on former research 4.1.1 Causes of The Great Recession: 4.1.1.1 Financial instruments: To understand the relationship between the bank and the market crash, it is necessary to investigate the financial instruments that played a role in the systematic collapse of the US economy, specifically asset-backed securities (ABS) and collateralized debt obligations (CDOs)  Securitization: Securitization is a process by which ownership of assets is transferred from the original owners into a separate legal entity called a special purpose vehicle (SPV) A special purpose vehicle, then, has to issue securities backed by these assets and sell them to investors The proceeds from the sales are collected by the originating company as payment for the assets When the securitization is done, the asset cash flows collected from customers are used to pay for both the interest and principal owed to the investors  Asset-backed securities: Asset-backed securities are securities of which cash flows are generated or backed by income-generating assets The securities which have the assets acting as collaterals are residential real estate called Residential Mortgage-Backed Securities (RMBS) The rest which are backed by other assets like auto loans, student loans, are called Non-Mortgage Asset-Backed Securities  Collateralized debt obligation: A collateralized debt obligation (CDO) is a complex structured finance product that is backed by a pool of ABSs and can even collateralize a number of CDOs, making a chain of CDOs collateralizing others possible Unlike ABSs, where the main source of returns to the investors is the interest payments from the collateral pool, the returns to a CDO can come from more varied sources CDOs have a collateral manager who executes trades in the securities in the collateral pool to earn a rate of return higher than the aggregate cost of the bond classes After gaining an understanding of these financial instruments, we can examine how banks used them to cause the most significant economic recession since the Great Depression of 1929-1930 The structures of these new instruments, particularly CDOs, were overly complicated, making it difficult for investors to track cash flows and estimate their true value, leading to a significant information asymmetry that disadvantaged consumers and the economy as a whole Banks, with their knowledge of the risks involved, created as many ABS and CDOs as possible, profiting from issuing fees and selling them off without worrying about the consequences of default This led to an influx of subprime loans when there were not enough mortgages to securitize 4.1.1.2 Subprime loan and Credit rating fraudulence: The 2007 financial crisis was caused by subprime loans, which were high-risk loans given to borrowers who could not repay them Borrowers defaulted on their loans, and the decline in housing prices made it difficult for them to sell their homes Credit rating agencies provided fraudulent ratings for these loans and complex financial instruments, leading investors to believe they were safe This practice exacerbated the crisis, as investors were unaware of the true risk involved 4.1.1.3 The collapse of unstable loan system: The 2007 financial crisis was caused by the collapse of the unstable loan system, particularly the proliferation of subprime loans Many borrowers defaulted on their loans, leading to a decline in the housing market, which further exacerbated the crisis Financial instruments, such as CDOs, created from these loans were sold to investors with fraudulent credit ratings, causing them to suffer significant losses when the loans defaulted 4.1.2 Consequences of The Great Recession: The 2007 financial crisis is widely regarded as the most significant economic catastrophe that caused extensive damage to the global economy It resulted in a decline in property values and high levels of unemployment Its effects were so profound that the financial system continues to experience some of its ramifications to this day 4.1.2.1 In the US economy: The consequences of the 2007 financial crisis on the US economy were severe The crisis caused a sharp decline in economic activity, leading to a rise in unemployment and a drop in consumer spending Housing prices also fell sharply, leading to a surge in foreclosures and a decline in household wealth The crisis had a significant impact on the financial system, causing the collapse of several large financial institutions and leading to a credit crunch, which made it difficult for businesses and individuals to access credit The US government responded with a series of measures aimed at stabilizing the financial system, including the Troubled Asset Relief Program (TARP) and the Dodd-Frank Wall Street Reform and Consumer Protection Act While the US economy has since recovered, the effects of the crisis are still felt today, particularly in terms of ongoing debates around financial regulation and income inequality 4.1.2.2 In the world economy: The global economic slowdown caused by the crisis of 2007 had far-reaching consequences on various regions of the world, resulting in a decrease in the demand for oil for production and consumption and causing a subsequent decline in oil prices This had a severe impact on oil exporting countries whose economies heavily relied on oil exports At the same time, the crisis also led to concerns about instability, which triggered food speculation and contributed to high food prices towards the end of 2007 and early 2008 In addition to these effects, stock markets worldwide experienced significant devaluation, resulting in severe losses for investors Many investors shifted their portfolios to strong currencies such as the US dollar, Japanese yen, and Swiss franc, leading to these currencies becoming more valuable than many other currencies This made it difficult for investors to invest, and exports from the United States, Japan, and Switzerland were adversely affected Furthermore, these currency disturbances also caused some countries to seek help from the International Monetary Fund Overall, the crisis of 2007 had far-reaching impacts on various sectors of the global economy, and its effects were felt for years to come 4.2 Government Intervention in Response to The Great Recession 4.2.1 Monetary Policy: After the Great Recession, 8.7 million US people had lost their jobs, which caused a two-fold increase in the unemployment rate, and a decrease in GDP by 1.97% In response, the Federal Reserve, for the first time, used unconventional monetary policies such as quantitative easing, interest on reserve balances, and overnight reverse purchase agreement 4.2.1.1 Conventional monetary policy’s tool: During the Great Depression in 1929, the Fed mishandled its lending power, especially during the 1933 banking crisis In contrast, during the 2008 financial crisis, the Fed learned from the Great Depression and responded positively by providing loans to banks and financial institutions To achieve its goals of employment, stable prices, and moderate long-term interest rates, the Fed adjusts the federal funds rate target through traditional monetary policy This overnight interbank lending rate impacts the economy through various channels Higher interest rates reduce investment projects (interest-rate channel), cause currency appreciation affecting imports and exports (exchange rate channel), and impact lenders' ability to lend and borrowers' creditworthiness (lending channels) Looking at the chart, we can see the Fed continuous rate cuts and the gap between Federal fund rate and discount rate is also shortened Open market operations, buying and selling securities, are vital for monetary policy The Fed adjusts reserve supply to stabilize the Federal Reserve Interest Rate (FER) Only low-risk securities, like government bonds, are traded