Compare and contrast the global financial crisis in 2007-2008 with the Asian financial crisis in 1997. Examine carefully the causes and the consequences of the two crises respectively. Briefly discusses economic policies that had been implemented to overcome the two crises by the United States and China.
Global Financial Crisis 2007-2008
According to Shah (2009), prior to the global financial crisis, banks were off-loading risky loans onto others by polling their various loans into sellable assets. Although millions can be made from such money-earning loans, they are tied up for decades. Hence, they were turned into securities: the security buyer gets regular payments off those mortgages while the banker off-loads the risk. Once thought to be the greatest financial innovation of the 20th century, securitization, which was meant to reduce risk and increase lending, backfired and triggered the financial crisis.
In order to create more securitization, banks borrowed more money (to lend out): as long as they could borrow from other banks and sell those loans as securities, whatever bad loans there were would be the responsibility of whoever bought the securities. Eventually, some investment banks (e.g. Lehman Brothers) went into mortgages, buying them just to securitize and sell them, while other banks loaned even more, just to securitize those loans; some banks even started buying securities from other banks. When banks started to run out of whom to loan to, they turned to the riskier (sub-prime) loans: rising house prices misled lenders about the risks involved about such loans; soon becoming popular.
Without the right controls and management, many banks and financial institutions, and investors started to use derivatives (meant to give buyers the right to buy something in the future at a price agreed in the present) to take on more risk to make more money instead of reducing their risk. Thus, exposure to problems increased: risks spread but were very complicated and volatile, often hiding the bad loans – no one wanted bad news while things were still good.
Soon, weaknesses in the global financial system surfaced and confidence began to fall: the complex and twisted financial instruments (and products) had proliferated to the degree that it had become impossible to calculate the market value of many of them, making it impossible to know the market value of institutions that held or guaranteed them. As a result, lending slowed (i.e. some investment banks had to sit on risky loans that investors did not want) and the value of assets plummeted (i.e. lenders wanted to take their money back). (Shah 2009)
The Great Recession of 2008 caused the collapse of the U.S. sub-prime mortgage, together with the reversal of the housing boom in other industrialized economies, quickly spread globally to institutions and banks that held financial instruments (and products) related to these mortgages. These firms soon found their net worth disappearing, and subsequently (because of these developments) liquidity disappeared from the financial system. Many banks were caught in this web: suddenly having to obtain additional equity capital in order to meet regulatory requirements and maintain the confidence of depositors.
As a result, world stock markets and large financial institutions collapsed (i.e. job loss leading to social unrest) or were bought out; even governments in the wealthiest nations had to bail out their financial systems. (Conklin & Cadieux 2008) The total that governments (especially in the West) have spent on bailouts is tremendous. According to Bloomberg, 33% or $14.5 trillion of the value of the world’s companies have been wiped out by this crisis.
Asian Financial Crisis
The Asian financial crisis stemmed from the unprecedented economic growth Asian countries (i.e. Korea, Thailand etc…) experienced before 1997: exports were the basis for (and fueled) economic growth in these countries. A combination of factors such as inexpensive and relatively well-educated labor, export orientated economies, and falling barriers to international trade, transformed these countries into export powerhouses. (Hill, The Asian Financial Crisis)
Wealth created by export-led growth helped inspire an investment boom in areas like commercial/residential property, industrial assets and infra-structure (i.e. value of commercial/residential real estate in cities like Hong Kong and Bangkok started to soar). However, as the volume of investments increased during the early 1990s, the quality of many of these investments declined significantly (often at the bequest of national governments), resulting in investments that were made on the basis of projections about future demand conditions that were unrealistic; causing the emergence of significant excess capacity.
The investment boom resulted in an increase in imports: investments in infrastructure, industrial capacity, and commercial real estate were using (required) foreign goods at unprecedented rates. With the growing imports from countries such as America and Europe for capital equipment and materials, deficits started to pile up; many Asian states saw the current account of their Balance Payments shift into the red in the mid 1990s.
In addition, much of the loans to fund these investments (i.e. commercial/residential property, industrial assets and infra-structure) had been in US dollars instead of local currencies, further worsening the situation (e.g. increasing the size of the debt burden when measured in local currency). Having started from Thailand (e.g. the devaluation of the baht), a domino effect hit other Asian currencies. Many (East) Asian countries (e.g. Thailand and Korea) found themselves incurring external debts which they had difficulty making scheduled payments: the combination of high borrowing, excess investments, and with most loans (to fund investments) being in US dollars; placing them in a deteriorating balance of payments position.
For example Korea, having been caught up in the Asian financial crisis, sought a record $58 billion bailout from the International Monetary Fund (IMF). The crisis exposed fundamental weaknesses in the Korean economy, from bad loans to reckless growth policies pursued by large conglomerates. The Korean economy rebounded quickly with sweeping reforms. (Alfaro & Kim 2007)
While the Asian financial crisis had very minimal impact on Western economies, the global financial crisis impacted many countries throughout the world, especially U.S, UK and European economies. Although the recovery of countries affected by the Asian financial crisis was relatively fast (i.e. with the help of the U.S and Europe maintaining a level of support), the recovery from the aftermath of the global financial crisis may take a longer time: many Asian countries whose economies where believed to be sufficiently "decoupled" from the Western financial systems gradually become impacted by the implications of the crisis: the rapid growth and wealth creation in many Asian countries (i.e. China) have led to enormous investments in Western countries. Hence, many Asian countries (e.g. China) have seen their stock market suffer and a downward trend in their currency values. (Conklin & Cadieux 2008)
During the Asian financial crisis, China and the United States were relatively unaffected, thus they did not implement any economic policies (Schmidt 2009). The global financial crisis, on the other hand, greatly affected both China and the United States.
Central banks reacted dramatically with attempts to reduce interest rates and to increase financial liquidity. The U.S. government introduced a stimulus package worth more than $800 billion in a bid to stabilize and stimulate the economy with increased government spending (i.e. bailing out/lending money to institutions (e.g. General Motors) that were affected), as well as new banking policies for benefit of its customers. In addition, personal taxes were cut through a tax refund program. (Conklin & Cadieux 2008; Pittman & Ivry 2009)
Concerned that falling demand for the country’s exports (due to the global financial crisis) would put further downward pressure on overall economic growth, China implemented a series of monetary and fiscal policies. The country’s interest rate and reserve requirements were lowered to stimulate domestic growth in a bid to offset any drop-off in exports, there was cut in policy rates, and banks were encouraged to lend more. (BBC 2008; ChannelNewsAsia 2008) The drop in property and stock prices in the United States enabled China to buy (invest in) more U.S Treasury Bonds, in order to keep it’s yuan from rising (more than it wants) against the U.S dollar (Bergsten 2010).
• Alfaro, L, Kim, R, 2007, Transforming Korea Inc.: financial crisis and institutional reform, Oct 30
• Bird, G, Mandilaras, A, 2005, ‘Reserve Accumulation in Asia’, World Economics 6, no. 1, pp 85-99.
• Carbaugh, R J, 2009, International economics, 12th edn, South-Western Cengage Learning, USA
• Conklin, D W, Cadieux, D, 2008, ‘The 2007-2008 financial crisis: causes, impacts and the need for new regulations’, June 9
• Isgut, A E, 2001, ‘Developing countries’ borrowing in the international financial market with an uncertain credit ceiling’, International Journal of Finance 7 Economics, no. 2, pp 171-183
• Bergsten, C F, 2010, How quickly will China move?, 16 April, viewed 10 April 2010,
• Shah, A, 2009, Global financial crisis, Global Issues, 25 July, viewed 18 April 2010,
• Schmidt, R, 2009, The 1997 Asian financial crisis, StockBreakThroughs, 12 January, viewed 10 April 2010, <http://stockbreakthroughs.com/2009/01/12/the-1997-asian-financial-crisis/>
• Pittman M, Ivry, B, U.S. Taxpayers Risk $9.7 Trillion on Bailout Programs, viewed 12 April 2010,
• BBC, viewed 15 April 2010, <http://news.bbc.co.uk>
• Bloomberg, viewed 15 April 2010, <http://www.bloomberg.com>
• ChannelNewsAsia, viewed 16 April 2010, <http://www.channelnewsasia.com>
• IMF, viewed 16 April 2010, <http://www.imf.org/>
• Hill, W L, The Asian Financial Crisis, University of Washington viewed 19 April 2010, <http://www.wright.edu/~tdung/asiancrisis-hill.htm>