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The region is in better shape and by acting now, it can advance the pace of recovery for the world economy. Bangkok Post 6th Dec 2008

Lim Chin

If the Great Depression of the 1930s can be blamed on the massive macroeconomic policy failure of the US government, then the origin of the 2008 global financial crisis can be traced to the market failures buried in the microstructure of the current financial system.

Deregulation in the financial institutions that began in the 1980s unleashed forces of competition and innovation that succeeded in bringing great profits and joy to Wall Street, but this has come at the expense of expanding systemic risk. Financial derivatives such as mortgage-backed-securities (MBS) and credit-debt-swaps may have transferred credit default risk from one party to another, but the total risk in the system expanded because the ability to transfer risk encourages market participants to make more risky loans. The result was a financial time bomb waiting to be detonated by the housing bubble of 2007.The credit default shock from the bust of the sub-prime housing market created at least three financial shock waves, damaging several major financial institutions in the US and Europe, freezing up their credit markets, melting down global stock markets, and now plunging the industrialised world into a recession.

Impact on Asia

The first shock wave toppled major financial institutions that were directly exposed to credit-default risk embedded in the MBS debt that they held. Emerging Asia was mostly spared in this round because of limited direct exposure to the MBS market.The second shock wave followed soon after when fear and uncertainty of counterparty risks led to panic. Cash redemption and the flight to the safety of the US bond markets caused a freeze in the credit market and a meltdown in global stock markets. In this round, Asia's financial and stock markets were not spared, as they were hit by the risk of illiquidity that results from deleveraging and the reverse flow of funds back to the US. The third shock wave that began soon after was the transmission of real economic shocks. Falling asset prices depress consumption, and the credit squeeze constrained investment. Together, these effects cause economic slowdown, depress output and raise unemployment. Both the US and the major economies in Europe are already in recession, and this has dampened the growth of Asia's export-oriented economies.

Deflation-recession spiral?

The chances of the world spinning into a deep deflation-recession spiral just like the Great Depression are remote for a number of reasons. First, much has been learned from the mistakes of flawed macroeconomic management during the 1930s, when monetary contraction and bank failures were allowed to happen. Economists and central bankers now have a much better understanding of business cycles and how to manage them.

After several rounds of monetary responses to slash interest rates, inject liquidity, insure interbank loans, and to bail out major banks and financial institutions, the Fed still has in its arsenal some unspent monetary policy bullets such as pushing interest rate to zero and to print money to finance government expenditure as a last resort.

Second, the recession of the 1930s was made deeper and more prolonged by shrinking world trade, caused by another misguided policy. On June 17, 1930, Congress passed the Smoot-Hawley Tariff Act that eventually led to retaliatory tariffs around the world. This time around, a repeat of this mistake is unlikely. When the 20 world leaders - representing nearly 90% of global GDP - met in Washington for the G-20 summit on Nov 15 to discuss how to repair the financial system and combat recession, suppressing trade protection tendencies was high on their agenda. They agreed that the final round of the protracted Doha trade negotiations should come to a close by the end of the year.

That said, the likelihood of a prolonged recession in the US and Europe cannot be ruled out. However, the chances of a deep recession would be reduced if every country does its best to maintain demand in its economy.

Emerging Asia,

despite being dragged down from its recent fast growth path by declining exports, is in a far better shape to cope compared with others because of healthier official foreign reserve positions, low debt-to-GDP ratios, well capitalised banks - a result of prudent economic house keeping after having suffered through the Asian financial crisis. They are now in an enviable position of being able to help the world climb out of recession while helping themselves.

Internal, external imbalances

For the last decade, emerging Asia, especially China and India, have grown at an extraordinary pace. Fast growth, however, was achieved at the expense of two kinds of imbalances - one internal and the other external. First, public development investment in infrastructure and in social services such as health, education, and others was concentrated at cities and growth centres.Second, as the aggregate level of such investment expenditures was inadequate, private saving rose to compensate and this, in turn, resulted in a high aggregate savings-investment gap, and a large current account surplus.

Both imbalances are unhealthy. First, internal imbalance creates tension between the haves and have-nots, and is politically unstable. China, for instance, could postpone attending to this problem as long as it could grow at an accelerated pace. With growth slowing down and with insufficient demand to absorb the rising pool of labour from the rural population, it can ill afford to wait any longer to fix the internal imbalance.

Second, global macroeconomic imbalances cannot persist without causing a crisis. In the 1980s, current account deficits in the US averaged 3.5% of GDP, while large current account surpluses were observed for its large trading partners such as Germany and Japan. That eventually led to a serious exchange rate crisis and the signing of the Louvre Accord in 1987 by the G-7 economies. In the accord, Japan and Germany agreed to spend more to reduce their current account surpluses while the US would do the reverse to reduce its current account deficit; the purpose was to prevent a drastic depreciation of the dollar.

The annualised US account deficit is now higher at more than 5% of its GDP, and it is obvious that this cannot go on forever without precipitating another crisis. One argument is that the 2008 global financial crisis was triggered by the bust of the US housing bubble that was driven by low interest rate and excess liquidity supplied from excess savings in emerging Asia.Now rather than later Looking ahead, each economy in emerging Asia could make a difference for both domestic and global recovery. For instance, China's recent announcement to spend a massive US$586 billion (15% of its GDP) over two years in infrastructure and social development throughout the economy has multiple benefits, both for the short and the long run. It will stimulate its own economic growth, and China's higher level of imports going forward will soften world recession. Moreover, its development expenditure in the hinterland will redress the internal imbalance and enhance political stability, and it will also narrow the global current account imbalance.

Economies in Asia are in different stages of economic and social development and each has its own variant of internal and external imbalances. One may need more ports, roads and railways. Another may need more public housing and power plants. And others may need more education, health care and social security. Governments that are able should seize the opportunity during the current economic slowdown to build for the future. And acting now rather than later has the added advantage of helping the pace of economic recovery, both for itself and for the global economy.

The writer is an economist and professor with the NUS Business School, National University of Singapore. These are his personal views. Published in Business Times (Singapore) on Nov 26.

Its wake up time America. These bailouts are not helping the American people just Companies who have reaped millions in rewards and done nothing to change their strategies over the years. None of them deserve bailouts and the US government cannot run these joints??? so the underlying question is how much of thise bail out money will be spent on themselves---- most of it so watch.

2009 Obama is saying as we say the Recession was caused by the finance and banking execs who paid themselves large amounts of bonuses & salaries. These & their board of directors are the ones to blame to the financial collapse.

Check out Pattaya/Bangkok Shipping & Transport services

BANKRUPTCY UNDER CHAPTERS 7 & 11

Chapter 11 of the Bankruptcy Code means to "reorganize" the company and try to become profitable. Management continues to run the day-to-day business operations but business decisions must be approved by a bankruptcy court.

Under Chapter 7, the company stops all operations and goes completely out of business. A trustee is appointed to "liquidate" (sell) the company's assets and the money is used to pay off the debt, which may include debts to creditors and investors.

The investors who take the least risk are paid first. eg secured creditors take less risk because the credit that they extend is usually backed by collateral, like a mortgage or other company assets. They know they will get paid first if the company declares bankruptcy.

Bondholders have a greater potential for recovering their losses than stockholders, because bonds represent the debt of the company and the company has agreed to pay bondholders interest and to return their principal. Stockholders own the company, and take greater risk. They could make more money if the company does well, but they could lose money if the company does poorly. The owners are last in line to be repaid if the company fails. Bankruptcy laws determine the order of payment.