Korea on the Load Ahead

Korea on the Road Ahead

Following the burst of IT bubble in 2000, governments have kept low interest rates and expansionary monetary policies which have caused an overall bubble in the real economy.

Historical Interest Rates

Historical Interest Rates

The U.S. & U.K.'s Asset Price Trend

The U.S. & U.K.'s Asset Price Trend

The 'global imbalance' began to take shape as advanced countries experience excessive liquidity through the influx of capital from developing nations

  • Developing nations, such as China, accumulated wealth through their saving glut and current account surpluses which were reinvested into purchasing treasury bonds particularly from the U.S.
  • These excessive funds that went into the U.S. in turn were used by American citizens in purchasing houses and consumer products, which resulted deficits in their current account balance and a real estate bubble.

The rapid technological advancements and innovations in finance led to financial transactions became increasingly more detached from the base assets, whereas adequate supervision and regulation to meet these financial advancements were non-existent.

  • Due to the speed in which financial advancements took place in the private sector, there has been a failure in the financial system to detect and manage the risks that must go along with it.
    * The regulation came short of expanding its supervision over from the traditional banking system to the "shadow banking system".
  • The mark-to-market concept and credit rating system embedded in the current financial system also amplified the financial cycle.
    * The main financial regulatory concepts of Basel II such as the capital asset regulation and mark-to-market which forced losses to be recognized immediately on the balance sheet have led to further deterioration in the market.

PROGRESS OF FINANCIAL CRISIS

Stage 1 : Mortgage Insolvency (June 07 ~ March 08) Stage 2 : MBS and CDO Insolvency Stage 3 : Bankruptcies of Major Financial Companies Stage 4 : Worldwide Spread of Credit Crunch

Mortgage Insolvency

  • In the U.S. real estate market, as asset prices began to decline, a large portion of mortgages became insolvent which eventually gave rise to insolvency issues for related financial companies.
    * In June 2007, a BNP Paribas affiliated hedge fund came near bankruptcy.
    * In March 2008, as major investment banks such as Bear Stearns began showing signs of bankruptcy, the FRB stepped in with a bailout plan totaling US$29bn to stabilize the market. JP Morgan was acquired in the process.

MBS and CDO Insolvency

  • Entering the second half of year 2008, due to the continuous decline in the U.S. housing market, an increasing number of mortgaged related derivative securities became insolvent.
    * Fannie Mae and Freddie Mac largely exposed to MBSs showed signs of the mounting insolvency problem.

Bankruptcies of Major Financial Companies

  • Lehman Brothers filed for bankruptcy protection and Merrill Lynch was acquired by Bank of America for US$50bn, followed by drastic fall of investor sentiment. (Mid-September)
  • Right after Lehman collapsed, worries of global financial turmoil peaked when AIG came near bankruptcy, at which time FRB decided to bail them out with a US$85bn financial support.

Worldwide Spread of Credit Crunch

  • Despite the U.S. government's announcement of TARP (Troubled Asset Relief Program) worth US$700bn, LIBOR interest rates continued to soar, worsening the credit crunch.
  • Investors engaged in a 'flight to safety' mode as funds invested in emerging markets were pulled back. Stocks plunged and foreign liquidity worsened as uncertainty and tension spread over the markets.
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