I came across a site The Indian Blogger:Life & Times of India.... The author has written a awesome article about reason for Last year recession. I have taken this article from his site . An excellent read...
Now we all the story...In US, a boom in the housing sector was driving the economy to a new level. A combination of low interest rates and large inflows of foreign funds helped to create easy credit conditions where it became quite easy for people to take home loans. As more and more people took home loans, the demands for property increased and fuelled the home prices further. As there was enough money to lend to potential borrowers, the loan agencies started to widen their loan disbursement reach and relaxed the loan conditions. The greed factor came in .the loan was then given to customer without checking their repaying capacity...But this had to come to end someday. About that i shall write later...
What was intersting about the this article is that he says how US got such a large inflows of foreign funds?
For this we have to go back to 1997-98s. At this time, the tiger economies of Asia (a term used to refer the countries of South East Asia like Thailand, Malaysia, Indonesia etc...) suffered a major economic crisis. Several countries of South East Asia had developed worrying financial weaknesses which were the results of heavy investment in highly speculative real estate ventures, financed by borrowing either from poorly informed foreign sources or by credit from under regulated domestic financial institutions.
The crisis began with wrong banking practices. In those countries crony capitalism (where borrower had the connections with government) became too dominant. The minister’s nephew or the president’s son could open a bank and raise money both from the domestic populace and from foreign lenders, with everyone believing that their money was safe because official connections stood behind the institution. Government guarantees on bank deposits are standard practice throughout the world, but normally these guarantees come with strings attached. The owners of banks have to meet capital requirements (that is, put a lot of their own money at risk), restrict themselves to prudent investments, and so on. In Asian countries, however, too many people were granted privilege without responsibility, allowing them to play a game of “heads I win, tails somebody else loses.” And the loans financed highly speculative real estate ventures and wildly overambitious corporate expansions.
This bubble was inflated still further by credulous foreign investors, who were all too eager to put money into faraway countries about which they knew nothing (except that they were thriving). It was also, for a while, self-sustaining: All those irresponsible loans created a boom in real estate and stock markets, which made the balance sheets of banks and their clients look much healthier than they were.
However, this bubble had to burst sooner or later. At some point it was going to become clear that the high values Asian markets had placed on their assets weren’t realistic. Speculative bubbles are vulnerable to self-fulfilling pessimism: As soon as a significant number of investors begin to wonder whether the bubble would burst, it did.
So Asia went into a downward spiral. As nervous investors began to pull their money out of banks, asset prices plunged. As asset prices fell, it became increasingly doubtful whether governments would really stand behind the deposits and loans that remained, and investors fled all the faster. Foreign investors stampeded for the exits, forcing currency devaluations, which worsened the crisis still more as banks and companies found themselves with assets in devalued baht or rupiah, but with liabilities in lamentably solid dollars.
In 1996 capital was flowing into emerging Asia at the rate of about $100 billion a year; by the second half of 1997 it was flowing out at about the same rate. Inevitably, with that kind of reversal, Asia’s asset markets plunged, its economies went into recession, and it only got worse from there.
Eventually International Monetary Fund (IMF) had to step in to save these economies. How these economies later recovered and at what cost is a different story. However, this crisis brought with it some major lessons for the Asian economies. One of the most important lessons for them was to create a solid Foreign Exchange Reserve so as to withstand the most volatile exit of the money from their markets. High reserves promise safety in a storm. Therefore, most major economies of Asia (including the big China and India) adopted a strategy of maintaining high forex reserve so as to ensure safety from any such crisis in future. This shift in priorities created a very interesting situation.
In the mid-1990s, the emerging economies of Asia had been major importers of capital, borrowing abroad to finance their development. But after the Asian financial crisis of 1997-98 these countries began protecting themselves by amassing huge war chests of foreign assets, in effect exporting capital to the rest of the world.
To say in other words, the Asian economy came in to a Saving mode. In order to maintain huge foreign reserve, they also started buying US securities. This resulted in a huge inflow of dollars into the US economy. As more and more dollars kept coming into the US economy from world over, the American investors started devising very sophisticated and innovative methods to convert the flood of money from Asia into a borrowing and spending spree for American consumers.
This Money was helped people to take more and more home loans ..which boomed the housing sector in US...
Thus it gives a brief overview of the crisis that helps us to understand the current mess in world as it is all linked.
cheers...
RJFS
