Asset prices, leverage and financial crisis: the case of Thailand

The first part of this thesis examines the role of highly-leveraged institution in creating vulnerability in the financial system. By applying the framework of Kiyotaki and Moore (1997), Chapter 2 shows that when an asset price bubble bursts which cuts the value of land being used as collateral, the sudden fall in collateral value can create the possibility that firms’ net worth is entirely wiped out and the whole financial system collapse. This is due to the powerful feedback effects where forced selling further depresses prices, setting in motion a downward spiral of asset prices and loan recalls. We then show how wholesale financial collapse can be avoided by co-ordinated loan roll-overs in the form of a general financial freeze; and how the breathing space gained in this way can be used to arrange for loan write-downs or capital injections. In Chapter 3, the degree of corporate leverage is analysed more explicitly by introducing margin requirements into the model and two types of adverse shocks are examined numerically, an asset bubble bursting and a sudden rise in real interest rates. We find that when the economy is highly leveraged, a small shock to real interest rates can have powerful impacts on asset prices and cause widespread bankruptcy of the credit-constrained sector. To shed light on the recent debate on the role of prudential regulatory policies in mitigating the impact of a bubble bursting, we show that relaxing margin requirements can be used as a form of ‘regulatory forbearance’ for avoiding and/or reducing the knock-on effects. The second part of the thesis is a case study of Thailand. Chapter 4 provides a detailed account of Thailand economic developments from 1988 to 1998; it is argued that the nature of Thai financial crisis lied in the profound boom and burst in real estate sector which played a central role in creating tensions in the financial system and ultimately causing severe contraction of the economic activity. Chapter 5 explores some key issues relating to systemic bankruptcy of the corporate sector in aftermath of the Thai crisis

Financial crisis in East Asia: bank runs, asset bubbles and antidotes

Was the East Asian crisis just a creditor panic with a mad scramble for liquidity that brought the banking system to its knees and the region's much-vaunted 'economic miracle' to a standstill? Or was the miracle indeed flawed by fundamental problems in asset prices and resource allocation? After a summary of the facts and an outline of various types of financial crisis, we conclude that the truth involves both factors, interacting in a vicious downward spiral. There certainly was panic among the creditors but it was triggered by genuine problems of overinvestment and overvaluation in emerging East Asian economies. Before turning to outline various approaches of crisis prevention and management and a brief account of the future prospects, we discuss how contagion can occur in environments where investors are poorly informed and each looks to the others for guidance. The paper ends with immediate steps that might help resolve the current crises; and with proposed reforms to the international monetary system to prevent a recurrence

Asset prices, leverage and financial crisis : the case of Thailand

The first part of this thesis examines the role of highly-leveraged institution in creating vulnerability in the financial system. By applying the framework of Kiyotaki and Moore (1997), Chapter 2 shows that when an asset price bubble bursts which cuts the value of land being used as collateral, the sudden fall in collateral value can create the possibility that firms’ net worth is entirely wiped out and the whole financial system collapse. This is due to the powerful feedback effects where forced selling further depresses prices, setting in motion a downward spiral of asset prices and loan recalls. We then show how wholesale financial collapse can be avoided by co-ordinated loan roll-overs in the form of a general financial freeze; and how the breathing space gained in this way can be used to arrange for loan write-downs or capital injections. In Chapter 3, the degree of corporate leverage is analysed more explicitly by introducing margin requirements into the model and two types of adverse shocks are examined numerically, an asset bubble bursting and a sudden rise in real interest rates. We find that when the economy is highly leveraged, a small shock to real interest rates can have powerful impacts on asset prices and cause widespread bankruptcy of the credit-constrained sector. To shed light on the recent debate on the role of prudential regulatory policies in mitigating the impact of a bubble bursting, we show that relaxing margin requirements can be used as a form of ‘regulatory forbearance’ for avoiding and/or reducing the knock-on effects. The second part of the thesis is a case study of Thailand. Chapter 4 provides a detailed account of Thailand economic developments from 1988 to 1998; it is argued that the nature of Thai financial crisis lied in the profound boom and burst in real estate sector which played a central role in creating tensions in the financial system and ultimately causing severe contraction of the economic activity. Chapter 5 explores some key issues relating to systemic bankruptcy of the corporate sector in aftermath of the Thai crisis.EThOS - Electronic Theses Online ServiceEconomic and Social Research Council (Great Britain) (ESRC) (R000239216)University of Warwick. Centre for the Study of Globalisation and Regionalisation (CSGR)GBUnited Kingdo

Asset bubbles, domino effects and 'lifeboats': elements of the East Asian crisis

Credit market imperfections have been blamed for the depth and persistence of the Great Depression in the USA. Could similar mechanisms have played a role in ending the East Asian miracle? After a brief account of the nature of the recent crisis, we use a model of highly levered credit-constrained firms due to Kiyotaki and Moore (1997) to explore this question. As applied to land-holding property companies, it predicts greatly amplified responses to financial shocks – like the ending of the land price bubble or the fall of the exchange rate. The initial fall in asset values is followed by the ‘knock-on’ effects of the scramble for liquidity as companies sell land to satisfy their collateral requirements – causing land prices to fall further. This could lead to financial collapse where – like falling dominoes – prudent firms are brought down by imprudent firms. Key to avoiding collapse is the nature of financial stabilisation policy; in a crisis, temporary financing can prevent illiquidity becoming insolvency and launching ‘lifeboats’ can do the same. But the vulnerability of financial systems like those in East Asia to short-term foreign currency exposure suggests that preventive measures are also required

Asset Bubbles, Domino Effects and `Lifeboats': Elements of the East Asian Crisis

: Credit market imperfections have been blamed for the depth and persistence of the Great Depression in the USA. Could similar mechanisms have played a role in ending the East Asian miracle? After a brief account of the nature of the recent crises, we use a model of highly levered creditconstrained firms due to Kiyotaki and Moore (1997) to explore this question. As applied to land-holding property companies, it predicts greatly amplified responses to financial shocks - like the ending of the land price bubble or the fall of the exchange rate. The initial fall in asset values is followed by the `knock-on' effects of the scramble for liquidity as companies sell land to satisfy their collateral requirements - causing land prices to fall further. This could lead to financial collapse where - like falling dominoes - prudent firms are brought down by imprudent firms. Key to avoiding collapse is the nature of financial stabilisation policy; in a crisis, temporary financing can prevent illiqu..