2. Provide a Concise Summary of the Causes of the 1997 Asian Financial Crisis and the Resulting Damages. Students Are Advised to Link Concepts Taught in Class to Their Answer.

Strong growth was typical of economies in the South East Asian region in the years leading up to the currency crisis (Mckinnon 1997). Significant increases in stock and land prices in the region fueled foreign investments and lending, creating an economic boom. This lasted until the mid-1990s when growing competition and a weakening Japanese yen slowed economic growth and reduced asset prices (Moreno 1998). These events triggered collapsing currencies starting with the Thai baht. In retrospect, the growth witnessed in Thailand was most likely caused by a large influx of foreign capital facilitated by a pegged exchange rate. Moreno suggests that poor credit allocation was also a factor, in which borrowers who were well connected were also granted credit. In addition, financial intermediaries were protected by government guarantees, creating severe moral hazard. This resulted in poor risk management and transformation and gave little incentive to banks to choose clients wisely. This became apparent in South Korea where companies with unhealthy debt ratios were granted credit and had to rely on special government loans to service their debts.

Since it is common for financial intermediaries to practice size and maturity transformation (Casu 2006), a sudden withdrawal of deposits would make the system vulnerable to collapse and be unable to fulfill its obligations. This is because as liquid deposits, in the form of foreign investors, start to panic and withdraw, financial intermediaries are left with collateral, often in the form of illiquid and highly risky assets. In addition, the risky lending practices that were present at that time suggests that a significant number of borrowers would have defaulted on their loans. A weakening currency and slowed economic growth would then cause these illiquid assets to fall in value and be difficult to convert into liquid funds.

In April 1997, Thai authorities suspended trading in finance company shares on the...