Transmission to Developing Countries in Asia

The short chronicle of financial developments in industrial countries during the crucial build up of the global recession and the spread of the crisis to the rest of the industrial world highlight the speed and ferocity of the financial meltdown as well as the timid response of central banks and governments. Regulators were initially fearful of choking off the economic boom while at the same time underestimating the power of leverage and the riskiness of many of the arcane financial instruments that were being marketed and sold so aggressively and widely by investment banks in the so called “shadow banking system”. The degree of potential systemic risk was also underestimated. Investor panic and fear of default on subprime mortgages played a central role and this was compounded by the lack of risk transparency. In most cases it was a liquidity crisis not a solvency crisis. Since banks were unwilling to lend to each other even solvent banks were stressed because they were unable to meet withdrawal demands of jittery investors or to meet their short-term obligations that had been traditionally dealt with through short-term borrowing or trade credit. The crisis of confidence was widespread. The secondary impact of the subprime mortgage crisis was a crisis of trust and expectations which often morphed into depositor panic and sharp deterioration of equity markets. This perceived risk resulted in loss of capital and deposits and could only be stopped by sale to a more stable bank or by government or central bank intervention. By the fall of 2009 it became clear that the bottom of the recession has been reached while the process of rebuilding confidence and further growth began slowly and with substantial caution. The IMF downgraded its outlook several times beginning in September of 2008. In its report released in the spring of 2009 it speaks of the “corrosive global feedback loop that has undermined policymakers’ efforts to remedy the situation” (IMF, 2009, Chapter 1, p. 4).