We should all continue to be alert to the further developments and effects of the international financial situations.
I recently drew attention to the possibility of a "second wave" in the continuing global financial crisis. This may have surprised some people, but I hope they will understand that I was trying to alert them to developments that may affect them so that they can take appropriate preventive measures to protect themselves. With the financial crisis far from over, there is a need for continued vigilance from everyone.
This likely further developments, as they are now understood, are very much an extension of the earlier ones, in that financial institutions, particularly those of the developed markets, have continued to report large losses, arising directly or indirectly from their past involvement in the manufacture, distribution, trading and holding of toxic financial assets. The size of these losses, revealed in the fourth-quarter numbers of major financial institutions, is beyond market expectations, leading to renewed concern about the severity of the crisis, at a time when many have been hoping to see improvements, after the implementation by various governments of unprecedentedly large rescue packages. Instead, the latest situation in the developed markets calls for even larger rescue packages for their financial systems. Worse still, there has been little sign that the functioning of these systems is returning to normal. The important role of financial intermediation in supporting the economy continues to require the presence (and at increasingly significant levels) of the central banks in various capacities, notably as guarantors of assets of the banking system and as providers of capital and liquidity. The balance sheet of the US Federal Reserve, for example, has more than doubled since the crisis began, and is still increasing (its total assets increased from US$0.87 trillion on 1 August 2007 to US$2.04 trillion on 21 January 2009).* The UK government has just announced an asset protection scheme and the Bank of England a separate asset purchase facility, among other measures.
Meanwhile, credit tightness in the developed markets and the sharp economic downturn are reinforcing each other, threatening to create further financial turmoil, perhaps involving large credit losses at the banks, as borrowers face difficulties and find themselves unable to service their debt. Governments are now urgently encouraging the banks to lend, to the extent of providing different incentives, or themselves directly or indirectly incurring credit risks. I certainly hope that these efforts are successful. The downward spiral of credit tightness and economic downturn must be arrested before there can be any hope of financial and economic stabilisation in the developed markets.
I also drew attention to the possibility that any second wave might be rather more contagious for emerging markets, given that many of them have, in the past few months, been sent into recession by the financial crisis. The sharply weaker economic numbers, in terms of GDP growth and exports, unemployment, exchange rates, corporate earnings (particularly those of financial institutions) and so on, have increased their vulnerability to sudden adverse shifts in sentiment, which may be manifested in destabilising volatility in their financial markets.
A lot of research reports are now surfacing concerning, for example, emerging markets as an investment class, outlooks for individual emerging markets, or even the outlooks for their currencies, presumably to draw attention to the possibility of sharp changes. While these are useful for those who need to manage the associated risks, there is indeed a need for vigilance by all of us, not least those responsible for maintaining monetary and financial stability. Hopefully, the global financial crisis has made international finance somewhat less potent than before, at least relative to the increased financial robustness of most emerging markets in the region, and the stronger bilateral and regional financial co-operation that has been established in the past decade, so that we may not see a repeat of the type of attacks we saw in Asian financial markets in 1997-98. But there is no room for complacency. No two financial crises are ever the same.
Forgive me for repeating something I have said many times before. Promoting general awareness of risks is an effective way of limiting their adverse impact in the event that they materialise. It may even pre-empt the risks from emerging, which will be good for everybody.
Joseph Yam
5 February 2009
* Source: Federal Reserve's official website.
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