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Asian Financial Crisis

According to Dawson (2002), one of the roots of the Asian financial crisis started when the United States Treasury and the International Monetary Fund encouraged the utilization of short-term foreign capital among developing nations. Subsequently, the rapid and overflowing short-term capital inflows encouraged inefficient use of funds. Short-term funds were used even long-term projects, particularly in real estate. Many developing economies did not have the financial structure to regulate and/or supervise where to channel proceeds of the short-term loans were going.

At the sign of trouble, foreign financiers withdrew their funds devastating the economies of the Asian developing countries. Corden (1998) believed that the International Monetary Fund was neither right nor wrong. He puts part of the blame on the use of fiscal policy for pump-priming the economy. Developing economies did not Other theories on the cause of the Asian financial crisis echo the same opinion. Pesenti and Tille (2000) believe inadequate supervision of the respective economies’ monetary sector led to the crisis.

But they also cited that regional structural links served as a conduit for the spillover effects. Aside from weak financial regulation, Asian countries had various weaknesses in their banking system. Political and cultural factors also contributed to the crisis. The practice of crony capitalism was prevalent in the region. The practice was not limited to the laggard economies, since crony capitalism was present even among the successful emerging economies like South Korea, Malaysia and Thailand. The malpractice was not limited to the people close to the powerful elite in each economy.

Beneath the mantle of crony capitalism, was an intangible factor contributory to the crisis. Lee (1999) cited a prevailing attitude in the private sector that gave a false sense of security to the domestic creditors. The latter believed that if anything goes wrong, the government will bail them out. Another factor is the foreign exchange policy of the respective governments. Corden (2002) believed the crisis was precipitated by the following factors: Foreign exchange policies did not reflect the true value of the respective currencies so that many are overvalued.

He also cited the imbalances in the current and trade account. Kawai (2005) of the Asian Development Bank also cited the role of bad monetary and foreign exchanged policies. The current account deficit of the Asian economies was financed by short-term capital inflows. To make it worse, these short-term funds came from Asian savings which came back as short-term foreign capital. These were the same funds used in financing long-term projects leading to what he termed as “double mismatch” problem. Some authors view the Asian financial crisis as resulting from long-term vulnerabilities.

In other word, a trigger has to kindle and turn these vulnerabilities into a conflagration. Dornbusch (2001) mentioned three vulnerabilities: misaligned exchange rate, nonperforming loans, and mismatches. Similarly, Kaminsky and Reinhart (1999) contended that vulnerabilities among the Asian nations led to the contagion. They said that regional blocks have certain characteristic practices that lead to similar vulnerabilities. Among them are common export markets and the sources of loan funds. As a result, an event in one country serves as a trigger leading to a contagion affecting other countries in the region.

The trigger that set off the crisis was the collapse of the Thai Baht in 1997. The August 2007 edition of the Economist gives a good picture of the effects of the US subprime crisis on the world economy. The US Federal Reserve Bank has implemented measures to alleviate the effects of the crisis on its monetary system. But a US recession is expected as a result of the crisis. With its huge trade deficit, any slowdown in the US economy is expected to affect the world economy. By July 2007, US housing construction has gone down signalling an oncoming recession.

The construction industry is further burdened by existing unsold houses, which is at its highest level for the past sixteen years. While housing prices continue to fall. One of the problems is psychological panic. The negative effects of the US subprime crisis are spread around the world but the magnitude is not great. However, its occurrence around the world will spread nervousness and aversion to risks in the capital markets increasing the risk of contagion. The Asian Development Bank has warned East Asian economies of the potential adverse effects of the US subprime crisis.

In particular, risk aversion can lead to a similar outflow of foreign capital funds may occur as during the Asian financial crisis ten years ago. The Philippine Central Bank is of the opinion the Philippine economy is more resilient compared to the time of the Asian financial crisis (Inquirer, November 2007). Among the East Asian nations, the Philippines was least affected by the contagion ten years ago. The Central Bank said the economy is more resilient as a result of respectable growth rates, good level of international reserves, and improved fiscal policies.

In Latin America, The Brazilian-American Chamber of Commerce conducted a private sector survey and the results were similar to the Philippine case. Interesting portions of the survey are summarized as follows: Ricardo C. Amorim (Head of Latin America Research at WestLB) said that it is hard to determine what the effect of the US subprime crisis will be in Brazil. He is of the opinion that negative effects will be limited. Amorim is hoping that the American economy will remain robust. But in case of a recession, he is hoping that the Asian and European growth economies will compensate for the slowdown.

Finally, he says that The Brazilian economy has strong fundamentals. This resulted from improved foreign debt structure, high level of international reserves, and a surplus in its current account. Jose Alfredo Coutino (Sr. Economist for Latin America at Moody’s Economy. com) said that Brazil has strong economic fundamentals and can withstand external shocks. Alexei G. Remizov (Senior Vice President for Global Capital Markets, Latin America at HSBC Securities) has a more reserved observation. Although the effect of the crisis is minimal, foreign banks are reducing cross-border financing as a safety precaution.

Lisa M. Schineller (Director of Sovereign Ratings at Standard & Poor’s) expects the Brazilian monetary authorities to raise interest rates. They will maintain higher rated until the level of uncertainty in the market declines. Although pessimistic about its effects on Brazil’s trade surplus, she is in consensus with the other respondents that the country will withstand external shocks. Actual losses are still being estimated by financial institutions throughout the world. Current reviews show a problem magnitude that can be withstood by developing economies in various parts of the world.

But these estimates are based on a scenario prior to the completion loss calculations. Benson (January, 2008) gives a pretty pessimistic scenario. He states what is currently seen in the present problem is only the “tip of the iceberg. ” For the past years, loose credit appraisal policies have resulted in the approval of doubtful loans. For the past six years, he said loans were approved on the basis of stated incomes with no subsequent asset or income verification. Loans of this type covered approximately fifty percent of all mortgage loans in the US.

As borrowers struggle to make mortgage payments, rates are expected to increase. Benson estimates that there will be over a trillion dollars of bad loans that can not be refinanced until salary earnings increase significantly. The overall consequence of the US subprime problem is not known as of the present time. Economists expect the Federal Reserve Bank to be able to quell fears and prevent panic in the financial markets. Various countries believe that their economic fundamentals are strong and can withstand external financial shocks.

Among Asian and Latin American countries, this sense of confidence stems from respective monetary and fiscal measures based on lessons learned from the Asian financial crisis (ESCAP, 2007). Perhaps, contagion is not expected as the regional structural weaknesses of the past have been addressed (Lim, June 2007). But the structural and institutional monetary and fiscal improvements is no guarantee that a 2nd financial crisis will occur. Whether it’s from the current US subprime crisis or any other external shock, it is presumed that vulnerabilities still exist in the world economies.

But financial triggers can occur and again these vulnerabilities can transform into contagion. Lim puts forward the idea of an Asian currency that will answer the perennial problem of financial demand and supply in the international market. The underlying problem, however, is the degree of recession the United States is going to undergo. The US is the world’s biggest consumer of world output. A decline in its trade deficit will resulting in corresponding declines of exporters, particularly China and the East Asian economies.

If the subprime problem is prolonged, expect a more serious slowdown in the US economy. But unlike ten years ago, the East Asian economies and other developing economies are better prepared to absorb external shocks. For these reasons, a 2nd Asian financial crisis is unlikely. Section B Part i) Effect of Cross Border Merger and Acquisition activity on Shareholder Wealth In the light of the current global financial crunch, Zamitsu fears deterioration of their traditional markets and decided to acquire a Brazilian company.

The Chief Executive Officer supports the decision in order to transform his company into a “truly global corporation. ” The acquisition to be successful has to address the global situation and the synergies that the decision provides (Ross, Westerfield & Jaffe 2005). The primary synergy the company expects is market expansion. It is likely the managers of the Brazilian company will undertake defensive moves to prevent a takeover. The manner of takeover is an important decision. It can turn out to be very costly since Zamitsu may have to consider a significant premium over the current stock market price.

DeAngelo, DeAngelo and Rice (1984) showed that the price of a leverage buy out and is just about the same as in an acquisition type of takeover. This decision requires a separate study. Ruback, J. , Richard, S. & Jensen, M. (1983) made a study on the market for corporate control. They were able to gain scientific evidence that takeovers end in positive gains. The non-executive directors of Zamitsu will welcome the finding shareholders of the acquiring firm do not lose. The study also discovered that shareholders of the acquired firm, likewise, gain from the takeover.

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