The American crisis mainly began as a solution to cater for the borrowers who were a high risk and who had less history in the credit borrowing as well as low income levels. This made the system to be referred to as sub- prime. The mortgage payments were processed by the banks as securities, the bonds or even as debt obligations. This was in return sold to the financial institutions all over the world. This also increased the private sector participation in the mortgage financing market because of the high demands achieved which were mainly motivated by the need for easy financing to the clients. (Reinert, 2005).
The incentives of the loan which assured clients that the terms were favorable and they would be able to finance the loan later was one of the reasons that led to the success of the debt obligations systems. In addition this was also motivated by the rapid increase of the housing prices. The problem however arose when the prices for the houses fell down and lenders began calling for their loans. This led to the loanees being affected mainly because they consisted of the low income earners and people at high risk. (Reinert, 2005). This therefore made many people to default on payment of the loan. This contributed to big losses to the lenders and the investors who had bought the mortgages from the debt obligation systems. Eventually, lending institutions were forced to reduce their rate of crediting to the clients or they issued the loans at very high interest rates. Consequently, this led to shortage of funds by individuals and other corporations resulting to a credit crunch.
The crisis in East Asia also started along similar lines where there were new opportunities for profit making mainly in the Asian Pacific markets. This led to great expansion of the credit market in order to cover for the new investments in actual constructions and in speculative activities. The speculation aspect led to many promises and optimism which led to more spending, over lending by the firms and outstretching the boundaries of a healthy risk market. In addition many of the East Asia lending firms were not banks but firms with good political connections therefore the availability of funds with low interest rate made them to lend money to speculative investors who wanted to make a killing by betting on the real estate market. It even became more vulnerable when the banks were allowed to take short term foreign debts after the liberalization of the capital accounts. (Reinert, 2005). Thereafter some of financial companies were forced to close their shops after they lost their confidence. In addition foreign lenders became reluctant to lend. This made the local currency to be floated and to loose its value. The efforts of the central banks to safeguard the value of the currency by raising the interest rate made the economy and the loans to become more oppressed. This is in contrast to the USA crisis where lending rates were raised as a result of loss of confidence on the ability of the borrower to repay the loan.
The crises were global ones because it affected the rest of the world equally. The slow rate of spending that was witnessed in America led to a subsequent slow demand and expansion for the American investments. This was the case both abroad and in the local market. This therefore affected the global markets that were dependent on America making the prices of the commodities to rise steadily globally. The prices of many food products rose steadily which made the value of the dollar to drop. (Reinert, 2005). The drop in the dollar value made other foreign currencies to appreciate against the dollar reducing the competition of the foreign countries. This was more particularly felt in the East Asia as the held the reserves for the foreign currencies mainly in dollars. This reduced the value of the reserves affecting the regions protection against any potential recession. In China, for example, 20% of the imports go to the USA while 54% go to the higher economies therefore the global recession had a toll on the world economy. The Indian firms were also affected as the companies in India began selling their investments to the Indian based firms in India in order to cover for the losses that they incurred.
The similarities of the 2 crisis are that they were both as a result of greedy optimism for profits taking the place for cautionary measures. The financial regulations were careless in both cases. The crises in both cases were similar in that the risks affected the financial institutions. It affected all parties eve those that were not involved in the borrowing or the lending process. (Reinert, 2005).
On the differences, the US crisis affected only the US while the East Asian crisis was a regional crisis. Secondly the East Asian crisis was worsened by the financial speculators who were not available in the US sub prime crisis. Thirdly, the East Asian crisis was affected by the foreign investors while the American crisis was only limited to the American nationals. (Reinert, 2005).
It is difficult to make any future assessment by comparing the solutions that were proposed or implemented with whether they resolve the cause of the crisis. For instance, if the sub prime crisis was as a result of unregulated access of funds, then it would be wise to correct the role played by the credit institutions and regulators have to take strict actions on this. However, it is not clear yet why the credit institutions provided a go ahead for the mortgage backed securities. The Federal reserves must be mindful of the effects of under pricing the risks to the banks. This takes us back to the emphasis on prevention rather than cure. Therefore the central banks should be allowed to manage the supply of credit and money instead of handling issues of inflation. (Reinert, 2005).
Reinert, K.A. (2005). Windows on the World Economy: An Introduction to International Economics. Thomson South-Western. University Press.
Copyright 2019 - Education WordPress Theme.