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196 Taiwan Development Perspectives 2009
I. Foreword
The collapse of Lehman Brothers touched systematic
breakdowns in the U.S. and EU financial markets
that have not only severely eroded the confidence of
investors and depositors in banking and insurance institutions,
but also caused a worldwide market panic.
The United States and the European Union have
jointly lent an impetus to bailout plans, with hundreds
of billion dollars being injected into the troubled banks
to resolve the worsening illiquidity problems arising
from capital shortages. Before the bailout plans were
rolled out, several countries had started relaxing monetary
policy to prevent the liquidity crisis from escalating
to a national scale. Besides, public funds were used
to buy bank stocks to stabilize market confidence in the
banking industry.
The United States and some European countries
are strong enough to consistently adopt loose monetary
policy and bailout plans to cope with the financial crisis
in the Group of Seven. But other European countries
such as Iceland and Ukraine are endangered by economic
bankruptcy. The crisis has also made serious
impact on Asian countries. American dollars keep
flowing out of the area and the depreciation of the Korean
hwan continues. It would be quite appropriate to
say that the Asian Financial Crisis of 1997 is being repeated.
The international financial crisis arising from the
subprime loans failure is quite similar to what occurred
in the 1980’s and 1990’s. It resulted from economic
bubbles, which were blown up by slack monetary and
credit policy. Then, after money supply started being
tightened and credit crunch was on the way, the bubbles
went burst. The crisis is originated from the combined
effects of bubbles in real estate, housing loans and derivative
markets, and the scope of its impact has quickly
escalated worldwide thanks to financial globalization
and the Internet. The economic bubbles this time are
somewhat different from what were evidenced in the
real estate and stock markets in Japan and Taiwan in the
1980’s, because the impact of the latter was only local
and had no direct influence on the international financial
system.
Originally, various securitization products – such
as Mortgage-Backed Securities (MBS), Asset-Backed
Securities (ABS) and Credit Default Swap (CDS) –
were designed as financial vehicles to diversify credit
risks and improve the asset liquidity of banks. However,
while these securitization vehicles are comprehensively
used as underlying assets of derivatives with more
complicated structures such as Collateralized Debt Obligation
(CDO) and Synthetic CDO (SCDO), issues
over information opacity and risk underestimation
emerge. The credit rating companies were either not
fully aware of the potential risk of these fancy products
or, even worse, conspired with investment banks to
mislead the general public.
Moreover, the investment banks used lots of subprime
loans purchased from banks to create new types
of financial derivatives. The loans with different credit
quality were repacked as complicated structured notes.
Although the structured notes were useful securitization
tools for banks, the risks of these products were severely
undermined, because the investment banks did
not make proper disclosures on the products structures
and the credit rating companies as well did not fully
capture all the critical risk dimensions, such as the default
risks of the issuing and selling banks.
While the U.S. financial authorities failed to effectively
supervise and manage the risks of structured
notes and derivatives, the investment banks were then
able to successfully promote these high leveraged
products across the world by their far-reaching marketing
networks and distinguished reputation for financial
engineering. The sequences of adverse market responses
to the burst of subprime loan bubbles have seriously
battered global financial system and economy.