Financial Crisis

The current financial crisis in USA is similar to the Asian Financial Crisis, exactly ten years ago.

In the Asian financial crisis (1998), corporates borrowed on short term loans in USD to fund long term property and business projects. When the USD increased sharply, they could not repay their debts.

In the current financial crisis (2008), many special investment vehicles and hedge funds borrowed money on the short term to invest in other assets, such as equities, to earn the margin between their cost of borrowings and the higher return on risky asssets.

The defaults of subprime mortgages started the crisis. It spread beyond the subprime mortgages. When the short term borrowings of the SIV and hedge funds fall due, the lenders refused to refinancing the loans. The borrowers could not refinance their debts. They had to sell equities and other assets to repay the loans. This caused the collapse of the stock markets.

Lesson: It is very risky to borrow on short term to invest for the long term, or to invest on borrowed money (i.e. leveraging).