What Can We Learn from the
Past Financial Turmoil?
Inmoo Lee, Ph.D.
Vice President
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What Should We Do in the Middle of a Financial Crisis?
► Every financial crisis we have experienced in the past has had
different causes, and levels of seriousness have also varied.
► However, in making our investment decisions as of now, lessons we
can learn from the past might be the best guidelines we can use in
these turbulent market conditions.
– What else can we use as a guideline?
1

Financial Crises
► Asian Financial Crisis in 1997.
► Japanese Financial Crisis in the mid to late 1990s.
► UK Secondary Banking Crisis in 1973-1974.
► Swedish Banking Crisis in the early 1990s.
2

Asian Financial Crisis
► In 1997, currencies of Indonesia, Korea, Malaysia, the Philippines,
and Thailand depreciated in a dramatic way and as a result, created
crises in these countries.
► Timely and thorough responses.
– Partly due to the requirements of the IMF.
3

The Magnitude of International Short-Term Debt of Banks
1993-2007
Total Short-Term Debt to Foreign Exchange Reserves1
(In percent)
350%
South Korea
300% Thailand
Asia 82
250%
Malaysia
200%
150%
100%
50%
0%
1993 1995 1997 1999 2001 2003 2005 2007
1. Short-term debt is the sum of such debt in the consolidated banking statistics (Table 9A, column B) and short-term securities
(Table 17B); there may be double-counting, but see text regarding short-term debt not included.
2. China, India, Indonesia, South Korea, Malaysia, the Philippines, Thailand, and Taiwan (China).
Sources: IMF, BIS, authors’ calculations.
Amounts estimated based on visual appearance of original.
4
Robert McCauley and Jens Zukunft, “Asian Banks and the International Interbank Market,” BIS Quarterly Review, June 2008.

Exchange Rates and Interest Rates
3-Month Interest Rates Move in
Change in Real
Change in Dollar
Average Peak Date of Stock Market
Exchange Rate
Exchange Rate
in 1996 Level 1997 Peak during 1997
Jun 1997 to Sep 1998
Jun 1997 to Sep 1998
(a) (c)
(b)
5.5% 25.0% October 0.0% 16.1% -18.7%
Hong Kong
13.8% 27.7% October -77.7% -56.3% -37.0%
Indonesia
7.3% 8.8% November -39.8% -27.2% -52.2%
Malaysia
11.7% 85.0% October -38.3% -26.0% -40.3%
Philippines
3.0% 10.3% December -17.6% -2.7% -31.7%
Singapore
13.3% 25.0% October -33.8% -19.8% -42.6%
Korea
5.5% 9.8% October -19.4% -12.4% 9.3%
Taiwan
13.0% 26.0% December -36.7% -19.1% -55.2%
Thailand
Eshan Karunatilleka, “The Asian Economic Crisis” (UK House of Commons Library research paper no. 99/14, February 11, 1999):
5
Table 5, http://www.parliament.uk/commons/lib/research/rp99/rp99-014.pdf.

Japanese Banking Crisis
► Different from the Asian Financial Crisis in 1997, Japan’s financial
crisis had occurred over an extended time period, throughout the mid
to late 1990s, after experiencing significant drops in stock prices and
real estate prices at the beginning of the 1990s.
► Evergreening loans—no immediate and thorough responses.
– Even during the extended troubled time period, banks seemed to
continue to provide loans to the weakest firms at interest rates not
high enough to compensate the inherently high risks.1
1. Joe Peek and Eric S. Rosengren, “Unnatural Selection: Perverse Incentives and the Misallocation of Credit in Japan,”
6
American Economic Review 95, no. 4 (September 2005).

Growth in Residential Land Prices
1985-1998
Growth in Residential Land Prices
20%
15%
10%
5%
0%
-5%
1985 1987 1989 1991 1993 1995 1997
Amounts estimated based on visual appearance of original.
7
Akihiro Kanaya and David Woo, “The Japanese Banking Crisis of the 1990s: Sources and Lessons” (IMF working paper no. 00/7, 2000): Figure 1.

UK Secondary Banking Crisis in 1973-1974
► The UK experienced a severe crisis in the banking system in 1974
when a number of small banks specialized in the property sector
(secondary banks) failed and threatened the liquidity of the entire
banking system.
► Prevented a flood of sales of troubled assets through the “Lifeboat
Operation.”1
– Other financial institutions bought troubled assets from the
property companies.
– British property companies disposed of more than £2 billion of
assets between 1974 and the early months of 1978, mainly to
the financial institutions.
1. Peter Scott, “The New Alchemy: Veblen’s Theory of Crisis and the 1974 British Property and Secondary Banking Crisis,”
8
Journal of Economic Issues 30, no. 1 (March 1996).

Swedish Banking Crisis
► Sweden experienced a surge in leverage and asset values in the
late 1980s and then experienced a significant devaluation of its
currency and large drops of asset values in 1992.
► Swift Responses by the government.
– Guarantee—not for equity.
– Even though there was no formal deposit insurance at that
time, the Swedish government announced that it guaranteed
the bankrupt bank’s obligations, except for its equity.
– Bad bank.
– The government founded a bad bank to buy the struggling
banks’ bad assets, and it also took over the bankrupt bank.
9

Increase in Housing Prices and Leverage
Index (1981 = 100) by assessed value and period Ratio
240 1.6
1.5
220 Home Prices
1.4
200
1.3
180
1.2
160
1.1
Price/Rent (right axis)
140 1.0
120 0.9
Rents
0.8
100
1981 1983 1985 1987 1989 1991 1993 1995
Percent Percent
14
–
1.4 Debt/Income
Interest Expenditure 12
–
1.3
to Disposable Income 10
–
1.2 8
–
(right axis)
– 6
1.1
– 4
1.0 – 2
0.9 – 0
– -2
0.8
Real After-Tax Lending Rate – -4
0.7 (right axis) – -6
0.6 – -8
1980 1984 1988 1992 1996
Amounts estimated based on visual appearance of original.
Note: The shaded bar marks the recession.
Sources: Statistics Sweden; and the Riksbank.
O. Emre Ergungor, “On the Resolution of Financial Crises: The Swedish Experience” (Federal Reserve Bank of Cleveland
10
Policy Discussion Paper no. 21, June 2007): Figure s 1 and 2.

Stock Market Performance around the Crises
and Implications to Investors

Asian Financial Crisis: Stock Market Performance
Monthly: January 1990-September 2008
Monthly Stock Market Indices
4,000 KLCI
PCOMP
3,500
SET
KOSPI
3,000
JCI
2,500 SPX
2,000
1,500
1,000
500
0
Jan-90 Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08
Data provided by Bloomberg: Indonesia (JCI), Korea (KOSPI), Malaysia (KLCI), Philippines (PCOMP), Thailand (SET), and US (SPX).
Indices are not available for direct investment; its performance does not reflect the expenses associated with the management of an actual
12
portfolio. Past performance is no guarantee of future results.

Japanese Stock Market Performance
Daily: January 4, 1990-October 20, 2008
Japanese Nikkei 225 Index
40,000
35,000
30,000
25,000
20,000
15,000
10,000
5,000
0
Jan-90 Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08
Data provided by Bloomberg. Nikkei 225 is a price-weighted index of 225 top-rated Japanese companies listed in the First
Section of the Tokyo Stock Exchange.
Indices are not available for direct investment; its performance does not reflect the expenses associated with the management
13
of an actual portfolio. Past performance is no guarantee of future results.

UK Stock Market Performance
Monthly: January 1970-September 2008
UK and US Stock Market Performance
4,000
FTSE All-Share Index
3,500 S&P 500 Index
3,000
2,500
2,000
1,500
1,000
500
0
Jan-70 Jan-74 Jan-78 Jan-82 Jan-86 Jan-90 Jan-94 Jan-98 Jan-02 Jan-06
Data provided by Bloomberg. The indices are in local currencies.
Indices are not available for direct investment; its performance does not reflect the expenses associated with the
14
management of an actual portfolio. Past performance is no guarantee of future results.

Swedish Stock Market Performance
Monthly: January 1985-September 2008
Swedish Monthly Index (SAX)
450
400
350
300
250
200
150
100
50
0
Jan-85 Jan-87 Jan-89 Jan-91 Jan-93 Jan-95 Jan-97 Jan-99 Jan-01 Jan-03 Jan-05 Jan-07
Data provided by Bloomberg. SAX is the OMX Stockholm All-Share Index (price-only).
Indices are not available for direct investment; its performance does not reflect the expenses associated with the management of an actual
15
portfolio. Past performance is no guarantee of future results.

Annualized Holding Period Returns around the Asian
Financial Crisis—Market
Indonesia Korea Malaysia Philippines Thailand
Peak to Trough
7/30/97-10/7/98 6/17/97-9/23/98 7/2/97-9/1/98 7/18/97-9/11/98 7/29/97-9/11/98
-56.60% -54.39% -70.29% -53.74% -64.71%
Date Reached the Level at the Peak
1/5/04 4/27/99 12/5/06 10/25/06 12/15/03
Invest at Peak
-31.05% -6.25% -7.07% -6.54% -24.82%
One-Month
-32.28% -64.62% -56.32% -31.79% -60.82%
One-Year
-7.25% 2.54% -12.03% -0.67% -17.67%
Two-Year
-8.68% 0.82% -7.66% -15.09% -11.67%
Five-Year
12.38% 8.43% 2.30% 3.59% 2.41%
Ten-Year
Invest at Trough
32.99% 31.03% 42.19% 20.25% 37.52%
One-Month
121.19% 223.59% 191.99% 93.99% 102.59%
One-Year
25.95% 37.73% 74.19% 18.74% 18.26%
Two-Year
18.28% 19.63% 23.15% 3.62% 21.40%
Five-Year
20.01% 17.47% 15.41% 9.61% 11.92%
Ten-Year
All returns are annualized except for one-month return and the return from peak to trough. Returns are calculated based on the
index of each country used. Data provided by Bloomberg. The Bloomberg symbols of indices used for Asian countries are JCI
(Indonesia), KOSPI (Korea), KLCI (Malaysia), PCOMP (the Philippines), and SET (Thailand). \"Indices are not available for direct
16
investment; its performance does not reflect the expenses associated with the management of an actual portfolio. Past
performance is no guarantee of future results.\"

Annualized Holding Period Returns—Market
1994-1995 Japan 1997-1999 Japan UK Sweden
Peak to Trough
12/29/94-6/29/95 6/16/97-10/9/98 10/29/73-1/6/75 5/21/92-10/5/92
-26.23% -34.50% -59.95% -35.13%
Date Reached the Level at the Peak
12/25/95 3/29/00 10/23/75 2/26/93
Invest at Peak
-7.94% -2.96% -9.44% -7.02%
One-Month
1.06% -28.32% -50.38% 7.63%
One-Year
-0.76% -8.60% 1.08% 24.48%
Two-Year
-0.91% -12.00% 12.74% 23.24%
Five-Year
-5.29% -1.39% 16.80% 13.91%
Ten-Year
17.53%
Thirty-Year
Invest at Trough
14.77% 9.64% 53.34% 13.12%
One-Month
55.50% 40.23% 166.62% 99.60%
One-Year
19.00% 11.49% 63.63% 47.20%
Two-Year
3.67% -3.93% 38.50% 38.51%
Five-Year
-2.29% -3.31% 32.26% 13.62%
Ten-Year
18.19%
Thirty-Year
All returns are annualized except for one-month return and the return from peak to trough.
Returns are calculated based on the index of each country used. Data provided by Bloomberg except for the UK data, which were provided by Elroy
Dimson, Paul Marsh, and Mike Staunton, Triumph of the Optimists: 101 Years of Global Investment Returns (Princeton, NJ: Princeton University
Press, 2002). For Japan, the Nikkei 225 was used and for the UK, the daily UK Market Index return, including dividends, was used up to December
17
2006 and the FTSE All-Share Index thereafter. For Sweden, the OMX Stockholm All-Share Index (price-only) was used. \"Indices are not available for
direct investment; its performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is no
guarantee of future results.\"

Conclusion

What Did We Learn?
► Common pattern.
– Increase in asset values and leverage before the crises.
– Significant drop in asset values around the crises.
– Financial institutions that provided capital to the suffering sectors got
into problems, negatively affecting broad areas of the economy.
– Very high stock market returns within a short period of time once the
recovery started.
► The time to recover varies—hard to predict the trough in advance.
19

Lessons
What do the lessons we learned from the past financial turmoil
and basic investment principles tell us?
► You can expect to earn higher returns only if you take higher risks.
► Risk premiums are higher when things are not going well.
► Investment decisions should be made on a forward-looking basis, not a
backward-looking basis.
► Itis almost impossible to predict when the market will start to recover, and
the short-term return from the trough has the potential to be very high.
– By closing an equity position after experiencing a huge drop in equity
values, an investor is very likely to give up an opportunity to earn high
returns when the market starts to recover.
– Short-term traders would correctly time the market recovery only by
chance.
20

What Can We Learn from the
Past Financial Turmoil?
\"Indices are not available for direct investment; its performance does not reflect the expenses associated with the
management of an actual portfolio. Past performance is no guarantee of future results.\"