Learning from Lehman

HONG KONG – When the US investment bank Lehman Brothers collapsed five years ago, emerging-market economies did not hold many of the toxic financial assets – mainly American subprime mortgages – that fueled the subsequent global financial crisis. But they were deeply affected by the drop in world trade, which recorded a peak-to-trough decline of at least 15%, with trade finance also contracting sharply, owing to a shortage of dollar liquidity. Have policymakers responded appropriately since then?

Soon after the crisis erupted, the G-20 countries embraced massive stimulus packages, unconventional monetary policies in the advanced economies, and major institutional efforts, such as the Dodd-Frank financial-reform legislation in the United States and the Basel III initiative to strengthen banking standards. China’s ¥4 trillion stimulus package, unveiled in November 2008, restored confidence in global commodity markets. Led by strong Chinese growth, emerging markets stabilized.

Since 2009, quantitative easing (QE) by the US Federal Reserve has resulted in record-low interest rates around the world. But, while the resulting surge in capital flows to emerging markets stimulated economic growth, it also inflated asset bubbles.

Now, with the Fed publicly considering an end to its massive, open-ended purchases of long-term securities and foreign capital fleeing home from emerging markets, many fear that Asia’s economies could come crashing down, as they did in the late 1990’s. Leverage in some emerging markets’ household and corporate sectors has reached record levels. China’s annual economic growth has slowed to around 7.5%, while Indonesia and India – and, outside Asia, Brazil and South Africa – are experiencing sharp downward pressure on their exchange rates.