Bank of America's second largest investor, Korea Investment Corp, announced in early July that it plans to maintain its US$800 million stake in the US bank. The chief investment officer of the $30 billion Korean sovereign wealth fund (SWF) stated: "Right now, the best option is to be holding this. We do believe the US economy will recover and we think Bank of America shares will recover along with the economy."
Beyond the investment-speak of the KIC official, the significance of the SWF's action reflects a changing face of global power. The financial panic of 2007-08 and the ensuing great recession have leveled the playing field in the global financial arena. The big question is whether Asian institutions are willing to step up into a leadership role in global finance.
Finance has probably been the most globalized of all economic sectors, functioning as a critical transactional lubricant for individuals, companies and governments. In many ways it has become the commanding heights of the global economy. Up until the first decade of the 21st century, Western financial institutions dominated the economic landscape. While Singapore had its own set of SWFs (Temasek Holdings and GICS) and Japan boosted of some of the world's largest banks in terms of asset size, Western banks provided the heavy financial muscle, pushed along by hard-boiled business cultures structured around cutting-edge technology, product innovation and profit motivation.
This was supported by a blind faith in in the self-correcting nature of free markets, minimalist supervision, and quantitative modeling. The result was a period of financial products that were complex, heavily leveraged, and sold around the world to investors hard-pressed to find yield.
But the landscape was already changing in the period following the global economic slowdown in 2001-02. A sustained period of economic growth and a commodities boom (2002-08) poured considerable capital into the foreign exchange reserves of a number of Asian countries, such as China, South Korea, India, and Singapore. In turn, these countries were forced to reconsider their past investment strategies, the institutions mandated for investment, and the long-term consequences of investment patterns. While the relationship with Western banks would remain comfortable, local talent existed that was increasingly of the same caliber. Moreover, the newly formed SWFs could afford to lure away talent form the investment banks.
The major tectonic shock hit in 2007-09 when the Western financial universe melted down. Longstanding financial brand-names such as Lehman Brothers, Bear Stearns and Merrill Lynch disappeared - either into bankruptcy or merged into other institutions. Longstanding "safe harbors" for investment, such Fannie Mae and Freddie Mac, were proven to be highly risky and their future status unclear. Moreover, this carnage was not limited to the United States as the United Kingdom saw its first bank run since the Great Depression, a number of major European banks threatened to fail and were only saved by government intervention, and the massive pumping of loans into Eastern Europe threatened to turn into a sea of defaults.
Since 2007, the losses from the sub-prime disaster and related credit messes have largely hit US and European financial institutions. According to Bloomberg, US financial institutions account for close to $1 trillion in losses and their European counterparts close to $500 billion. In sharp contrast, Asian financial institutions have lost around $40 billion. This situation has been reflected in the US and Europe by failures, government bailouts, and a number of quarters of less than stellar earnings.
Asian banks largely sidestepped the sub-prime derivative time bombs. Despite the upheaval in global markets, they were generally well capitalized, had relatively stringent loan underwriting, and were not plagued by a downturn in housing markets. Many Asian bank managers remember the 1997-98 financial crisis that witnessed widespread bank failures in Korea, Indonesia and Thailand. Although there has been negative fallout from the economic slowdown in 2008 and 2009, there has not been the same rash of bank failures. Indeed, banks in China, India and Korea have been playing an important role in providing credit and help reactivate regional economic growth.
Asian financial institutions are well-placed to take advantage of the bruised and battered state of Western finance. SWFs from Korea, China, and Singapore still have considerable cash and Western assets are still cheap on a historical basis. It is also important to note that China is the largest holder of US Treasury debt, with $801.5 billion as of May 2009, followed by Japan at $677.2 billion. Chinese apprehension over US creditworthiness prompted a visit by to Beijing by US Treasury Secretary Timothy Geithner in June, where the message was that Washington is committed to the repayment of its debt, has a responsible approach to the economy, and will maintain the sovereign ratings of AAA (critically important for bondholders).
The new financial landscape is more suited for Asian financial institutions. The current global financial supervisory regime clearly favors plain vanilla financial products, a sparse use of leverage, and far less risk. Indeed, public sentiment in much of the West leans toward the development of banking systems that function more like public utilities - banks are to be institutions where the public can safely deposit their money, can earn a little interest, and are able to borrow (only after proper due diligence screens borrowers). Needless to say, many in the Western financial sector are opposed to this because a public-utility approach limits upside in terms of profits and compensation.
The battle over what banks should be allowed to do is one of the core issues in the US, UK and a number of European countries. Even in the US, the traditional bastion of free-market orthodoxy, the government now has ownership of a number of major banks (such as Citigroup and Bank of America), is a major supplier of credit, and is considering a much more heavy-handed regulatory regime. The message is clear: Western banks stumbled and the state is intervening to clean up the mess, a process that is likely to take years and will function as a drag on the economy. It also substantially reduces Western economic clout around the world and leaves the door open to other potential financial leaders, such as Asian banks and SWFs.
Asian financial institutions in the aftermath of the financial panic of 2007-08 have emerged with considerably more influence than before, remain very much at the center of national development for countries like Japan, China, India, Korea and Singapore, and are one pillar of global recovery. They also must deal with the pressing need to change Asia's overarching export-driven development model.
In this, banks have often functioned (to varying degrees) as an adjunct of government economic policy. In the past, this was referred to as guided finance - sparse credit in developing economies guided by the state from the banks to a sector regarded as likely for success. While there has been a move away from this, banks often play a role that is not terribly removed from guided financing, especially in China.
The old trans-Pacific economy functioned on Asian exports being bought by American consumers, who borrowed from Asian savers. At the same time, the US functioned as a safe harbor for Asian export profits, a system in which Western banks functioned as facilitators finding the right things in which to invest. While this system worked for over three decades in elevating Asian standards of living and building up foreign exchange reserves to record levels, it left a trail of macroeconomic imbalances in the global economy, two of the most glaring of which were the levering of the US consumer and the string of US current account imbalances.
The financial panic and great recession are bringing this system to an end, a development that is poising a challenge for Asian economies. Moody's, in its Asia Banking Outlook 2009 (June 2009), noted that another "significant uncertainty is whether the recent surge in wealth across Asia can generate sufficient levels of consumption to compensate for the lower demand from the US and other developed economies, traditionally the significant buyers of Asia's goods."
What replaces the old system must be one that is more balanced. This translates into a different economic landscape for Asian financial institutions. In the short term, they must remain supportive of the West, via purchases of US Treasuries (needed to finance the economic recovery, or so we hope), but over the long term they must be more global in investing and more supportive of the development of local capital markets, critical for the deepening of domestic markets.
This could also mean a more competitive environment, which reduces the barriers to entry in banking. None of this is easy, and if the track record of other countries in financial experimentation is any indicator, there are some pretty dangerous downsides. Japanese financial institutions made a major excursion into global markets in the late 1980s, a venture that ended in huge losses and a lengthy crisis in the Japanese economy. It also left an aversion to stepping out too far in terms of financial innovation and risk.
The recent global financial crisis is changing the landscape. Although it is questionable whether Japanese banks are willing to seek a more substantial role, Chinese and Indian and perhaps Singaporean and Korean banks and financial institutions could take up the challenge, especially as their countries are on the rise. No doubt we will look back on the 2007-09 period as a crack in time, when one age came to an end and another began. The mystery will be whether Asia let the moment pass in addressing the need to change the economic model and the role of its financial institutions.
If change is embraced Asia's economic and political convergence with the West will be accelerated; if not, the West will reinvent itself and long-sought parity between East and West will be frustratingly slower.
Scott B MacDonald is the Head of Credit and Economic Research at Aladdin Capital Management, LLC, in Stamford, Connecticut and is writing a book on globalization and Asia.
Beyond the investment-speak of the KIC official, the significance of the SWF's action reflects a changing face of global power. The financial panic of 2007-08 and the ensuing great recession have leveled the playing field in the global financial arena. The big question is whether Asian institutions are willing to step up into a leadership role in global finance.
Finance has probably been the most globalized of all economic sectors, functioning as a critical transactional lubricant for individuals, companies and governments. In many ways it has become the commanding heights of the global economy. Up until the first decade of the 21st century, Western financial institutions dominated the economic landscape. While Singapore had its own set of SWFs (Temasek Holdings and GICS) and Japan boosted of some of the world's largest banks in terms of asset size, Western banks provided the heavy financial muscle, pushed along by hard-boiled business cultures structured around cutting-edge technology, product innovation and profit motivation.
This was supported by a blind faith in in the self-correcting nature of free markets, minimalist supervision, and quantitative modeling. The result was a period of financial products that were complex, heavily leveraged, and sold around the world to investors hard-pressed to find yield.
But the landscape was already changing in the period following the global economic slowdown in 2001-02. A sustained period of economic growth and a commodities boom (2002-08) poured considerable capital into the foreign exchange reserves of a number of Asian countries, such as China, South Korea, India, and Singapore. In turn, these countries were forced to reconsider their past investment strategies, the institutions mandated for investment, and the long-term consequences of investment patterns. While the relationship with Western banks would remain comfortable, local talent existed that was increasingly of the same caliber. Moreover, the newly formed SWFs could afford to lure away talent form the investment banks.
The major tectonic shock hit in 2007-09 when the Western financial universe melted down. Longstanding financial brand-names such as Lehman Brothers, Bear Stearns and Merrill Lynch disappeared - either into bankruptcy or merged into other institutions. Longstanding "safe harbors" for investment, such Fannie Mae and Freddie Mac, were proven to be highly risky and their future status unclear. Moreover, this carnage was not limited to the United States as the United Kingdom saw its first bank run since the Great Depression, a number of major European banks threatened to fail and were only saved by government intervention, and the massive pumping of loans into Eastern Europe threatened to turn into a sea of defaults.
Since 2007, the losses from the sub-prime disaster and related credit messes have largely hit US and European financial institutions. According to Bloomberg, US financial institutions account for close to $1 trillion in losses and their European counterparts close to $500 billion. In sharp contrast, Asian financial institutions have lost around $40 billion. This situation has been reflected in the US and Europe by failures, government bailouts, and a number of quarters of less than stellar earnings.
Asian banks largely sidestepped the sub-prime derivative time bombs. Despite the upheaval in global markets, they were generally well capitalized, had relatively stringent loan underwriting, and were not plagued by a downturn in housing markets. Many Asian bank managers remember the 1997-98 financial crisis that witnessed widespread bank failures in Korea, Indonesia and Thailand. Although there has been negative fallout from the economic slowdown in 2008 and 2009, there has not been the same rash of bank failures. Indeed, banks in China, India and Korea have been playing an important role in providing credit and help reactivate regional economic growth.
Asian financial institutions are well-placed to take advantage of the bruised and battered state of Western finance. SWFs from Korea, China, and Singapore still have considerable cash and Western assets are still cheap on a historical basis. It is also important to note that China is the largest holder of US Treasury debt, with $801.5 billion as of May 2009, followed by Japan at $677.2 billion. Chinese apprehension over US creditworthiness prompted a visit by to Beijing by US Treasury Secretary Timothy Geithner in June, where the message was that Washington is committed to the repayment of its debt, has a responsible approach to the economy, and will maintain the sovereign ratings of AAA (critically important for bondholders).
The new financial landscape is more suited for Asian financial institutions. The current global financial supervisory regime clearly favors plain vanilla financial products, a sparse use of leverage, and far less risk. Indeed, public sentiment in much of the West leans toward the development of banking systems that function more like public utilities - banks are to be institutions where the public can safely deposit their money, can earn a little interest, and are able to borrow (only after proper due diligence screens borrowers). Needless to say, many in the Western financial sector are opposed to this because a public-utility approach limits upside in terms of profits and compensation.
The battle over what banks should be allowed to do is one of the core issues in the US, UK and a number of European countries. Even in the US, the traditional bastion of free-market orthodoxy, the government now has ownership of a number of major banks (such as Citigroup and Bank of America), is a major supplier of credit, and is considering a much more heavy-handed regulatory regime. The message is clear: Western banks stumbled and the state is intervening to clean up the mess, a process that is likely to take years and will function as a drag on the economy. It also substantially reduces Western economic clout around the world and leaves the door open to other potential financial leaders, such as Asian banks and SWFs.
Asian financial institutions in the aftermath of the financial panic of 2007-08 have emerged with considerably more influence than before, remain very much at the center of national development for countries like Japan, China, India, Korea and Singapore, and are one pillar of global recovery. They also must deal with the pressing need to change Asia's overarching export-driven development model.
In this, banks have often functioned (to varying degrees) as an adjunct of government economic policy. In the past, this was referred to as guided finance - sparse credit in developing economies guided by the state from the banks to a sector regarded as likely for success. While there has been a move away from this, banks often play a role that is not terribly removed from guided financing, especially in China.
The old trans-Pacific economy functioned on Asian exports being bought by American consumers, who borrowed from Asian savers. At the same time, the US functioned as a safe harbor for Asian export profits, a system in which Western banks functioned as facilitators finding the right things in which to invest. While this system worked for over three decades in elevating Asian standards of living and building up foreign exchange reserves to record levels, it left a trail of macroeconomic imbalances in the global economy, two of the most glaring of which were the levering of the US consumer and the string of US current account imbalances.
The financial panic and great recession are bringing this system to an end, a development that is poising a challenge for Asian economies. Moody's, in its Asia Banking Outlook 2009 (June 2009), noted that another "significant uncertainty is whether the recent surge in wealth across Asia can generate sufficient levels of consumption to compensate for the lower demand from the US and other developed economies, traditionally the significant buyers of Asia's goods."
What replaces the old system must be one that is more balanced. This translates into a different economic landscape for Asian financial institutions. In the short term, they must remain supportive of the West, via purchases of US Treasuries (needed to finance the economic recovery, or so we hope), but over the long term they must be more global in investing and more supportive of the development of local capital markets, critical for the deepening of domestic markets.
This could also mean a more competitive environment, which reduces the barriers to entry in banking. None of this is easy, and if the track record of other countries in financial experimentation is any indicator, there are some pretty dangerous downsides. Japanese financial institutions made a major excursion into global markets in the late 1980s, a venture that ended in huge losses and a lengthy crisis in the Japanese economy. It also left an aversion to stepping out too far in terms of financial innovation and risk.
The recent global financial crisis is changing the landscape. Although it is questionable whether Japanese banks are willing to seek a more substantial role, Chinese and Indian and perhaps Singaporean and Korean banks and financial institutions could take up the challenge, especially as their countries are on the rise. No doubt we will look back on the 2007-09 period as a crack in time, when one age came to an end and another began. The mystery will be whether Asia let the moment pass in addressing the need to change the economic model and the role of its financial institutions.
If change is embraced Asia's economic and political convergence with the West will be accelerated; if not, the West will reinvent itself and long-sought parity between East and West will be frustratingly slower.
Scott B MacDonald is the Head of Credit and Economic Research at Aladdin Capital Management, LLC, in Stamford, Connecticut and is writing a book on globalization and Asia.
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