Crisis Resolution: Further Urgent Measures Needed

The root cause lies in US residential mortgages. Too many Americans were encouraged or enticed to take on higher levels of debt on their houses than they could afford. When high oil prices and inflation eroded their income, they found it difficult to keep up their monthly payments. And when home-owners defaulted, it started two chain reactions.

First, the prices of derivative securities backed by mortgages plunged, leading to insolvent financial institutions, fear of bank failure, deposit runs, the interbank market seizing up, and banks holding back credit for new projects. And because financial markets around the globe are interconnected, this affected banks everywhere. Lack of confidence also spilled into capital markets, resulting in losses to both retirement savings and consumer confidence.

Secondly, but much more important, mortgages have to be foreclosed and home-owners thrown out (thus leaving empty houses and a negative affect on the neighbourhood). Foreclosed houses have to be auctioned off, leading to a house price decline. House price decline results in negative equity in mortgages, and hence feeds back into a fear of non-performing mortgages.

House price decline is also the most important factor that affects consumer spending, leading to lower demand for emerging-market exports worldwide, then lower prices for assets everywhere. It all translates to a hard landing for the whole world.

When Thailand went through the 1997 Asian Crisis, we took measures to strengthen the financial institutions. The government then guaranteed bank deposits as well as their debts. Banks had their capital reduced and replenished. But even after they had been strengthened, banks still could not lend new money because the financial health of their corporate customers was still weak.

The root cause of the Thai crisis was over-investment by businesses. Non-performing-loan companies were therefore the weak link, causing a lack of confidence.

The Thai government solved the problem by setting up Thai Asset Management Corporation. TAMC restructured NPLs by rescheduling payment dates to suit the debtors' cash flow. Basically, the reschedule was done to match the debtors' ability to pay, with conditions for them to pay more should their actual cash flow be better than forecast. This enabled the NPL companies to obtain new trade credits and new working capital. They resumed their operations and retained their employees.

The economy would not have recovered otherwise.

The lesson is that a comprehensive crisis resolution must address the problem at the root cause. In the case of Thailand, it was the NPL companies that experienced cash flow problems because they over-invested and over diversified. In the case of the USA, it is the residential mortgages.

In this crisis, therefore, all efforts must be made to stop the first domino from falling, the residential mortgages - and only the US government can do it.

I propose that the US government consider the following measures as a new deal for homeowners:

1. Allow maturity of mortgages to be extended, by at least double, for up to 50 or 60 years. This will not affect the rate of interest but will lessen the monthly payment amounts. It will enable homeowners to continue to service their mortgages, stay in their homes and retain ownership. In Japan, mortgage repayment over two generations of father and son is not uncommon.

2. Guarantee, partially or wholly, mortgages below a certain value. This can be restricted only to houses occupied by owners, to avoid supporting speculative purchases, and only for loans incurred in the past, to avoid future moral hazard.

All this, I believe, will result in much less actual government cash outlay than the total mortgage values. Actually, the mere announcement of the new deal will shore up confidence more than any of the previous measures announced.

I fear for the emerging Asian economies. A lot of hope is pinned on us to carry the weight of world growth next year. But too many of us have been weakened by domestic political fights. And too many of us are still disproportionately dependent on export manufacturing.

But we can carry the weight of world growth. We can do so if, and only if, a comprehensive package of financial crisis resolution measures is undertaken - by the country that matters.

(Thirachai Phuvanatnaranubala, who is the secretary-general of the Thailand Securities and Exchange Commission, has sent this article to the Obama administration.)