In the last few weeks, movement in the US stock market has been driven more by news about the fate of the economy rather than the monetary easing from the Federal Reserves(Fed).

It is a sign that the market finally realizes that the economy could suffer a deeper credit crunch, rather than just liquidity problems, which are a confidence issue.

If history is helpful in predicting the future, the Asian Financial Crisis (the last credit crisis) could give us some indication of how long or how deep the current market weakness could be.

Indeed, the events of the recent US credit crisis are strikingly similar to the Asian Financial Crisis stemming from easy credit. In Asia, short-term foreign capital was pumped into emerging Asian economies seeking higher yields. In the US, extremely loose monetary policies after the technology bubble in the early 2000s led to an increase in loans to borrowers with bad credit history. In both cases, easy credit had indeed created asset bubbles.

When the Asian bubble burst, the price of property collapsed, the market turned illiquid. It resulted in a massive non-performing loan (NPL) floating in the market. Banks in Asia could not find buyers for their NPLs or the collateral in their portfolios. Hence, there was no way of valuing the assets held by the banks as collateral. In effect, there was no way of knowing the extent of their losses, and Asian banks suffered massive write-downs in their capital.

Since it was not easy to raise capital compared to developed countries, most Asian banks had to carry the NPLs in their books for several years.

Furthermore, banks became totally risk averse after the Asian crisis. Thus, the banks' collective reluctance to lend became a barrier to the economy's growth, and the banks failed to act as financial intermediaries in their basic function in the economy. At the time, in order to deal with the impaired assets which were sold at deep discounts, it was the US investment firms who came to rescue the Asian markets.

The Asian crisis showed how a weak banking system can damage the economy as a whole.

Given the lessons of the past, it seems that the US market is showing a similar pattern and heading in the same direction. A US recession seems inevitable.

But on the stock-market level, most Asian markets declined for a year (from their peak) before bottoming out in the summer of 1998. Meanwhile, the US subprime issues began to unfold in July 2007, and the market peaked in October 2007. It could take another nine months before all the bad news is discounted.

Given a better capital market than Asia, aggressive rate cuts from the Fed and foreign capital inflow to the financial sector, there could be a quicker turnaround and the bottom in the US market may be nearing soon.

The author is a director with Convoy Asset Management Limited.

(HK Edition 02/19/2008 page3)