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As the fallout from the U.S. subprime mortgage crisis widens, experts warn that Korean banks are under threat of foreign currency losses from their investment in bonds issued by American mortgage lenders Fannie Mae and Freddie Mac. If those two lenders go belly-up, requiring an injection of government aid and prompting shareholders and creditor banks to share the financial burden, their stocks will plummet and the bonds they issued will also be classified as junk.
At present, an estimated $40 billion, or 16 percent of Korea¡¯s total dollar reserves of $247.5 billion, are invested in bonds issued by those two mortgage lenders. A Bank of Korea official says the chances of losses are ¡°minimal,¡± but nobody can be sure.
Originally, the subprime mortgage crisis appeared to be calming after reaching critical level in spring. But the fallout has begun spreading recently even to the prime mortgage market. That has driven Fannie Mae shares down 23 percent, while Freddie Mac stocks have dropped 30 percent over the last two days.
Foreign currency reserves are assets the Bank of Korea holds in order to deal with a sudden exodus of short-term investment or to repay debts overseas. Foreign currency reserves are the last option Korea has to defend its economy from an emergency such as the Asian financial crisis in late 1997. It is a problem if this important reserve is wasted on unwise investments rather than being expanded through savvy financial decisions.
Moreover, in July, the Korean government attempted the difficult task of defending the won and depleted the foreign reserves by over $10 billion. While this was happening, Korea¡¯s short-term debt, maturing in less than a year, swelled to over $215.6 billion. That¡¯s more than 87 percent of Korea¡¯s total foreign reserve volume.
Since we opened our capital markets, our economy stands fully exposed to each international financial crisis. If we are to avert a second Asian financial crisis, we need to study the best ways to manage our foreign reserves.
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