Thai Bhat Crisis of 1997

Since it's in the news and had major impacts on our markets in the past (think Vic Niederhoffer), I found a good summary of the events that created a huge market drop in July of 1997:

"Imagine for a moment that you are a Thai banker. You borrow $1 million dollars (at, say, 10 percent interest) and convert this sum into 25 million Baht, which you expect to lend in Thailand for an interest rate of 15 percent.With the Thai government's exchange rate promise in force, this appears to be a good deal for everyone. The US lender gets 10 percent interest. The Thai borrower gets access to funds for business investment that might not be available if you didn't borrow abroad. And you stand to gain the difference between the 15 percent interest you will collect and the 10 percent interest you owe. If everything works out as planned, you stand to collect $50,000 on this deal (5% of $1 million) from the difference in interest rates. Very nice, don't you think.

However, the biggest impacts were in the financial sectors and to see this you need to think about yourself as a Thai banker again. Recall that great investment you made just a few paragraphs ago. You borrowed $1 million at 10 percent interest in the US, which you converted into 25 million Baht. You lent the Baht in Thailand at 15 percent interest. Your reward? The difference between the two interest rates, or about $50,000 per year. Not bad for a few hours' work, eh?But this profit was based on your assumption that the government would honor its pledge to keep the exchange rate fixed at 25 Baht per dollars. Here's where you stand after the currency crisis.You borrowed $1 million and you lent 25 million Baht. If your loan is repaid on time and with all the 15 percent interest you are due, you should get back about 28,750,000 Baht. At the post-crisis exchange rate of 50 Baht per dollar, this sum is worth only $575,000 -- much less than the $1 million you borrowed.You are bankrupt.
You owe $1 million and you have no prospects to repay it. Although you have made good business decisions -- perhaps you have lent the money efficiently and will get repaid in full and on time (in Baht) -- you cannot possible repay your US dollar loan because to do so requires twice as much Baht as you expected.
You are bankrupt (deep in debt beyond your means to repay), but because you are a banker this problem affects many more people than you. Your depositors will become concerned about their funds and may stage a run on the bank. You will be less able to give new loans to Thai borrowers. You may have to call in existing loans, forcing current borrowers to liquidate their investments, perhaps even forcing them into bankruptcy."

~source International Political Economy