Financial convulsions triggered by Legoland

Korea’s fiscal, financial and monetary authorities have joined forces to stabilize the fluctuating capital market. Deputy Prime Minister and Finance Minister Choo Kyung-ho, Bank of Korea Gov. Rhee Chang-yong, and Financial Services Commission Chairman Kim Joo-hyun held an emergency meeting on Sunday to pump a minimum of 50 trillion won ($35 billion) into the bond market to ease the liquidity squeeze for Korean enterprises.

The relief fund will help mobilize the reserves in the bond market stabilization fund and state institutions like the Export-Import Bank of Korea and the Korea Development Bank. The Bank of Korea (BOK) will discuss emergency relief funds for commercial banks at the next monetary board meeting in November. The central bank will accept corporate bonds issued by those banks as collateral for immediate funding to them. The BOK had run the liquidity aid program for a year from March 2020 temporarily at the onset of the Covid-19 outbreak.

Due to a freeze in short- and longer-dated debt, even large companies have had trouble in raising new funds. A large company tried to issue its corporate bonds worth 150 billion won, but it gave up the plan after they were undersubscribed. Another company even had to borrow 500 billion won for three months from one of its sister companies after it could not raise immediate funding from the market.

The default by a public developer behind Legoland Korea for its asset-backed commercial papers (ABCP) worth 205 billion won ($142 million) worsened the debt market, which is already jittery over the unprecedentedly rapid rises in interest rates. A default of debt backed by a local government raised doubts about other Korean debt and project financing programs.

Smaller companies are in graver hardship. They are unable to issue their new corporate bonds even when they are offered at yields higher than 10 percent. On Friday, interest rates of insecure three-year corporate bonds of BBB- jumped to 11.59 percent, the highest since January 2010 in the wake of global financial crisis.

The uninterrupted hikes in base interest rates by U.S. and Korean central banks have already been battering the financing market. The Federal Reserve is expected to deliver another hike by 75 basis points early November. The Bank of Korea would have to match the galloping pace to some extent to prevent foreign capital from fleeing out of the country and help sustain the value of the Korean won.

The government and central bank have been jointly acting to bolster liquidity. But the Legoland-triggered liquidity crunch could be just the beginning. Investors should be liable for their losses.

Authorities must act to their utmost to prevent a financial risk from the liquidity crunch. They must prevent a chain bankruptcy of companies due to short-term liquidity woes.