However, the violence of the responses to what seemed to be relatively mild imbalances in Southeast Asia in 1997 and throughout the global economy in August and September of 1998 has illustrated yet again that the adjustments in asset markets can be discontinuous, especially when investors hold highly leveraged positions and when views about long-term equilibria are not firmly held. Enough investors usually adopt strategies that take account of longer-run tendencies to foster the propensity for convergence toward equilibrium. But from time to time, this process has broken down as investors suffer an abrupt collapse of comprehension of, and confidence in, future economic events. It is almost as though, like a dam under mounting water pressure, confidence appears normal until the moment it is breached. Risk aversion in such an instance rises dramatically, and deliberate trading strategies are replaced by rising fear-induced disengagement.
Yield spreads on relatively risky assets widen dramatically.
History tells us that sharp reversals in confidence happen abruptly, most often with little advance notice. These reversals can be self-reinforcing processes that can compress sizable adjustments into a very short time period. Panic market reactions are characterized by dramatic shifts in behavior to minimize short-term losses. Claims on far-distant future values are discounted to insignificance. What is so intriguing is that this type of behavior has characterized human interaction with little appreciable difference over the generations.