Using our theoretical model of Chapter 3, we demonstrated in Chapter 4 that a drop in demand can move the economy from one equilibria (that is, structure of the business groups) to another, leading to a string of bankruptcies in the process. We argued that such a string of bankruptcies precipitated the financial crisis in Korea in 1997. In this appendix, we supplement that theoretical demonstration with two empirical arguments related to the financing of the business groups in Korea. While these arguments fall outside the narrow confines of our Walrasian model, they nevertheless offer insight into the sources of the crisis there.

First, we argue that the bankruptcies before November 17, 1997, are predicted well by the excessively high debt/equity ratios of the groups. In contrast, the bankruptcies after November 17 cannot be explained by the overall debt/equity ratios, but rather, by the excessively high levels of short-term debt of these groups. In other words, the bankruptcies before November 17 show every indication that the capital market was working as it should, whereas the bankruptcies after November 17 show the characteristics of a financial panic, in which banks are not willing to roll over short-term loans regardless of the performance of their debtors.

Second, we explain how the interaction between the bankruptcies of chaebol and the precarious structure of the financial system combined to create the financial crisis during the last quarter of 1997.