Sunday, March 01, 2009

International Financial Crisis

In the second week of September 2008, the international banking system staggered an almost collapsed after Lehman Brothers went into bankruptcy. Bankers and governments managed to keep the system from going under, but four four major problems still haunt the clever people of the world.

1. Sub-prime Crisis
The collapse of the housing bubble has caused enormous problems for banks. This is often referred to as the subprime crisis, but the problem goes far beyond subprime sectors. Defaults have increased among all borrowers and the shocks have spread to financial institutions throughout America and Europe due to the wide spread securitisation of mortgages.

2. Eastern Europe
European banks are heavily exposed in Eastern Europe. They have fund a housing bubble in these countries, but now with house prices falling and their currencies collapsing, many will be unable to repay their loans. Ambrose Evans-Pritchard at the UK Telegraph tends to be overdramatic, but he provides a good description of the problem.

Western banks that have lent $1.74 trillion to the ex-Soviet bloc -- split between $1 trillion in foreign loans and $700bn in local currency debt through subsidiaries,
3. Synthetic CDOs
A huge problem that has not yet surfaced is synthetic CDOs. These complex financial instruments have been clearly described by Alan Kohler at the Business Spectator. He suggests that that $0.5 trillion of these could be out standing. The sting in the tail is that if eight or nine major named financial institution collapse (five or six have already gone), the holders of these securities will lose their money. This might prove to be a worse problem than the subprime debacle.

4. Private Equity
Over the large decade private equity firms undertook a huge number of leveraged buyouts. The private equity model minimises equity and maximise debt. This has left banks with huge exposure to businesses that are declining in value as their profits collapse. These chickens have still no come home to roost, so the banks are uncertain what their liabilities will be. This is one reason why they are holding extra reserves.

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