Great Depression Online Archive Issue:

International Contagion

Great Depression Online
Long Beach, CA
February 19, 2008

Inside This Issue You Will Discover…

*** A Global Loss of $7.7 Trillion
*** International Contagion
*** The Transmission
*** And More

A Global Loss of $7.7 Trillion

Joseph Quinlan, chief market strategist at Bank of America, did the research.  And what he discovered was a $7.7 trillion international credit crisis.

Writing for gurufocus.com on February 15th, Andrew Abraham gives the details… 

“According to the report the meltdown in the U.S. sub-prime real estate market has led to a global loss of $7.7 trillion dollars in stock market value since October.”

Here we’ll pause, as we often do, to gawk at the mammoth loss – $7.7 trillion or $7,700,000,000,000 – poof…gone.

“Quoting Bank of America chief market strategist Joseph Quinlan , ‘The crisis, which has spread beyond US shores to banks and other sectors worldwide, is ‘one of the most vicious in financial history.”

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Quinlan’s report also “…states that the losses are worse than any in the past few decades, including Wall Street’s Black Monday of 1987, the 1999 Brazilian real currency crisis and the collapse of hedge fund Long Term Capital Management (LTCM) in 1998.”

International Contagion

So what started as a U.S. sub-prime mortgage meltdown has spread the world over.  And it has done so in rapid succession.

In fact, we dug up a Reuters story from August of 2007 to show how far and how fast things have changed.

“Treasury Secretary Henry Paulson said on Wednesday,” as reported by David Lawder on August 1, 2007, “the repricing of credit risk was hitting financial markets, but U.S. sub-prime mortgage fallout remained largely contained due to the strongest global economy in decades.”

We know hindsight is easy, opposed to foresight, but could Paulson have been more wrong?

For edification on the market dynamic that spreads a national financial crisis into an international financial crisis, we’ll look to Charles Kinderberger, and quote from his masterwork: Manias, Panics, and Crashes: A History of Financial Crises.

“Boom, distress, and panic are transmitted between national economies through a variety of connections: arbitrage in commodities or securities (and marking up or down prices in one market when they change in another, without actually buying and selling), movement of money in various forms, specie, bank deposits, bills of exchange, interest rates changed through uncovered arbitrage, cooperation among monetary authorities, and, readily neglected, pure psychology.”

The Transmission Device

Here we had Wall Street wizards, slicing up mortgages and repackaging the debt as securities that were sold to investors throughout the world.

We don’t entirely understand the complexities behind this structured debt fiasco, but we don’t feel so bad because most of Wall Street doesn’t understand the complexities either…and they created them.

Yet we won’t let our ignorance stop us.  Here’s our layman understanding…

These collateralized debt obligations (CDOs) were comprised of many mortgages of many grades.  For example, one CDO could contain a mix of loans – some to borrowers with excellent credit and some to borrowers with sub-prime credit.  The purpose of these structured investments was to spread risk and offer a higher return, based on risk pricing models.

But now that mortgages (i.e. the collateral) are going into foreclosure and the assets supporting them (i.e. house prices) are dropping, the presumed value (i.e. the modeled price) of these investments are uncertain.

Lenders throughout the world who accepted CDOs as collateral want out, but because they’re comprised of varieties of dubious mortgages, no one knows what they’re now worth.  Subsequently, there are no new buyers.

The result: An international credit crisis of $7.7 trillion…“one of the most vicious in financial history.”

Sincerely,

M.N. Gordon
Great Depression Online

P.S.  If you don’t have a copy Charles Kinderberger classic: Manias, Panics, and Crashes: A History of Financial Crises, you can pick up a copy here: Manias, Panics, and Crashes: A History of Financial Crises.

 

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