Posted by: Dark Defender | October 26, 2008

More dominoes set to fall?

In the last month we’ve seen the credit crisis spread from the US, to Europe to Asia. 

Now it seems contagion is set to hit the developing world in earnest.

On Friday Megan McArdle noted that export driven Asia and oil exporters were beginning to take real heat.

Today news has come out confirming the Gulf states aren’t as safe as they thought.  Some quotes:

KUWAIT CITY (AP) – Kuwait moved Sunday to prop up the country’s second-largest commercial bank and scrambled to protect depositors at other domestic banks, dashing hopes the oil-rich Arab Gulf would emerge largely unscathed from the global financial crisis.

The central bank halted trading in Gulf Bank shares because of high derivatives losses, just a day after Gulf finance ministers said the region’s banks were insulated against the liquidity crisis that has rippled through the global banking industry.

“The halting of Gulf Bank shares spread panic in the bourse today because the government has been saying banks are safe from (global financial crisis) losses,” investor Ahmed al-Fadhli said a telephone interview.

The Saudi stock exchange—the region’s largest—fell by 8.7 percent Saturday and is down more than 50 percent since January. Saudi’s benchmark Tadawulindex closed down about 1.6 percent Sunday, while the Dubai Financial Market sank 4.7 percent, and Qatar’s exchange closed down almost 9 percent. Kuwait’s exchange was down 3.5 percent at closing.

The losses tracked most other major world market indices, which saw declines Friday.

….

Because most of the region’s banking sector is privately held, little is known about the institutions’ true risk exposure.

The Gulf Bank news also appeared to have pushed the Kuwaiti government to take a step it has so far resisted—guaranteeing deposits. The country currently makes no deposit guarantees.

The central bank said it would propose an urgent bill to guarantee deposits at local Kuwaiti banks in an effort to “boost confidence in our banking sector.”

The bank woes and nervous market highlighted problems the oil-rich states may still confront as they try to sustain massive spending and high economic growth rates amid falling oil prices and bank uncertainty.

Gulf Bank said in a statement it had advised the central bank Thursday some customers had incurred losses stemming from “the significant decline” in the exchange rate of the euro against the U.S. dollar. Louis Myers, the bank’s chief executive, said the losses will “have no major effect on the soundness of the Bank’s financial position.”

Gulf countries had contended they are largely insulated from the global crisis, in part because of the financial cushion built during years of high oil prices.

In an emergency meeting Saturday, the six Gulf Cooperation Council ministers praised regulatory regimes they said protected them from the crisis.

But their draft agenda, obtained by reporters, said “unjustified fears” still could lead to a “hysteria” of bank runs in the Gulf. And, it voiced the very real fear that foreign investors may pull money from Gulf markets as developed countries’ growth slows.

The International Monetary Fund says many of the countries still could see GDP growth of about 6 percent on a regional average.

But the property boom that has underpinned a sizable chunk of the growth could take a significant hit.

Not good for them, I wonder if that IMF report figures in the massive decrease in oil prices? If not they could be in even more trouble than it appears.

Also it appears the EU has some big problems bubbling up in its own backyard:

The financial crisis spreading like wildfire across the former Soviet bloc threatens to set off a second and more dangerous banking crisis in Western Europe, tipping the whole Continent into a fully-fledged economic slump.

Currency pegs are being tested to destruction on the fringes of Europe’s monetary union in a traumatic upheaval that recalls the collapse of the Exchange Rate Mechanism in 1992.

“This is the biggest currency crisis the world has ever seen,” said Neil Mellor, a strategist at Bank of New York Mellon.

Experts fear the mayhem may soon trigger a chain reaction within the eurozoneitself. The risk is a surge in capital flight from Austria – the country, as it happens, that set off the global banking collapse of May 1931 when Credit-Anstalt went down – and from a string of Club Med countries that rely on foreign funding to cover huge current account deficits.

The latest data from the Bank for International Settlements shows that Western European banks hold almost all the exposure to the emerging market bubble, now busting with spectacular effect.

They account for three-quarters of the total $4.7 trillion £2.96 trillion) in cross-border bank loans to Eastern Europe, Latin America and emerging Asia extended during the global credit boom – a sum that vastly exceeds the scale of both the US sub-prime and Alt-A debacles.

Europe has already had its first foretaste of what this may mean. Iceland’s demise has left them nursing likely losses of $74bn (£47bn). The Germans have lost $22bn.

Stephen Jen, currency chief at Morgan Stanley, says the emerging market crash is a vastly underestimated risk. It threatens to become “the second epicentre of the global financial crisis”, this time unfolding in Europe rather than America.

Austria’s bank exposure to emerging markets is equal to 85pc of GDP – with a heavy concentration in Hungary, Ukraine, and Serbia – all now queuing up (with Belarus) for rescue packages from the International Monetary Fund.

Exposure is 50pc of GDP for Switzerland, 25pc for Sweden, 24pc for the UK, and 23pc for Spain. The US figure is just 4pc. America is the staid old lady in this drama.

Amazingly, Spanish banks alone have lent $316bn to Latin America, almost twice the lending by all US banks combined ($172bn) to what was once the US backyard. Hence the growing doubts about the health of Spain’s financial system – already under stress from its own property crash – as Argentina spirals towards another default, and Brazil’s currency, bonds and stocks all go into freefall.

Broadly speaking, the US and Japan sat out the emerging market credit boom. The lending spree has been a European play – often using dollar balance sheets, adding another ugly twist as global “deleveraging” causes the dollar to rocket. Nowhere has this been more extreme than in the ex-Soviet bloc.

Hungary stunned the markets by raising rates 3pc to 11.5pc in a last-ditch attempt to defend the forint’s currency peg in the ERM.

It is just blood in the water for hedge funds sharks, eyeing a long line of currency kills. “The economy is not strong enough to take it, so you know it is unsustainable,” said Simon Derrick, currency strategist at the Bank of New York Mellon.

Romania raised its overnight lending to 900pcto stem capitalflight, recalling the near-crazed gestures by Scandinavia’s central banks in the final days of the 1992 ERM crisis – political moves that turned the Nordic banking crisis into a disaster.

Russia too is in the eye of the storm, despite its energy wealth – or because of it. The cost of insuring Russian sovereign debt through credit default swaps (CDS) surged to 1,200 basis points last week, higher than Iceland’s debt before Götterdammerung struck Reykjavik.

The markets no longer believe that the spending structure of the Russian state is viable as oil threatens to plunge below $60 a barrel. The foreign debt of the oligarchs ($530bn) has surpassed the country’s foreign reserves. Some $47bn has to be repaid over the next two months.

Traders are paying close attention as contagion moves from the periphery of the eurozone into the core. They are tracking the yield spreads between Italian and German 10-year bonds, the stress barometer of monetary union.

The spreads reached a post-EMU high of 93 last week. Nobody knows where the snapping point is, but anything above 100 would be viewed as a red alarm. The market took careful note on Friday that Portugal’s biggest banks, Millenium, BPI, and Banco Espirito Santo are preparing to take up the state’s emergency credit guarantees.

Hans Redeker, currency chief at BNP Paribas, says there is an imminent danger that East Europe’s currency pegs will be smashed unless the EU authorities wake up to the full gravity of the threat, and that in turn will trigger a dangerous crisis for EMU itself.

Again not good.  I’m going to leave the economic repercussions to people better in economics than me (perhaps our own econ expert will weigh in?)

I wonder what effect this will have politically though. 

We are only 9 days away from a Presidential election.  If the bottom falls out and we see major crises overseas how will it affect the election? My sense is it will be very impactful.  If it happens in the next couple days, perhaps the lid will be kept on and the implosion will come after the election, but if it happens now I think it will have a major effect.

But how? I think that depends on what happens, if this sets another round of major market metdowns around the world and the DOW joins them in a race to find the bottom, Obama may get his landslide.  If on the other hand this blows up but stays contained overseas (owing to the US’s much smaller exposure noted above), perhaps we even see a flight to safety which lifts the DOW, in that case I think it might be the bit of wind at his back that Mccain needs to limp over the finish line.

It will be interesting to see what happens in the markets tomorrow and if this story develops with the rapid speed we’ve seen in other crisises we could be in for a wild ride.  As Joe Biden might say “By the beard of Jupiter gird your loins!”

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