Jim Jubak
This works as long as there are deep pockets willing to take both sides of a bet.
The subprime mortgage market is a good example right now. Banks with exposure to the risk that borrowers will default in larger-than-predicted numbers are buying derivative insurance to protect against losses. Hedge funds, other banks and some insurance companies have been selling that coverage because they think the banks are overestimating the dangers of default. That works to keep the subprime mortgage market liquid and functioning -- no bad thing -- since some lenders will continue to lend as long as they can get insurance in the derivative market. But it does set up the possibility of a swift collapse of the subprime market if the bet starts to go against the sellers of insurance and either a big seller of insurance can't honor its derivatives or enough sellers of derivative insurance pull out, suddenly persuading subprime lenders to stop all lending. You don't have to look to the mind-numbingly complex world of derivatives to see evidence that the financial markets are too complacent about risk -- and that it could be starting to catch up with the markets and us. The world is building up a long list of ticking financial bombs that are only kept from exploding by the continued supply of cheap money around the globe: Latvia: This is my favorite example right now. Its economy has been growing at 12% a year, relying on the current flood of cheap money. Credit growth has been running at 60% -- meaning there are 60% more loans outstanding today than a year ago -- and inflation at 7%. Consumers, like their counterparts in the U.S., have kept cash registers ringing even when the country wasn't producing the wealth to pay the bills. Latvia's trade deficit (current-account deficit) came to about 18% of the country's GDP in 2006. The current account deficit in the notoriously spendthrift U.S. amounted to less than 1% of GDP in 2006. India: India is on the road to an economic and financial hard landing that would send the Mumbai stock market plunging -- certainly taking other emerging markets with it as hot money flees these stock markets. Tiny Latvia is too small to inflict much global damage if it goes into crisis, but India is big enough. Its Mumbai stock market is much more important in the world financial markets than Shanghai's. Interest rate increases by the Federal Reserve, the Bank of England, the European Central Bank and the Bank of Japan haven't significantly cut the global supply of money or raised its cost. Too much money continues to chase too few good opportunities.
RSS
