Financial crisis provokes global intervention


Despite the efforts of Warren Buffett and many others to instill confidence in the U.S. markets, the signs are becoming increasingly clear that the financial crisis is continuing to spread around the world, perpetuating the volatility and lack of confidence that has rocked global markets over the last month. The combined shocks of frozen credit markets and panicked investors withdrawing assets from the developing world created a shortfall in foreign currency reserves for smaller economies at exactly the moment when they must roll over their foreign debt. The result this month in Iceland was the tragic meltdown of their entire financial system, leading to the seizure of the country’s three largest banks by the government and the collapse of the Icelandic krona. The IMF stepped in this week to ensure that a similar fate would not befall Hungary and Ukraine. The loan of $16.5 Billion to Ukraine comes at a moment when the nation’s depositary institutions have been frozen and the currency has fallen 50% against the dollar in a matter of weeks. The speedy measures undertaken by the IMF to protect these fragile economies are reassuring, but not sustainable, and the Fed has stepped in to pick up the slack, offering its currency swap facilities to Brazil and South Korea. The sandbags being laid out against the rising tide will slow but not stop the spillover of the global crisis.

Investors around the world have fled equity markets in the developing world for the currency safe havens of the Yen and Dollar. The Hang Seng Index, which tracks stock trading in Hong Kong, is illustrative of the current situation around the world: recent up-ticks have posted record gains, only to be followed by a continuation of selling. Statistical analysis shows that these brief gains are occurring where markets have moved downward extremely quickly, but not a single market has successfully established a new equilibrium price in over a month. Until prices converge on a new average, we can expect an extension of the current losses.

Most shocking of all though is the unprecedented volatility across all markets. Volkswagen’s stock demonstrated this dramatically by rocketing upward on Tuesday to levels which briefly made the German automaker the most valuable company in the world. This 500% explosion was a phenomenon known as a short-squeeze. According to, more than 12.5% of the stock was on loan for short trading when Porsche announced that they would increase their stake in the company from 35% to 70% instead of only 50%. This 15% increase in demand came as a surprise to hedge fund managers who had bet the firm’s value would fall on its merger with Porsche, and traders scrambled madly to cover their positions. The uncontrollable madness raged out of control because unlike a long position in a stock, where the investor stands only to lose the amount put forward, a short position can be subject to potentially infinite losses if the stock price charges upward, and this can be further magnified by the degree of leverage taken on the position.

Swings of several percent in value have plagued all the major stock exchanges lately, but relative to markets around the world, U.S. equities have held their value fairly well. Although the Dow Jones index is down 35% on the year, the S&P 39%, and the NASDAQ 42%, the European FTSE and Dow Jones Stoxx are down 41% and 47% respectively and the Japanese Nikkei has lost more than 50%. Developing world markets have fared much worse by comparison, having universally lost more than half their value in the past year. Despite the financial crisis having originated in America, the Dollar has fared strongly against foreign currencies. However, stagnation is setting in, as even a half-percent cut in the key interest rate today was not sufficient to bolster Wall Street. As the current volatility calms down, we will begin to approach December, and the record lows in consumer confidence will make the barons of Wall Street the Grinches who stole Christmas. Stagnation will give way to another sell-off across the markets as the predictably dismal results come back, and only then will we begin to assess the true value of equities.

Our next president will have to face the challenges of a market which is fundamentally broken and will need to develop creative and dynamic solutions, informed by bold historical models like the IMF and the Bretton-Woods arrangement. The current financial order makes it too easy for nations like Iceland and Ukraine to quickly become dependent on foreign credit, and when coupled with derivative instruments that spread the risk of sovereign default across the entire financial system, this poses systemic risks to core financial institutions. America, for its part, has enjoyed immunity for a long time from these balance of payments difficulties because its currency plays such a central role in the global system of international trade. Its weakness, however, is that due to its central position in the global economy, the U.S. Government cannot allow poorly managed private institutions to fail. Whatever new system is developed in the wake of the current crisis, it should be founded on a single set of rules that will be fair to all players, great and small, in the global economy so that our international relations in the future can be a source of stability and justice rather than a cyclical battle to capture the fruits of economic boom before the next collapse.

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