Sometimes bank borrowers default.
"Today Russia is once again at the heart of financial market instability."
The financial crisis of 2008-2009 toughened up the American banking system. Banks needed to pass hypothetical "stress tests." Russian default is not hypothetical. They announced they are repaying sovereign debt with worthless rubles. Loans to Russian businesses may not be repaid, either. A financial system is an interlocking set of risks offset by balances from counterparties. The failure of a major player affects everyone else.
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| New York Post |
College classmate Sandford Borins is an emeritus professor at the University of Toronto, where he taught public management. Today's Guest Post is an excerpt from the recent post at his website www.sandfordborins.com. In retirement he makes frequent comments on politics, economics, and culture. Readers can subscribe at his site.
I consider Borins' post an early warning. While we are thinking about inflation, supply chain disruptions, COVID returning, ongoing war, refugees, and the potential of escalation, there is something else to consider. Russian defaults endanger a financial system.
Watch the banks.
Guest Post by Sandford Borins
Twenty-five years ago, the hedge fund Long Term Capital Management (LTCM) was using the ideas of two Nobel Prize-winning economists, Myron Scholes and Merton Miller, to speculate on bond prices. In 1998, these boffins predicted that spreads between certain bonds would revert to their historical averages. They were spectacularly wrong when Russia defaulted. LTCM was so highly leveraged that its imminent bankruptcy would have led to unsustainable losses for the financial institutions that lent it money. To avoid systemic failure, the Federal Reserve had to bail out and wind down LTCM. (At least Scholes and Miller lost all their equity in the firm.)
Sandford Borins
To Russia with Risk
Today Russia is once again at the heart of financial market instability. A second-order consequence of the economic sanctions being levied against Russia is that Russian assets are being sharply devalued or rendered worthless. The holders of these assets outside Russia are incurring losses and may indeed be forced to write them off completely.
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| Fortune Magazine |
Most Russian commercial aircraft are owned by overseas aircraft leasing firms. The Russian airlines will fail to make their payments and the lenders will try, likely unsuccessfully, to recover planes that are parked on Russian tarmacs. The Russian Government may then seize the planes, nationalize the airlines, and try to continue operating them as long as it can find replacement parts.
The Russian Government has stated that it will make interest payments on its sovereign debt in non-convertible rubles, which is tantamount to a default. Russia has $150 billion US in sovereign debt, which is apparently widely held by western banks and pension funds. They will likely have to write off their Russian debt. Hopefully, no overseas investor will have gone so heavily into Russian debt that its losses would be unmanageable.
Western firms that are leaving Russia are running the risk that their assets may be seized by the Russian government and nationalized. These firms too would have to write off their investments in Russia.
The one major financial institution that has not withdrawn from Russia is Deutsche Bank, which suggests that it is deeply involved in the Russian economy. Deutsche Bank has shown itself to be accident-prone in recent years (and decades), so that would not be surprising.
My overall point is that the sanctions against Russia will create pain for overseas investors in Russian debt and business in Russia. Hopefully, the aggregate size of the investments is small enough (a mere $150 billion in sovereign debt) and the investments are spread widely enough that the situation will not create systemic failures in the global financial system. This is not an argument against the sanctions, but rather a call for bank regulators and finance ministries to anticipate and respond to the second-order effects.
Rebuilding Ukraine and Suing Russia
Ukraine is also suffering financial devastation, but that is a result of Russian military action. Destroying housing will likely impose losses on Ukrainians themselves rather than foreign investors. We can expect that when the war is over its allies as well as the Ukrainian diaspora will provide financial support to rebuild Ukrainian infrastructure.
When the war is over, many Russian assets may have changed hands and the new owners will attempt to make money employing assets they purchased at fire-sale prices. Purchasers of defaulted sovereign debt will sue the Russian government to repay the debt at prices below face value but nevertheless highly profitable (a strategy that worked in recent years for speculators in defaulted Argentinian sovereign debt). Perhaps Russian oligarchs will buy up Russian businesses and commercial assets, hoping that Putin or his successor will allow them to operate profitably. Or, if the Russian Government nationalizes assets now, it may have to return them as the price of rejoining the global economy.
As Keynes well knew, wars have economic consequences.
14 comments:
I just hope the sanctions against Putin and his cronies are more effective than those imposed on the Sackler family, responsible for the opioid crisis, which still left them with more money than they can spend in one lifetime.
Whatever the financial consequences may be, hitting Russia as hard as possible for their atrocities in Ukraine is worth it.
I and I hope we will start giving the Ukrainians everything they need to defeat the Russian army and send them dragging their asses home with their tail between their legs.
These comments infer that Putin will survive which should be unacceptable. If he remains then he will have many accomplices for his war crimes.
The sanctions have one purpose: to force an end to violence and prompt an internal regime change in Russia. They should continue at full strength until this happens.
American investment in Russia was intended to coerce them into being good international actors, as well as open that market to US multinationals. Western goods and culture for oil.
It hasn't worked.
Killing Russian soldiers isn't the answer. This is very similar to a civil war. It's tragic for families on both sides.
It's the leaders who start the wars, corporations that profit and families who pay the price.
Mc,
Russian soldiers are killing Ukrainians. How would you stop them without fighting and thus killing many of them?
Are any republicans on the list of sanctions by Russia?
It looks like a list written by the former president. Coincidence?
The preferred approach to stopping conflict is through diplomacy and sanctions, not by taking part in it. However, for those so inclined, I heard that Ukraine is welcoming volunteers.
The “preferred approach” worked poorly the last time it was tried under similar circumstances. Neville Chamberlain’s “peace in our time” only lasted a year. Sometimes handling a situation takes more than what one might prefer.
Going back to the original topic of Peter‘s post, there will undoubtedly be major financial consequences to this war. We will all need to contribute as much as we can to ameliorate those and to help Ukrainians once they finish doing the job on the (thankfully) incompetent and clueless Russian military.
Comparing what Biden is doing to Neville Chamberlain is disingenuous at best. As the effects of sanctions ripple through the global economy, everyone will be contributing plenty whether they want to or not. I hope those who advocate doing more for Ukraine will remain as committed when gas prices hit $6/gallon, but I have my doubts.
Second order effects, yes. And after that, third and fourth order. Keynes also said that in the long run, we’re all dead. Perhaps our run is much shorter than we presently believe.
Mike,
I didn’t mention Biden. I wasn’t thinking about him when I wrote that. Maybe try assuming less and asking more?
Diplomacy and sanctions are the tools Biden has been using to try and resolve the conflict in Ukraine. That approach was compared to Neville Chamberlain’s approach to Hitler.
Mc; It's the leaders who start the wars, etc."
As has always been the case, sadly and Humankind seems determined to ignore the lesson.
Mikeb; Well put, and prices at the pump in some places are already exceeding $6, despite the global price of oil dropping well below a $100 a barrel, again. I ve been reading for years that Putin's economy needs at least a $100 a barrel to manage, so now there is even more pressure on the venomous little vermin.
I'm no prophet, but I'm guessing Pump prices in this Country are going to stabilize around $4 a gallon, just like they stabilized at a $1 after the ginned up Arab Oil Embargo of the early 70's.
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