zeb/ – your partner in stormy times

The financial crisis currently dominates the economic and political agenda. Many credit institutions and insurance companies face major challenges of an unprecedented scale and have to make intensive efforts to cope with the global crisis and its consequences in the foreseeable future. The crisis has manifold causes that unfolded their fatal effects especially through their interaction. Over time, three phases can be identified that were and are characterised by a further escalation of the turmoil and crisis symptoms. zeb/ provides an overview.

The US real estate bubble was largely based on the low-interest-rate policy pursued by the Fed at the beginning of this decade. Easy lending supplied enormous liquidity to the markets. Customers from the subprime segment were granted favourable loans that were securitised by banks and re-sold to financial institution all over the world — with exaggerated ratings as we all know now. These products offered high returns at an apparently low risk. These earnings prospects had an all too tempting effect in combination with incentive systems orientated to short-term profits. Because of pro-cyclical accounting rules and excessive leveraging, the activities of heavily involved credit institution were deemed to be “best practices”. Risk management receded into the background. A bubble developed. When the real estate prices eventually started to fall and the subprime borrowers were no longer able to serve their debts, the bubble burst. Through the securitisation chain, a local real estate crises turned into a global credit crisis.

The rising defaults in the subprime segment resulted in lower ratings for a high number of securitisation instruments. As a consequence, this market saw a mass exodus of investors. On account of unclear securitisation chains and the products’ complexity, there was a lack of transparency with regard to the risks involved in the positions and on who would have to shoulder the loss resulting from defaulting loans at the end of the day. This eroded trust among the banks. Although central banks flooded the market with liquidity all over the world, several institutions faced solvency problems. The insolvency of the investment bank Lehman Brothers triggered an aggravating chain reaction on the markets. The crisis started to spread to other product types. For example, bank bonds and credit default swaps experienced a massive loss in value because of the imminent insolvency of several institutions. Trust among banks completely vanished. It was only when governments approved billion-euro rescue packages that the market started to stabilise again.

Although a slowdown in economic growth already was noticeable before the financial crisis, the risk of recession has dramatically increased because of the problems in the financial sector. Restrictive lending practices adopted by the banks make refinancing more difficult and more expensive for enterprises. On account of their rescue packages for the banks, governments have limited leeway for taking action. In all the major industrialised countries, newspaper headlines gradually start to be dominated by a slump in economic output. The financial crisis now definitely turns into an international economic crisis.