The global economic earthquake is far from over

Despite colossal state-backed bank rescues the global economic earthquake is far from over. The crisis is set to precipitate sweeping changes across many levels of global financial regulation. These are likely to range from the role of rating agencies to controls surrounding financial institutions’ practice of keeping assets off their balance sheets. Notably, measures aimed at better regulation, control and transparency in the use of derivative instruments – famously described by Warren Buffett in 2003 as ‘financial weapons of mass destruction’ – are also on the agenda. Pressure is mounting for credit default swaps, the focus of much speculative activity over recent years, to be settled through a clearing house, rather than directly between institutions.

As the US and Europe scrambled to shore up their undercapitalised banking systems, tighter global credit conditions have seen struggling emerging market countries frantically waving at the IMF, hoping for a financial lifeline to prevent them going under. Iceland was first in the loans queue, followed by Ukraine and Hungary, as the IMF doled out a total of over $30bn to the trio. With the credit default swaps market flagging major risks of sovereign debt default, Moody’s highlighted the vulnerabilities of eastern European states such as Ukraine, Latvia and Bulgaria, fanning worries that the crisis was far from over.

“During the boom years, foreign banks swooped to secure the spoils

While by no means the worst risk in terms of its credit default premium, Hungary amply demonstrates the financial crisis facing the arc of Eastern European states. With the prospect of sharply-reduced foreign direct investment set to expose its gaping current account deficit, the Hungarian parliament has approved an austerity package to secure around $25bn of combined funding from the IMF, the EU and the World Bank. Fuelled by years of easy credit since joining the EU in 2004, the Hungarian property market boomed as many consumers – knowingly or not – played a risky currency convergence trade, with as many as 90% of Hungarian mortgages funded in hard currencies, such as Swiss francs or euros. As elsewhere in Europe and the US, that boom has now turned to bust, and, as the forint slumped by around 20% in a matter of weeks, many consumers’ foreign-currency denominated mortgages soared, pushing some close to bankruptcy.

Though the IMF bailouts have soothed some of the market’s frayed nerves for the immediate term, the lack of long-term structural reforms in countries such as capital-thirsty Hungary pose real concerns about how well the rescue funds will be put to use. The ­government may have earned plaudits for its latest efforts to get the country back on a firmer economic footing, yet Hungary’s huge reliance on long-term access to foreign capital remains a major threat. During the boom years around the country’s ascension into the EU, foreign banks swooped to secure their share of the spoils, snapping up large chunks of Hungarian banks. Now that the global credit flow has become a trickle, serious questions are being asked as to how well placed – or how well-disposed – these foreign banks are to stand by their Eastern European customers as times get decidedly tougher.