CREDIT CARDS
Cracks in the plastic
Credit cards aren't what they used to be. When they were first sold, they were marketed to financially sound bank customers. Their relatively high interest rates reflected not so much risk as the fact that they weren't intended to be used for long-term loans. They were unsecured, but banks chose customers carefully. But credit cards turned out to be money-spinners for the issuers. That meant more banks scrabbling for market share. In turn, this implied less discrimination about customers and lower interest rates but also a frightening increase in defaults.
The result is that credit cards now head the banking risk list. Credit cards represent a risk so severe that defaults could create a debt crisis as significant as LDC and property loans in the 1980s. Loan volumes are huge $360 billion in the US alone, more than twice Brazil's foreign debt. Loans on cards are showing rapid growth: in the US it has averaged 20% annually for the past three years, with some banks expanding their portfolios 500% in that period. Not surprisingly, as the quality of borrowers diminishes an increasing proportion of them are going bankrupt. Bankruptcies have reached record levels they are expected to rise 30% to a forecast 1.15 million this year. At a time when the US economy is healthy, loan losses are almost as high as they were at the height of the 1991 recession.
So if the economy takes a nose-dive, losses are likely to get completely out of hand. The banks whose only line of business is credit cards are likely to be hit first. The crisis will then engulf all major banks.
"Credit cards are the number one risk in banking ... and the pressure can only intensify if we have an economic recession," says a report by US brokerage Gerard Klauer Mattison. It warns that unease could spread if a bank were to admit to difficulties by increasing loan-loss reserves or if regulators were to request higher capital allocations. The risk manager at a major UK bank says that "credit cards could certainly be a big issue in the UK and Europe as well as in the US".
In their bid to win market share, banks have waged a marketing blitz. Last year in the US 7,000 issuers sent out 2.7 billion mailings to attract new customers. Over the past two years, the average adult American has received 32 mailings offering him $130,000 of credit.
Individual banks have no clear picture of their borrowers' full debt position; the loans are without collateral and their repayment is a lower priority than home, car and other loans. Bankruptcy is a relatively easy procedure with little stigma attached. Half the net losses of large card issuers result from bankruptcies.
Under extreme conditions, securitization of credit card debt may make banks more, rather than less, vulnerable to losses. Loans have not been sold on and, if losses were to rise dramatically, the terms under which cards are securitized would force them back onto the banks' balance sheets. No capital has been set aside to cover such losses. On the contrary: "A prime reason for securitization on the part of card issuers is to reduce their capital and loan-loss reserve requirements," says George Salem, senior vice-president of Gerard Klauer Mattison.
If it comes, the US credit card crunch will expose banks to large loan losses that will show up their capital inadequacies. Banks wishing to avoid disaster should review their portfolios now.
PROJECT FINANCE
"Equity without the upside"
Project finance has always been a risky business. "Lending to a project is like equity without the upside," says Philip Wood, partner with UK law firm Allen & Overy. But market growth to nearly $370 billion of outstandings and erosion of margins have made it much more so.
Competition has pushed banks to give loans on over-generous and increasingly loose terms. There have been cases of them lending to power projects without a power-purchase agreement being in place. An example of this is the development by PowerGen of the UK of a coal-fired generating plant at Yallourn in Victoria, Australia. And banks are increasingly prepared to lend without guarantees from an export credit or multilateral agency. The value of such unguaranteed loans rose by 79% to $23.3 billion in 1995. They are "an accident waiting to happen", say many project finance insiders.
Given what competitive pressures have piled on top of the risks inherent in the business lending into remote places, dependence on unstable governments, lack of recourse it's hard to see how project finance can avoid a disaster in at least one country or sector. The softest landing would be if a sector were to fail soon and knock some sense into pricing.
"At the big-ticket end [of lending], banks have been taking their pricing into aggressive territory. This is most dangerous in project finance because of the leverage and cross-border elements," says Alan Brown, director of group credit policy for Barclays Bank. "There could be contagion by product, geography or sponsor. If one project failed, a bank which had underwritten loans to a similar project hoping to sell down 80% would no longer be able to do so." Wood points to the hazard of "creeping expropriation": a government gradually changing the rules raising taxes, lowering prices and insisting on localization such that a project becomes unviable. Even in developed markets, project finance is a tricky proposition witness the problems of Eurotunnel, the Anglo-French consortium that built the Channel tunnel. In emerging markets, the list of risks extends to political, currency, market, technology, regulatory and legal risks. Taken together, not properly priced for, they are a recipe for disaster.
LATIN AMERICA
A new bank debt crisis
Latin America's debt problems look as if they could return. Debts are building up again and the risk of default is increasing. Banks that thought bonds, not loans, would cause the problems this time around are mistaken. They will be dragged in as deeply as before.
If Latin American countries defaulted on their bonds, the banks would be forced to pick up the pieces as they did after the 1994 Mexico crisis. They will advance new loans in place of sovereign bonds. Fairly soon they will be carrying large and problematic exposures to Latin America. Sorting out these bad debts will be much more like the LDC debt crisis of the early 1980s than last year's Mexico bond default. "When capital market flows dry up, the countries go to the banks and the banks have to lend. They have no choice," says Raphael Soifer, a banking analyst at investment bank Brown Brothers Harriman.
Soifer continues: "There will be peer pressure, political pressure and pressure on their own portfolios [of bonds]. Many US banks hope to do a great deal of banking business in the countries themselves. In order to keep the government friendly they must support its borrowing needs."
A report by the Institute of International Finance confirms that "total bank flows [to emerging economies] almost doubled in 1995 to $83 billion ... [This partly] reflected the temporary restriction in availability of bond finance following the Mexican crisis."
Besides the fallout from bonds, the banks could be in trouble because of their generally high level of emerging-market lending not just to Latin America. Stealthily often without telling their shareholders US banks are increasing this. In 1995, according to a report from Brown Brothers Harriman, emerging-market lending increased by 5% on the previous year.
Notable increases in exposure were to Brazil, up 25% to $14 billion; Argentina, up 8% to $9.8 billion; Indonesia, up 27% to $3.9 billion; China, up 48% to $2.2 billion; India, up 47% to $2.2 billion; South Africa, up 59% to $2 billion; and Turkey, up 55% to $2 billion. Of the $83 billion total exposure, the six US money centre banks account for $63.2 billion, almost as much as their combined tangible common equity and 5% of their total assets.
Emerging economies are financing ever-larger current-account deficits with short-term borrowings, so crises look inevitable. Many analysts argue that the lending banks are better capitalized than they were in the 1980s when a systemic collapse was narrowly avoided. But this time they have extensive derivatives positions on emerging market instruments. If these turn out badly, there could be spectacular failures.
EMERGING-MARKET DERIVATIVES
Engineering in the dark
There are risks that financial engineering cannot overcome, especially in emerging markets. These markets are typically illiquid, volatile and lacking in transparency. If new derivative and structured instruments further obscure pricing and market intelligence, they may hasten rather than prevent crashes.
An example is the packaging of direct investments for portfolio investors. A large holding in a Malaysian or Thai company could be split between many investors, in packages that perhaps offer capital gains or dividend income. This enables investors who want to get out to sell their shares back to the bank, therefore avoiding the problems of illiquidity involved in dealing directly in the local market. But, if all the investors wanted to sell at once, either the investment bank would have to take a hit or it would have to try to unload, say, half a company into a tiny, illiquid stock market.
Systemic risk is heightened because the local governments are unaware of what is happening. On their books, such capital inflows look like long-term direct investment. In reality, they are short-term portfolio flows. Their economies are more exposed to capital flight and Mexico-style crashes than they realize.
"Derivatives in emerging markets can affect capital-flow accounting," says an IMF official. "What looks like foreign direct investment can be portfolio investment but won't be accounted as short-term liabilities." The source notes that since derivatives written on emerging markets are often over-the-counter instruments, local governments are more than likely unaware of them, making economic management more difficult.
Wall Street bankers reckon OTC derivatives contracts on the dollar/peso exacerbated the peso's fall during the 1994-95 Mexican crisis. Structured-note contracts worth $20 billion were taken out between Mexican banks and US banks on behalf of Mexican customers, say market participants. When the peso moved down, margin calls drained close to $4 billion from Mexican coffers in mid-December 1994.
As long as relatively opaque OTC instruments dominate relatively transparent exchange-traded ones and underlying markets are illiquid, the shocks will continue.
AGRICULTURAL BANKS
Europe's agro-nightmare
In Europe, reform of the Common Agricultural Policy (CAP) tops the list of likely policy changes that could harm banks. If subsidies and price supports to farmers are reduced, one or two French and German banks that specialize in lending to the sector could be seriously hurt, with wider effects on the banking system.
Growing budgetary pressures in the EU mean reform of the CAP is inevitable. The critical issue is whether it is gradual or sudden. If budgets were slashed at a stroke, multitudes of small European farmers could face ruin, taking banks that lend to them down as well.
"A fundamental change in lending assumptions, such as deregulation of prices or changes in tax rules, is what frequently causes a banking crisis," says John Leonard, a director of Salomon Brothers International in London. "In Europe, reform of the CAP is just the sort of change to facilitate a banking crisis."
A driving force behind CAP reform is the likelihood of enlargement of the EU to include eastern European countries. Of a 1996 EU budget of around Ecu90 billion ($112.5 billion), some Ecu40 billion is accounted for by agricultural subsidies. But, if east European states were admitted and subsidies retained their present form, this could rise by between 30% and 60%. Economists at Union Bank of Switzerland estimate that admission of the Czech Republic, Hungary, Poland and the Slovak Republic by 2000 would add 60% to an unreformed EU budget.
If the EU's political goals are to be achieved, the CAP must be trimmed. But in France, Greece and Italy, where farmers rely heavily on subsidies, there is solid resistance that could delay reform. Last year a report produced by a group of UK agricultural experts warned that "leaving reform until the CAP becomes unmanageable will result in panic measures designed to address immediate problems". The danger is that a political crisis such as instability in Russia might speed up the timetable for admitting eastern European countries into the EU before the CAP has been properly reformed.
SECURITIZATION
Damaged reputations
A new threat to the good name of banks has emerged. And its effects will be worse than the derivatives snarl-ups of a few years ago. At least those affected only individual customers, albeit important ones like Procter & Gamble and Orange County. But when asset-backed bonds run into trouble and no market has a smooth ride for ever thousands of investors will turn on banks with unprecedented ferocity. Courts will be overwhelmed by lawsuits.
Securitization is growing fast: publicly traded asset-backed securities reached $109 billion in 1995, up 45% on the previous year. The problem is that investors and borrowers don't fully understand the mechanics of securitization. Investors are content that the paper they buy is rated triple-A but yields better than a triple-A sovereign or corporate bond. "Securitization is a machine into which you often put double-B paper [or loans] at one end and out of the other comes triple-A," says George Salem, senior vice-president at Gerard Klauer Mattison. "There is an insatiable appetite for this paper because it is rated triple-A yet has a better than triple-A yield on it. It's too good to be true."
That these instruments are not a species of alchemy will become clear when a major
securitized instrument fails or falls substantially in price. Investors will realize the usual credit and market risks are implicit in their bonds, but will try to blame the issuing banks for their plight. The banks will have to decide whether they should pay compensation to protect their image, though they have done nothing financially untoward.
Borrowers might also enter the fray if they were to discover that loans negotiated in their name with a bank had been securitized and passed on to third-party investors. If a homeowner, for example, defaulted or fell into arrears, he might find that investors rather than the bank were pressing for repossession. It's easy to see how an anti-bank media campaign could be orchestrated on the back of the resentment this would generate.
Of all the securitization-linked risks worrying banks, the most serious is damage to reputation. "If something goes wrong for one bank, it's often bad for all of us," says Alan Brown, director of group credit policy for UK bank Barclays. "It may reduce the flow of business to us all. Reputation risk is one of our most serious threats." To avoid fallout from asset-backed securities flops, banks need to educate investors now on the instruments' true nature.
GOVERNMENT DEBT
A western European default
The governments of Italy, Belgium and Sweden seem disinclined to sort out their countries' public finances. If they wait much longer the global capital markets will do it for them.
These indebted European nations are failing to make sufficient cuts in social security spending or to raise taxes to cover it, so their debt-GDP ratios will rocket. If Italy carries on dolce far niente, its debt/GDP ratio could reach 700% by 2030. Even Germany's would go over 400% were it to keep on sitting on its hands. Even with higher interest rates, the Italian government could find itself unable to roll over a maturing bond and in technical default.
The panic would spread to other highly indebted countries, and other G7 countries and the IMF might be unwilling to underwrite massive bail-outs. The problems would have to be straightened out the old-fashioned way through mass bankruptcies, failures and economic stagnation.
"If governments continue going deeper into debt, if they don't face up to the entitlement issue and the markets don't force them, they could find themselves in inescapable debt traps," says McKinsey consultant Lowell Bryan.
In their book Market Unbound, Bryan and co-author Diana Farrell draw out positive and negative forecasts based on government use of savings. Between 1992 and 2002, they estimate, household net financial assets will increase by $12 trillion, half of which will be derived from the US. This is about one-third of the world's entire stock of financial assets (some $35 trillion). Savings have rapidly expanded because more and more people in the developed countries are reaching their high-savings years between their late 40s and retirement.
These savings are endangered by high-spending governments. In Bryan and Farrell's worst-case outcome, $10 trillion of them would be gobbled up by governments with growing debt burdens. Four or five countries could end up with debt-GDP ratios of 130%, paying real interest rates of 10% upwards and running real deficits of 13% because of interest costs. Eventually one country would default and be thrown into economic turmoil.
"Under this worst-case scenario, the world's economy would be devastated, and it could easily lead to armies marching and to massive social upheaval," the authors conclude. "This scenario, which is almost unthinkable, can be avoided if governments pursue the appropriate set of policies."
US TREASURIES
Taking on Uncle Sam
China is amassing the weapons that will put it in a position to engage in economic warfare with the US. Its foreign exchange reserves will reach $100 billion by the end of this year, second only to Japan's and ahead of those of Germany and the US. (US reserves stood at $85.6 billion at the end of May.) And China's trade surplus with the US overtook Japan's for the first time in June.
Vast foreign reserves imply the power to move international financial markets. China is buying Eurobonds and plans to build a portfolio of US treasuries. Foreign ownership of US debt is the Achilles heel of the US economy. "The foreign share [of US national debt] has grown sharply during the Clinton administration from 19.1% in 1992 to 27.5% in March of this year by far the highest percentage in American history," wrote Bruce Bartlett, senior fellow at the US National Center for Policy Analysis in the The Washington Times in July.
China will soon be able to emulate Japan's position in the treasuries market, affecting both US bond prices and the dollar. But there's an important difference at bottom Japan and the US are allies; the US and China are enemies.
The next time the US threatens China with sanctions for copyright or trade infringements, China's reply could be a large-scale treasuries sale. The resulting economic tumult would be felt worldwide. Bond prices and the dollar would plummet and markets fall into disarray.
To many economists, the fundamental friendliness or hostility of those holding vast amounts of US paper is of no consequence. The fact that the US is running huge trade deficits a record $173.4 billion last year funded by foreign money is destabilizing whoever it is borrowing from. In The Future of Capitalism Lester Thurow writes: "No-one can run a large trade deficit forever. The United States is very large, it can borrow a lot and sell a lot before it goes broke, but at some point the world's financial markets will clamp down upon it just as they clamped down on Mexico."
CRIME
Mainframes and the mafia
Russian crime is big business, so big that it threatens the world financial system. Russian criminals are an integral part of the social and political system, able to operate unhindered. They employ some of the world's top brains. They are capable of stealing from a foreign bank's computer system, as Citibank learnt in 1994 when around $400,000 was stolen by computer hackers based in St Petersburg.
Russia's next international computer hack will be bigger and more successful. It could bring down both banks and the system. Extortion by Russian criminal groups and money-laundering pose similar threats. Banks with Russian assets could discover that the whole portfolio was rotten. A regulator who decided to confiscate crime-linked assets would bring banks to their knees.
The troubles go back to the way Russian president Boris Yeltsin brought the old communist power-brokers and corrupt elements into Russia's reform process his "Faustian bargain". Even Yeltsin has admitted the extent of the problem: "Crime has become problem number one for us. It has acquired such scale and character that it poses great danger for ... the whole Russian state. Crime is destroying the economy, interfering with politics and undermining morale."
Internally, the murder rate shows how lawless Russia is in 1994 there were 32,000 murders, 21.8 per 100,000 people, roughly twice the US rate. Externally, the Russian mafia regards western financial institutions as sitting targets. Banks that fail to respond to extortion will soon learn that the technology for disrupting their operations has been upgraded. Reports in the British press in June 1996 claimed cyber-terrorists had extorted $600 million from banks by threatening to wipe out computer systems with high-intensity, radio-frequency guns. "Disabling and extortion are far easier to undertake than the urban fairy tale of the hacker rounding nickels and dimes into his own account," says John Howell, director of London-based Compliance Methodology Consultants.
International money-laundering flows, many of which originate in Russia, are so large they could take over an entire economy. In 1996 total flows arising from such sources as drugs, prostitution, extortion and outright theft of public resources were put at between $500 billion and $1 trillion. That's 10 times more than total aid flows and roughly equivalent to the combined economies of Switzerland, Sweden and India.
"The sheer size of profits from laundering can seduce entire governments of poor countries as an attractive alternative to the tough conditions of official international loans," says Jan Dauman, president and chief executive
of London-based strategy consultants InterMatrix Group.
THAILAND
The tequila effect
Mexico 1994, Thailand 1996? A Mexico-style collapse looks likely for the fast-growing Asian economy. The downgrade of its short-term sovereign debt by credit-rating agency Moody's earlier this month is the latest sign of how serious things are.
Thailand is exhibiting many of the features that characterized the run-up to Mexico's troubles a large current account deficit, high levels of short-term debt and an overvalued currency. And the Thai government seems to be taking no short-term measures to solve the problems.
With rating agencies and economists all highlighting Thailand's troubles, there's a danger of a self-fulfilling prophecy. The markets are spooked and a single piece of bad news could send them into free fall.
It could be a further slowdown in export growth, a bank failure or a political crisis. The markets would respond by speculating against the baht and the Bank of Thailand couldn't contain this, for all its $39 billion in foreign reserves.
Their depletion in a battle for the baht would take them far below Thailand's $41.1 billion short-term external debt. The central bank would then be unable to shore up the economy in the face of capital flight. A Thai crash would have serious knock-on effects in south-east Asia, damaging the region's standing as an engine of growth.
How did Thailand like pre-crash Mexico a model of reform get into this mess? "Thailand's current difficulties owe a lot to its persistence with an inflexible exchange rate which led to the contradiction of the central bank attempting to impose a tight monetary policy to only limited effect," says a report by the brokerage Asia Equity. "A sharp build-up in foreign debt resulted."
Paradoxically, though, while many of Thailand's difficulties have been caused by an undervalued currency, the baht is now overvalued. This is harming export competitiveness and adding to a current account deficit that has reached 8.5% of GDP.
But if Thailand devalues, it risks setting off a flight of newly arrived foreign capital. Its hard lessons on fixed exchange rates should be learnt by other emerging countries before similar fates befall them.
SOCIAL UNREST
Underclass struggles
With communism dead or dying, the external threat to capitalism has disappeared. But the internal threat is increasing. A huge, expanding underclass will make its presence felt.
As technology cuts out unskilled jobs and the axe falls on social spending, this lumpenproletariat will hit back. It will be organized, will cause social disruption, and could take over power if its needs were not answered.
"You can squeeze people for a long time, but eventually they start fighting back. When they do, they usually win," said a labour activist at last month's Democratic convention in Chicago. The backdrop to his remarks was TV footage of the 1968 Chicago Democratic convention, when police and anti-war protesters fought bloody battles that helped speed US withdrawal from Vietnam.
No political party in Europe or the US has a solution to widening inequality and joblessness. Force will drive change. In the US, real wages for the bottom 20% of males have fallen 23% in the past 20 years. The combined forces of technology and global capitalism with unskilled jobs going where costs are lowest will ensure they drop further. The result will be rising crime, poverty and urban decay.
In western Europe, relatively strong labour unions keep wage levels up; the cost is higher unemployment. The crisis there is being kept at bay by higher social spending. But the gravy train will have to stop, either just before or immediately after some European countries go broke. The US and Europe will then be in about the same position.
US president Bill Clinton has no solution but he has identified the problem: "The cast-offs and the drop-outs who were left out of the boom of the 1980s and who are now living in a world apart they don't vote, they don't work, don't report crimes, don't necessarily send their children to school, and sometimes don't even have a telephone to receive calls. And in the vacuum in which they live, it is unclear whether society holds any claim on them or power to censure them."
But the underclass will start exercising its power. With nothing to lose, urban terrorism will be a tempting option. Banks will find revenues from new business being eaten up by the costs of insurance and extra security. Governments will have to spend on policing what they save on welfare cuts. Bankers may start pressing governments for long-term investments in education and skills. But the payoff will be decades away. Meanwhile, the financial system may collapse under the strain.
US STOCK MARKET
It's the liquidity, stupid
At worst it will be a crash, at best a large correction. But it has to hit the US stock market before long. Equities are overvalued, but most market participants are miscalculating the impact of their being brought down to realistic levels.
Equity players think the pain should be moderate because they've had time to prepare. Many set great store by their new approaches to risk quantitative techniques, marking to market, hedging strategies and a focus on liquidity.
They believe these techniques will see them through. They will be disappointed. The banks' latest risk models will show as many shortcomings in the next equities crash as their old ones did in the last. In fact the new techniques will even contribute to market volatility.
US economist Henry Kaufman believes quantitative methods giving numerical values to the risk of a security or credit provide false comfort. "Computer models are based on past relationships, and they cannot fully give adequate weight to something that is just changing or is about to happen," he says. "But there has been an added degree of risk-taking because of the certainty of using numbers."
Kaufman argues that the extent of US households' equity investment and heavy consumer debt is worrying. A sharp fall in stocks and higher interest rates could produce setbacks in consumer spending and credit use much greater than cyclical expectations.
In a crash, the robustness of institutions is called into question. Players have tried to draw accurate, up-to-date pictures of their financial health by marking to market. But Kaufman argues that this is a blunt instrument unless it takes account of liquidity and beta (price volatility). Indeed, marking to market increases volatility because it encourages institutions to sell if assets change in value.
Kaufman warns that shorter investment horizons promote an "illusion of liquidity" that prompts the taking of larger and riskier positions. Yet in a financial crisis liquidity will dry up and hedging strategies will come apart.
"This contraction of liquidity feeds back strongly onto related markets and often onto unrelated markets, too," says Kaufman. "The inevitable results are sharp price breaks and other manifestations of volatility."
CHINA
Resurgent nationalism
Over the centuries China has gone through cycles of centralization and disintegration. Is there any reason to believe the pattern of the past has been broken? The evidence suggests not. Tensions in every sphere point to major dislocation probably break-up. In the process, foreign investors' dreams of a market of 1.2 billion consumers will be shattered.
The trigger will be a weakened central government desperately trying to regain control. The bid fails and civil strife follows. Provinces withhold taxes and form regional coalitions; the army splinters; political chaos degenerates into economic crisis.
The intractable economic problem is that communism has collapsed as an economic system yet remains the guiding political force. The government desperately needs a philosophy to justify its hold on power.
"Almost no influential figure in Chinese government or society believes in communism any more, and that has created a vacuum that nationalism, always a stronger element in the party's legitimacy, is filling," says Thomas Christensen, assistant professor of government at Cornell University.
But nationalism could become ultranationalism. Waging economic war on the US would be just the beginning. If an attempt was made to rein in the provinces, resistance would lead to chaos. Gangs and secret societies would expand their influence as the agents of local leaders; mass migration would take off as refugees and migrant workers rioted and fled; regional currencies would appear and regional trade blocs would be formed; nuclear weapons would fall into the hands of warlords.
When conspiracy meets cock-up
The intention of animal rights group Save Animals From People (SAFP) had been to send a message of disapproval to Alpine Bank CompanyCompagnie Alpine des Banques (ABCCAB). The bank was well known for funding the testing of a new contraceptive, Counterpartner, and using rabbits in its experiments. Unfortunately for the bank, details of an early test in which several hundred rabbits died were leaked to the press. A European newspaper reported that the rabbits had suffered lingering, painful deaths because a night supervisor had failed to comply with procedures for relieving stricken animals by placing them in an incinerator. ABCCAB had been criticized for its lack of knowledge of day-to-day activities at the laboratory.
SAFP, riding high after a successful direct-action campaign against ill-treatment of water buffaloes in Asian rice cultivation, decided to make its opposition to the Counterpartner project known to the bank. The agreed strategy was to hack into ABCCAB's computer system and place a rabbit icon on all the bank's PCs. When an operator clicked on the icon, comprehensive details of the bank's involvement in Counterpartner would flash up, together with a lurid description of a rabbit suffering.
Assembling a team of expert hackers sympathetic to SAFP was easy, and soon they were downloading the latest hacking software from the Internet and getting down to work.
The team was prepared for long nights of systematically searching for telephone access to ABCCAB's system and cracking its security. But what might have been a fruitless exercise lasting several weeks was never completed. At the outset, a novice hacker dialled up ABCCAB's Web site and discovered that the bank had left a standard trading programme running on it that led him on to a server. This allowed the novice to breach the firewall between the Web site and the bank's internal systems, and set off on his own hi-tech
journey around the bank.
Eager to earn his stripes as a SAFP radical, the novice decided he would wreak some destruction of his own before telling his comrades about his success. He began searching for files named Counterpartner and came up with hundreds of documents headed Counterparties, containing names and addresses, and endless columns of figures and data. He couldn't understand them so he deleted the lot, and those at the bank's bomb-proof back-up site.
Wiping out records of a bank's swap book would normally have caused distress but not catastrophe. But ABCCAB a major player in the swaps market was under severe financial pressure. It had been a heavy lender both to the troubled media sector in the West and to Russia, and was carrying a high proportion of non-performing loans. So when the bank announced that it was temporarily halting trading to sort out internal problems, the market panicked. Other banks pulled credit lines and depositors shifted their funds elsewhere. ABCCAB collapsed as did several banks with large exposures to it. SAFP admitted responsibility, pleading that it had not intended to bring about the bank's collapse. There were no prosecutions, since the hacker's identity, and the jurisdiction where the alleged crime had taken place were never established. BC
What else could go wrong?
Environmental fallout The financial effects of a second Chernobyl could be as damaging as the environmental ones. In the global economy, nuclear contamination of large tracts of agricultural land would bankrupt farmers, destroy businesses and ruin banks.
Index-led volatility The widespread investment practice of tracking market indexes even by non-index funds is giving huge powers to the diminishing number of active portfolio managers. A group of them could ramp up a market for short-term gains, then bring it down by selling out.
Leveraged folly Leveraged buy-out (LBO) funds are awash with money and, like banks with too much capital, it is difficult for them to resist using it. LBOs are starting to get as busy in the service sector as in manufacturing. But deals could easily come apart if equity prices were to fall and there was insufficient cashflow to cover the debt.
Hi-tech rout Hi-tech stocks are fashion victims. When in favour, their prices rocket out of all proportion to earnings. Sometimes there are no earnings as a product has yet to gain official approval. A high-profile collapse where investors are backing, say, a new cure for cancer which ends up causing it, would cause sector-wide problems.
Electronic money fraud Electronic money is being hailed as the final triumph of laissez-faire banking in which central banks and paper money disappear. But a major fraud could set back the technology. If a criminal found a way to insert false value into a smart card, he would substantially slow its progress.
Capital glut If $12 trillion in new savings is sloshing around the world by 2002, the problem could be finding homes for it. If emerging markets were to fail to liberalize their financial systems and make foreign portfolio investors welcome, too much money would be set chasing too few assets. The result would be overheating and inflation on a global scale.
Reaganomics resurgent US economists of all political colours are alarmed by a Bob Dole presidential campaign based on a 15% across-the-board tax cut and only vague spending cuts. A repeat of the soaring budget deficits of the 1980s could do serious damage to the treasuries market and the dollar.
A Saudi boycott Islamic fundamentalism in Saudi Arabia has grown stronger since the Gulf War and the latest US missile attacks on Iraq could increase its appeal. Control of Saudi Arabia by an anti-western government would lead to use of the oil weapon, with predictable effects on oil prices. |