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Is foreign exchange the new sub-prime?

Corporate FX losses are already running into billions. The problem, as the dollar’s rally continues, could be endemic.

In mid October, the Mexican central bank was forced to auction over $8 billion of dollar-denominated debt. The market immediately took the action as an intervention to shore up the peso. That didn’t even tell half of the story.

The action was prompted by the collapse of Mexican grocery chain Comercial Mexicana. It had, according to central bank governor Guillermo Ortiz, been acting like a hedge fund, trading volatility options with international investment banks. The central bank had been forced to intervene to facilitate an orderly unwind of the trades.

Unfortunately this was not an isolated incident. Latin American corporates took a one-way bet on the appreciation of their currencies against the dollar, and their treasuries thought it was a way of making easy money. Tell that to the shareholders of Brazilian companies Votorantim and Aracruz, which have each written off around $1 billion in FX derivative-related losses.

And don’t for one second think the problems are confined to Latin America. A week after the Mexican intervention, Chinese conglomerate Citic Pacific announced that it had suffered mark-to-market losses of $1.9 billion on leveraged foreign exchange trades – a sum substantially more than its net profit in 2007.

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