Financial storm or perfect storm?

April 2008 | By Francisco Lopez Lubian, Professor of Finance at IE Business School

The subprime crisis, which began with problems of liquidity, is now a confidence and profit crisis with a marked impact on the real economy. The virtuous circle could be turning vicious.

The financial crisis unleashed last summer was previously announced and summarised by reports from international organisations such as the IMF and the BIS. Essentially, the message at the time was: the real economy, fine; but be careful with the excesses of the financial economy.

At present, can we confirm that the crisis is essentially financial or are we in a situation where the elements necessary for a perfect storm have been blown together?

One summary of the facts could be the following:

1) Recent years of expansive monetary policy with negative interest rates in real terms, which has allowed intense growth in consumerism and investment (homes, corporate takeovers) based on significant family and corporate leverage.
2) A widespread development of financial products, especially credit risk transfer (CDS, CLO/CDO), on both a national and international scale.
3) An increase in the securitisation of credits, which has enabled an apparent alienation of risk and profits obtained simply from the structure.
4) The purchase of this securitised debt by investors who were looking for a higher level of profitability than that offered by the traditional markets on a scenario of very low interest rates.