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Start of a New Crisis?

ted-spread

I’ve had a couple of people ask me if the Dubai debt default is the start of a new financial system crisis, much like the bankruptcy of Lehman Brothers started last year’s stock market crash.

To determine if there is a systemic issue with the global financial system, we have to look at the chart above. I’ve written before about the TED Spread – the ratio of treasury to euro dollar yields. Generally, in a normally functioning market, the spread between the yields is around 1/4%. However, as you can see on the chart, when the subprime crisis started to pick up in 2007, you can see that the TED spread jumped from its normal range.

Those of you who’ve been reading this blog and my other writings since then recall that I told you we were reducing our financial sector exposure to zero at that time. The move of the TED spread was our indicator to do that. However, a significant move above 250 generally means that we have a systemic problem with the financial system. Normally, we’d anticipate an elevated level for a bit to precede a stock market crash – much like we had for a few weeks prior to the 1987 crash. However, you can see that the Lehman bankruptcy (which happened over a couple of days) shows that the indicator moved from 100 to 450 virtually overnight.

Fortunately, you can see that the TED Spread is hovering in the normal 25 range. So, given that the this indicator does not show we have a systemic problem, I don’t believe the Dubai crisis will lead to a wider global financial system crisis. It is more indicative of just the next stage of the ongoing current financial problem. The thing that is cushioning the impact of this dropping shoe is all of the liquidity that is floating around the world.

So, it is possible that there are other Dubais our there in the world that will pop up, and they might be giant sized problems. It is even possible that there will be a domino effect of one after another that could cause a Lehman-like impact on the system. However, the TED spread doesn’t show it, and until it does there is no need to borrow trouble.


This video requires that you follow the link to YouTube to watch it. They have the embedding feature disabled for some reason