TEST FOR POST-CRISIS BANKING SYSTEM The market turmoil this week will test Washington’s efforts over the last five years to bolster the financial system, Peter Eavis reports in DealBook. Investors are stampeding out of risky markets, dumping junk bonds issued by American energy companies that have borrowed heavily to exploit the shale oil boom. A steep slide in the price of oil could now cause some of the companies to default, analysts say. But the most dangerous pain is occurring abroad, particularly in Russia, which is dealing with a currency crisis.
“Such difficulties echo the crisis that buffeted markets in the developing world in 1998, when Russia actually defaulted on debt denominated in rubles,” Mr. Eavis writes. Back then, contagion made its way onto Wall Street through an enormous hedge fund called Long-Term Capital Management that nearly collapsed after making bets way beyond its means. “The parallels with 1998 have led investors and regulators to ask if any similarly dangerous weak points exist today. And if they do, the question is whether the big banks are sturdy enough to bear the shocks,” Mr. Eavis writes.
For the moment, many specialists say the system is sufficiently girded. For one, the big banks today rely less on borrowed money to finance their trading and lending. And the Wall Street banks are not lending as much money to hedge funds and other investors to make highly speculative bets. Still, the big banks continue to rely on billions of dollars in short-term loans that could dry up in a panic. And some investors are concerned about geopolitical risks undermining economic confidence. The plunging oil price, for instance, could create even harder economic times for countries like Russia and Iran. But low oil prices might also constrain governments that have stoked instability.
BOND INVESTORS SKITTISH OVER EMERGING MARKETS The biggest energy companies in some of the biggest emerging markets ‒ Petrobras in Brazil, Pemex in Mexico, Gazprom in Russia ‒ sold billions of dollars of bonds to investors eager to capitalize on the high interest rates. But as the price of oil tumbles and local currencies plunge in value, those bonds are looking shaky, Landon Thomas Jr. writes in DealBook. Concerns are now mounting that their troubles will unleash a new wave of market contagion as big funds unload their stocks, bonds and other investments in these countries, Mr. Thomas writes.
The steep slide in the Russian ruble ‒ and the collapse of the country’s bond and stock markets ‒ has already rattled investors, driving a sell-off in Mexico and Brazil. Like Russia, these countries also relied on cheap money to bankroll their energy investments and fund their growth. Economists have also warned of broader economic ripples if big, state-run companies like Petrobras and Gazprom are cut off from the bond market and lack alternative financing options. The bond yields of all three companies, which move in the opposite direction of their underlying price, have surged in recent days.
The debt issued by Petrobras, Pemex and Gazprom can be found in the portfolios of bond investors worldwide, including BlackRock, Pimco and Franklin Templeton. Now investors are realizing just how risky these bonds are. Pimco’s Emerging Market Corporate Bond Fund, for instance, has seen its performance sag and investors withdraw their cash. The fund’s assets now stand at $496 million, compared with $1.5 billion in late 2013, suggesting it can’t weather too much more.