Good and Bad Reasons to Worry About the Credit Crisis of 2008

Floyd Norris's column today reads as though it was written by two different people. Most if it is very good – a clear explanation of where the next credit crisis might come from. But then, at the end, it falls apart.

Paul Krugman has already pointed out the most obvious error: total subprime losses can't exceed total subprime losses, no matter how much dubious financial engineering was going on. Norris should have trusted his first instinct: anybody telling him something which "appears absurd" is, probably, telling him something which is absurd.

Norris then continues in such a vein, first talking about "C.D.S. defaults" (I think he's talking about counterparty risk here, but who knows), and then seemingly imagining that he's back in 1998:

Others worry that some emerging markets could run into big problems because many borrowers there have taken out loans denominated in foreign currency and could be devastated if local currencies lose value.

He means, of course, "lose value against the dollar" – which means that Norris is now worried that the US dollar is going to strengthen. But in any case, the currency-mismatch problem is much less of an issue now than it was ten years ago. Big sovereign borrowers are fast developing deep local capital markets where they can borrow money domestically in their own currency, and smaller ones are increasingly borrowing in their own currency abroad. Those few emerging-market borrowers which do still issue a lot of dollar-denominated debt are invariably in export industries, and therefore their income is in dollars rather than local currency in any case.

Norris's big-picture conclusion, then, is quite right: the credit crisis isn't just about subprime, and there could be multiple more shoes to drop in 2008. But some of his specific examples could have been better chosen.

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