Shock to the System
IN PRINT ARCHIVE CIR Summer 2008
to the System
By Wesley Phoa, vice-president, Capital Strategy Research Inc.
system is undergoing a severe crisis. The International Monetary
Fund has estimated that aggregate credit related losses might approach
$1 trillion. The global system is capable of absorbing that loss,
but there will be a significant impact on economic activity in the
medium term and on the structure of credit markets over the long
There has been no widespread credit crunch, but some markets have closed. While private sector mortgage- and asset-backed securities can still be issued, spreads are too wide to make ongoing loan origination viable. The secondary high yield and leveraged loan markets are active, but primary issuance is difficult. And markets for the highest quality credits have recovered substantially: debt can be placed, and while spreads are very wide, absolute yield levels are reasonable.
will continue. First, while subprime losses are well understood,
and alternative asset losses to some extent, ultimate losses on
option adjustable rate mortgages and home equity loans remain uncertain.
Second, losses on structured credit securities are unknown. Third,
a number of non-viable leveraged entities have not yet unwound,
but will do so. Fourth, losses related to commercial real estate
have not yet been fully recognized. Fifth, economic slowdown will
affect companies that recently underwent a leveraged buy-out, and
may lead to defaults.