More Trouble To Come

The Bank of England says that global losses on `toxic' assets have now soared to $2.8 trillion. There could be more financial instability to come.

The latest Financial Stability Report from the Bank of England makes for depressing reading. Let's start with the outlook for insurers.

Insurance companies

The Bank of England warns that insurance companies could hit trouble. Insurers hold a significant proportion of their assets in shares and corporate bonds, and the value of these assets has fallen in recent months.

The danger is that falling asset values could mean that insurers won't have enough assets to meet capital adequacy requirements. So insurers might have to raise fresh funds from the stock market or the government.

The Bank's report, however, argues that regulatory reforms in 2004 have reduced the chances of an insurance crisis. The report also points out insurance companies generally haven't used much leverage (borrowing to increase returns on investments.)

Hedge funds

It's a different story with hedge funds though. These funds are notorious for using leverage and are paying the price now. Hedge funds have, on average, fallen 10% in value in last quarter, according to the bank. As a result, hedge fund investors are withdrawing money which is forcing share sales by the funds.

What's more, in the current climate, hedge funds are struggling to borrow to cover their losses, which means they have to sell more shares.

Banks and toxic debt

Banks' losses on `toxic debt' in the UK, Europe and US have more than doubled to $2.8 trillion (£1.8trillion), according to the bank. Non-financial companies may also wish to borrow more from the banks on existing credit facilities as the economy slows.

That means banks may need to raise further capital at some point. That money may come from the stock market or governments. Today's report also says that banks need to reduce their reliance on short-term money markets for funding.

The falling pound

The bank's report doesn't touch on the falling pound which I think is another big issue in the current crisis.

The pound had edged up today but the current rate of $1.57 per pound is still well below the $2 rate we saw in the summer. That's bad news for those of us who want to travel to the US, but more importantly, it could also inflict further damage on our financial system.

Financial website, breakingviews, reports that the UK financial system has £333bn of foreign interbank deposits. A falling pound might encourage some foreign investors to withdraw cash and that could hurt UK banks further.

Emerging markets

Some emerging market economies are in deep trouble such as Ukraine and Hungary. Put simply, these countries have borrowed too much and may not be able to pay back their loans. Banks in the developed world that have significant operations in these countries will suffer.

Housing Market

Away from the Bank of England, the FSA has released some gloomy data on repossessions - the number of repossessions has risen 71% over the last year.

What now?

The UK economy is clearly in serious trouble. The only question is whether we'll see further major instability in the financial system. I've said before that I thought we were probably through the worst in the banking crisis. I worry I may have been too optimistic.

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