Would You Recognize a Crisis When You See It?

Would You Recognize a Crisis When You See It?

The complexity of financial instruments (credit default swaps, commercial paper, etc.) makes understanding the current economic situation very difficult for all but the most highly-versed financial professional. However, the sheer size and scope of the global banking industry contribute to the inability in appreciating the consequences of the ongoing credit crisis.

During the second quarter of 2008, data from the Bank for International Settlements (BIS) showed international banking activity dropped 3 percent versus the first quarter, or a whopping $1.1 trillion. To put it into perspective, this percentage decline is nearly three times the size of any previous calamity  over the past 30+ years (e.g.: the bursting of the dot-com bubble, Long Term Capital Management's failure). This contraction was largely prompted by financial institutions refusing to lend to one another as they didn't trust that they would be paid back or feared that they would need the funds for themselves to cover their own (deteriorating) positions. Since Lehman Brothers folded during the third quarter-in mid-September to be exact-and subsequently prompted a near-seizing of the financial system, the next set of data will look much worse by comparison. A trillion dollars here, and a trillion dollars there and pretty soon you're starting to talk about a lot of money.

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