Those who don’t learn from history, are doomed to repeat it.
However, the financial crisis of 2008-09 is a history you would want to avoid at all costs. And that is exactly why those who are aware of the gloom, that the Infamous crisis bestowed upon us (ahem), are keeping a close eye on the ongoing turmoil, that ‘Credit Suisse’ finds itself to be in.
With $22 Billion of Revenue, $1.5 Trillion of ‘Assets under Management’ and currently operating in 50+ Countries, the Swiss Mammoth is a systematically important financial institution. And given the scales, it's a no-brainer why its collapse can herald another calamity, with multi-fold consequences, just like what happened in 2008, when 'Lehman Brothers’ an organization that was deemed ‘Too big to fail’, went under and triggered worldwide mayhem. Flashes of those times still send a chill down the spine of Economists all over the globe alike.
But before we draw the parallels between the two companies and their predicament, let us understand a few terms.
First is Credit Default Swap (CDS)-
In lehman oops.. laymen’s terms, it's an insurance instrument, in which the insuring party charges an upfront fee for the promise of reimbursing them any losses due to the default by the borrowers. Here, the borrowers are usually companies that issue Bonds. In essence, the parties agree to swap the risk of Credit default.
(https://prepnuggets.com/glossary/credit-default-swap)
The fees charged by the party assuming the risk of default is called 'Credit Default Swap Spread' or CDS Spread. Higher the risk, the higher the CDS Spread that will be charged. Conversely, the higher the spread on a particular security, the higher the chances of it defaulting on its repayment commitments.
With this out of the way, let's wipe the dust off of our time machine, and travel back to 2007-08, when American Real Estate Sector was on an unprecedented boom, and Banks were churning out House Loans against Mortgage- Backed Securities, at a rapid pace. Thus, every Tom, Dick, and Harry were granted loans and bought homes, irrespective of their financial capabilities and credit history. Banks then hedged themselves by signing Credit default swaps with Institutions like AIG and..... (drumrolls please) Lehman Brothers. This activity spearheaded the ill-famed ‘Housing bubble’.
But like every other bubble that ever graced this planet, this one too, sooner or later, had to burst. And as they say, when it rains, it pours.
Due to the influx of so many houses in the market and people failing to honor their commitments, the housing sector collapsed like a bunch of legos. With piling defaults, Banks turned to the Institutions that issued Credit Default swaps, to get the payment. But those institutions weren't any Cash Printing Genie who could summon such humongous amounts at such short notice.
Subsequently, due to abnormally high default claims, they were left with no cash to honor the swaps and were looking at possible Bankruptcy. Although Institutions like Citi Banks and AIG were bailed out by the government, Lehman Brothers found themselves beyond salvation. They ultimately collapsed and declared bankruptcy on 15th September 2008. Their downfall and the aftermath of this crisis ushered an era of disastrous financial ramifications for the global economy.
Coming back to 2022, Macro-Economic factors don't instill a lot of confidence in the European Economy. With the ongoing Russia-Ukraine War, Energy prices rising by 175%, rapid depreciation of the Pound, and Europe still recovering from Covid-19's implications, it won't be an understatement to say that things are looking a bit iffy.
Further, after incurring losses in the last 5 out of 7 quarters, and laying off 500+ employees, Credit Suisse has watched 66% of its market cap getting eroded, since the beginning of 2022.
Along with that, the CDS spread on Credit Suisse's bond (which, as discussed earlier, indicates the risk on the security) stands at an all-time high of 4.4%, with the same metric for its Industrial counterparts standing at appx. 0.6%-0.8%. And with rising chances of defaults on loans due to severe economic shortcomings, investors are afraid that a fate like Lehman Brothers, might await Credit Suisse.
However, when we compare the position of Lehman Brothers at the time of bankruptcy, and Credit Suisse as of now, one might feel that the talks of Credit Suisse going down, is getting blown way out of the proportions.
Let us have a look at the factors given below.
Factor Lehman Brothers Credit Suisse Cash in Hand$19548 Mil$159752 Mil(Cash in Hand as % of assets)3.10%21.30%% of Assets in form of Securities 88.20%30.33% Leverage Ratio 24.34 Times15.9 Times
Also, Credit Suisse has a CET-1 Ratio of 13.5 % and a liquidity ratio of 191%. As one can see, it is in a significantly better position in almost all of the metrics. Further, The company is in process of raising $4 Billion from its existing investors and has onboarded a new CEO, who is faced with two impending tasks, i.e., to cut costs by $1 Billion p.a. and restructure the IB Department. Considering all of these, one can assume that the company is committed to getting back on track, as soon as possible.
But that does not undermine the gravity of the bedlam looming over it’s head. The risk is too damn high, but not all hope is lost. Whether Credit Suisse will go tumbling down or will it steer away from the danger unscathed, only time will tell. But one thing is for sure, a very cold winter awaits the Swiss Giant.
However, before departing, I'm going to leave you with an interesting trivia. The last name of the newly appointed Chairman of Credit Suisse is...wait for it...
Lehmann. Take that as you may, and I'll see you pretty soon.
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