tastytrade logo
Ukraine-Russia War's impact on financial systems represented with dominos being knocked down

Mar 18, 2022

Existential Threats

By:Josh Fabian

Watch more episodes of Sosnoff & Ratigan: Truth or Skepticism

For as long as markets have existed, financial engineers have worked to create products that create leverage allowing both customers and institutions to make more money by taking more risk. 99% of the time, it’s a very good thing. For example, mortgages are leveraged products that allow people to buy homes they otherwise couldn’t afford. Property is pledged as collateral in exchange for a loan to buy the property. Pledging of collateral in exchange for loans is perhaps the oldest form or leverage to exist. But what happens when the collateral loses its value?

In 2008, we saw what can happen when property loses value and loan amounts exceed property values. That problem was only exacerbated by the collateralized debt instruments banks created. The entire world’s financial system was brought to its knees. In 2022, there is a potentially similar problem. However, in this instance the risk stems from Russian stocks and property pledged as collateral in exchange for loans.

Sanctions on Russia caused the Ruble to lose more than half its value at one point. How far it will fall remains to be seen. When a currency is devalued like that, not only does everything begin to cost more (inflation), but anything tied to that currency loses value. Case in point, Russian stocks and property. The same stocks and property put up in exchange for loans from banks in places like, say, Europe.

Financial Crisis Domino Effect

Let’s look at a relatively simplistic example to illustrate our point. Assume a bank only has one customer and accepted five million Rubles from that customer in exchange for a one million U.S. dollar loan. Take it a step further (because these things are always more complicated than they appear) and imagine that same bank turned around and pledged those Rubles to a bank in Vietnam (you can really choose your own adventure here) as collateral against Vietnamese commercial paper. Suddenly overnight the Ruble loses half its value. The Vietnamese bank calls the European bank saying it needs more collateral against the commercial paper, but the European bank doesn’t have more money. So they call their customer for more money against his/her loan, but the five million Rubles was all they had. Are you picturing one of those incredibly long domino chains yet? No? Watch this…

Because the customer has no more money, the European bank demands the customer return the loan. However, that customer used the loan to buy a house in St. Petersburg which has lost half its value. And now we’re off to the races.

Even if they sold their house now, the most they could get is half what they paid. The bank, strapped for more money, forces a sale of the home. The customer gives all the proceeds to the European bank, who then turns around and gives the Vietnamese bank those same proceeds. However, it’s still not enough. So the Vietnamese bank forces the European bank to sell the commercial paper. That pushes down the value of the commercial paper below what the bank paid. Those funds are then given back to the Vietnamese bank. The original investor has now lost everything and still owes money. The European bank, which still owes the difference between what they paid for the paper and where they sold it, has lost everything. And the Vietnamese bank has, at a minimum, taken a loss on their loan (but the reverberation of this likely extends well beyond those three parties). Confused?

Risk to Financial Markets

An interconnected financial system has a ton of benefits. However, it also is susceptible to some vulnerabilities. Risk management systems are implemented to protect against most potential situations. But not too many people had Russia invading Ukraine on their bingo card until very recently.

Whether this results in a catastrophic shock to the entire financial system remains to be seen. Hopefully, the situation in Ukraine ends simply for humanitarian reasons. The longer it carries on is not only devastating for humanity, but could also increase risk to financial markets.

Written by Dylan Ratigan and Josh Fabian

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

Related Posts

tastytrade content is provided solely by tastytrade, Inc. (“tastytrade”) and is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, transaction or investment strategy is suitable for any person. Trading securities can involve high risk and the loss of any funds invested. tastytrade, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Investment information provided may not be appropriate for all investors, and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. tastytrade is not in the business of transacting securities trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. Supporting documentation for any claims (including claims made on behalf of options programs), comparison, statistics, or other technical data, if applicable, will be supplied upon request. tastytrade is not a licensed financial advisor, registered investment advisor, or a registered broker-dealer. Options, futures and futures options are not suitable for all investors. Prior to trading securities products, please read the Characteristics and Risks of Standardized Options and the Risk Disclosure for Futures and Options found on tastyworks.com. 

tastytrade is a trademark/servicemark owned by tastytrade.

tastyworks, Inc. ("tastyworks") is a registered broker-dealer and member of FINRA, NFA and SIPC. tastyworks offers self-directed brokerage accounts to its customers. tastyworks does not give financial or trading advice nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of tastyworks’ systems, services or products. tastyworks is a wholly owned subsidiary of tastytrade, Inc (“tastytrade”).

tastyworks, Inc. (“tastyworks”) has entered into a Marketing Agreement with tastytrade (“Marketing Agent”) whereby tastyworks pays compensation to Marketing Agent to recommend tastyworks’ brokerage services. The existence of this Marketing Agreement should not be deemed as an endorsement or recommendation of Marketing Agent by tastyworks. tastytrade is the parent company of tastyworks. tastyworks and Marketing Agent are separate entities with their own products and services. tastytrade has different privacy policies than tastyworks.

Quiet Foundation, Inc. (“Quiet Foundation”) is a wholly-owned subsidiary of tastytrade The information on quietfoundation.com is intended for U.S. residents only. All investing involves the risk of loss. Past performance is not a guarantee of future results. Quiet Foundation does not make suitability determinations, nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of Quiet Foundation’s systems, services or products.

© copyright 2013 – 2022 tastytrade. All Rights Reserved. Applicable portions of the Terms of use on tastytrade.com apply. Reproduction, adaptation, distribution, public display, exhibition for profit, or storage in any electronic storage media in whole or in part is prohibited under penalty of law, provided that you may download tastytrade’s podcasts as necessary to view for personal use.