The financial crisis is not over yet

This morning’s financial news is dominated by fears that the state-owned Dubai World is about to default on its debt repayments.

And guess which bank has the largest exposure to Dubai World? Of course, that’ll be good old Royal Bank of Scotland, underwritten by the British taxpayer.

Don’t worry, though, because RBS has only lent £2.2 billion to Dubai. That’s nothing compared to the huge amounts of toxic debt we were discussing this time last year. This morning’s initial panic seems to be subsiding after bankers and world leaders insisted that Dubai’s default would not cause major damage to the global economy.  

All the same, as Gillian Tett says, Dubai’s troubles are a sign that the financial crisis is still not over.

[W]hile investors used to assume that it was just emerging market countries that were prone to suffering truly nasty fiscal shocks, the debt fundamentals in Dubai are not necessarily so different from those in developed nations, be that Greece or even the US. Suddenly the line between “emerging” and “developed” countries is becoming more blurred.

So perhaps the best way to view the events in Dubai – and the Greek CDS price – is as a welcome wake-up call. In recent months, a sense of stabilisation has returned to the financial system as a whole, as central banks have poured in vast quantities of support. A striking liquidity-fuelled asset price rally has also got under way.

But the grim truth is that many of the fundamental imbalances that created the crisis in the first place – such as excess leverage – have not yet disappeared. Beneath any aura of stability huge potential vulnerabilities remain.

As my dad would have said, we’re not out of the woods yet.