Party Like It’s 1998. Russia Will Default Again. Remember The Last Time?

We’ve all followed the cascade of financial and economic sanctions the U.S. and its allies have piled upon Russia in the past two weeks.

The assets of the Central Bank of Russia (about $600 billion) have been frozen. Major Russian banks have all been kicked out of the global financial telecommunications system called SWIFT. High-tech and luxury exports to Russia have been banned.

Western banks are not allowed to trade or underwrite securities of Russian issuers. The assets of Russian oligarchs from super-yachts to multi-million townhouses in London are being seized.

The list goes on. But all of these banks and borrowers were doing business with investors in the West. When you freeze Russian payments, some Western bondholder is not getting paid, and some investor will end up taking the loss. That investor could even be you. If you look inside your 401(k), you might find an emerging markets ETF or fund that just happens to hold some Russian debt.

The point is that it’s easy to slap on sanctions, but it’s almost impossible to ascertain exactly where the loss will fall. This phenomenon is called “contagion.” It works exactly like a virus. One creditor loses money, and that causes him to default to another creditor, and so on.

It’s exactly the way a virus spreads from one victim to another. The most famous case of this also involved a Russian default. That was in 1998.

That financial crisis started in Thailand in 1997, spread to Indonesia, Malaysia, and South Korea before hitting Russia. From there, the next victim was not another country but a hedge fund in Greenwich, Connecticut called Long-Term Capital Management.

The Fed had to organize a $4 billion bailout to save world markets. I negotiated that bailout on behalf of LTCM as I explain in this interview with Fox Business. Now it’s happening again.

Russia is on the brink of defaulting on its debt, as described in this article. The initial losses could be as high as $150 billion. That’s based on the outstanding debt. But then contagion takes over.

There will be some initial losers, but those losses could cascade out of control as they did in 1998. Banks, brokers, and hedge funds are all at risk.

Individual investors could be at risk also as panic sets in and investors sell everything to raise cash. You can get ahead of that by reducing equity exposure and increasing allocations to cash now.

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