7 - Mathematizing risk: models, arbitrage and crises

Summary

Two moments in the financial history of high modernity: Monday, 17 August 1998. The government of Russia declares a moratorium on interest payments on most of its rouble-denominated bonds, announces that it will not intervene in the markets to protect the exchange rate of the rouble, and instructs Russian banks not to honour forward contracts on foreign exchange for a month. Elements of the decision are a surprise: countries in distress usually do not default on domestic bonds, since these can be honoured simply by printing more money. That Russia was in economic difficulties, however, was well known. Half of its government income was being devoted to interest payments, and investors – some fearing a default – had already pushed the yield on GKOs, short-term rouble bonds, to 70 per cent by the beginning of August. Nor is the news on 17 August entirely bad: Russia manages to avoid a default on its hard currency bonds. And Russia, for all its size and nuclear arsenal, is not an important part of the global financial system. ‘I do not view Russia as a major issue,’ says Robert Strong of Chase Manhattan Bank. Wall Street is unperturbed. On 17 August, the Dow rises almost 150 points.

Tuesday, September 11, 2001. Two hijacked planes destroy the World Trade Center in Manhattan, and a third hits the Pentagon, the heart of American military power. Thousands – the exact number only slowly becomes known – die.