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In January I quoted a report by the IIF that predicted 2009 would see a huge decline in capital flows to emerging markets, with Eastern Europe and Russia particularly hard hit. Now we can add a new dynamic to the mix: not only is new money going to stop flowing, but much of Eastern Europe's debt is short-term and will need to be either paid back or rolled over this year. Here's an article that lays out the implications, (via naked capitalism):

Stephen Jen, currency chief at Morgan Stanley, said Eastern Europe has borrowed $1.7 trillion abroad, much on short-term maturities. It must repay – or roll over – $400bn this year, equal to a third of the region's GDP. Good luck. The credit window has slammed shut....

Almost all East bloc debts are owed to West Europe, especially Austrian, Swedish, Greek, Italian, and Belgian banks. En plus, Europeans account for an astonishing 74pc of the entire $4.9 trillion portfolio of loans to emerging markets....

Whether it takes months, or just weeks, the world is going to discover that Europe's financial system is sunk, and that there is no EU Federal Reserve yet ready to act as a lender of last resort or to flood the markets with emergency stimulus....

As the article points out, $400 billion is also well beyond the capacity of the IMF. So where is the money going to come from? Or are we going to see swathes of bankrupt EU member states? This is messy stuff.

What's interesting is that recent history is filled with examples of countries who have set themselves up for precisely this sort of problem. In the mid-1990s, many East Asian countries (and their banks) were fueling their rapid economic growth with large amounts of short-term debt that was constantly in need of being "rolled over," or pushed off until a later date. But if creditors decide not to roll over your debt, you're in trouble - especially because creditors tend to be fairweather friends who will ask for their money back as soon as your financial situation starts looking shaky.

Moreover, many of these countries suffered from what are called currency mismatches: a state/firm borrows in a foreign currency and holds assets in the domestic currency. If the value of the domestic currency plummets, suddenly the debt becomes a whole lot more expensive - the assets are basically worth less to your creditors than they were a short time ago. That's what happened in East Asia, and sure enough, that's exactly what's happened once more. Again from the article:

In Poland, 60pc of mortgages are in Swiss francs. The zloty has just halved against the franc. Hungary, the Balkans, the Baltics, and Ukraine are all suffering variants of this story. As an act of collective folly – by lenders and borrowers – it matches America's sub-prime debacle....

And just to tie this all together:

"This is much worse than the East Asia crisis in the 1990s," said Lars Christensen, at Danske Bank.

It's discouraging reading. But from a political economy point of view, I'm curious as to what sort of incentives led banks to place themselves in this situation once more. Since they were probably aware of the precedent, there must have been incentives that outweighed their sense of prudence. Was it greed? Moral hazard? Prudential regulatory failures? A tragedy of the financial commons? I think I smell a steaming pile of Ph.D theses.