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The losses which inflicted many subprime mortgage investors are the direct result of the concentration of those risks by leveraging their positions with borrowed funds. The use of ten leverages for example, can transform a 10 % loss for a given initial capital. In addition, many of the positions were funded with very short-term loans. This strategy parallels that of the savings and loan associations of the 1980s, who also used maturity mismatched and leveraged portfolios, and with similarly dire results (Allen, Franklin, and Douglas Gale, 1994).

2.1.3. TRANSMISSION OF THE CRISIS TO THE DEVELOPING WORLD

There are many conditions which contributed to the transmission of the financial crisis from the US to the developing world. The echo of the financial crisis which inflicted the US caused tremendous fear in the developing world in both direct and indirect ways. Banks in developing countries can be affected to the extent to which they hold assets contaminated by subprime mortgages.

Many developing-country banks had limited interrelationships with international banks. Foreign owned banks are not significant players in most countries in Latin America and Africa (Naude, Wim, 2009. p.4). The exposure to subprime mortgages of United States origin in China, where the financial sector is largely controlled is minimal. However, there is a more serious indirect threat represented by declines and deterioration of stock market prices and housing prices.

As a result, the capital of banks is reduced. This might cause certain problems where they don’t hold sufficient levels of their capital in cash. In these situations, it is likely that banks will reduce lending in order to support their capital. Worse than that is that banks might face solvency problems and may require their governments to recapitalize them. Reduction in investment will be the direct result of reduction and shortage of capital. This will lower growth rates and increase unemployment rates which in turn will reduce economic growth further.

The second factor which contributed to the transmission of the crisis is reduction in export earnings. In recent years, most developing countries are basing their economies growth on exports. The most significant cases include China, India, Japan, Korea, Malaysia, and others. It is likely that the crisis will lead to a substantial decline in the countries' export earnings. The IMF expects growth in world trade to decline from 9.4 per cent in 2006 to 2.1 per cent in 2009.9. The expected declines will come through a combination of a decline in commodity prices, a decline in demand for their goods from advanced economies and a decline in tourism (Naude, Wim, 2009).

Export earnings are deeply affected by declines in commodity prices. The World Bank predicts that non-energy commodity prices shall decline by 19% in 2009 (Naude, Wim, 2009). A large proportion of countries which depend on commodity prices are in Africa. Over the past seven years, the prices of commodities, including copper, nickel, platinum and petroleum have risen to record highs, and contributed significantly to good growth in these countries.

The third factor is financial flows. The global financial crisis will have significant effects on international financial flows, with private financial flows developing countries expected to fall rapidly fr