Credit crunch losses will top $945-billion: IMF

Credit crunch losses will top $945-billion: IMF

HEATHER SCOFFIELD
Tuesday, April 08, 2008

Ottawa — The International Monetary Fund is pegging the losses related to the global financial crisis at $945-billion (U.S.), and warns that the side-effects of the credit problems will be harsh.
“It is now clear that the current turmoil is more than simply a liquidity event, reflecting deep-seated balance sheet fragilities and weak capital bases, which means its effects are likely to be broader, deeper, and more protracted,” the Fund says in its Global Financial Stability Report, released Tuesday morning.

The IMF issues the report twice a year to assess the fragility of the state of global finances. The April report raises the alarm, warning central banks and financial institutions that they should prepare for the worst.

“Notwithstanding unprecedented intervention by major central banks, financial markets remain under considerable strain, now compounded by a more worrisome macroeconomic environment, weakly capitalized institutions, and broad-based de-leveraging,” states the report, issued just days before central bankers and finance ministers meet in Washington for their bi-annual meetings which are expected to focus on how to resolve the crisis.

The increased strain on the global financial system is coming from a simultaneous deterioration of credit quality, a drop in valuations given to structured credit products, a market liquidity drought and the ongoing de-leveraging in the financial system.

“The critical challenge now facing policy makers is to take immediate steps to mitigate the risks of an even more wrenching adjustment, including by preparing contingency and other remediation plans, while also addressing the seeds of the present turmoil,” the IMF paper warns.

The estimate of potential losses at $945-billion is on the pessimistic side, but is not outrageously high. More pessimistic analysts have pegged total losses at well above $1-trillion when all is said and done.

Still, the IMF warns that the losses may circle back to hurt financial institutions in a second round of effects, especially as monoline insurers run into trouble. Plus, the risk of litigation is growing, the report warns.

While the United States remains the “epicentre” of the crisis, the spillover effects to other industrialized countries is major. The IMF warns that industrialized countries with inflated house price levels, as well as stretched corporate and household balance sheets.

The Bank of Canada has repeatedly pointed out that in Canada, corporate and household balance sheets are remarkably healthy, and financial institutions are well capitalized.

However, analysts are watching house prices closely for signs of bubbles. And the central bank is moving to set up new liquidity functions in case the credit crisis takes more direct aim at credit conditions and solvency in Canada. Until now, however, the main effects of the global credit crunch have been in the form of tighter credit and a slower economy, especially for Canada's non-commodity exports.

The head of the IMF, Dominique Strauss-Kahn, said this week that the need for government intervention in credit crisis is becoming more evident, but the Global Financial Stability Report steered clear of such sensitive issues. Rather, it stuck to suggestions for private-sector action and urged central banks to devise ways to stabilize the financial system without increasing moral hazard and fiscal costs.

In question is whether the rescue of investment bank Bear Stearns, led by the U.S. Federal Reserve last month, was a one-time event, or just the beginning of a string of major financial institutions hovering on the brink of insolvency. The debate will likely dominate the spring meetings of the IMF and Group of Seven this weekend.

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