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Credit crunch puts global growth at risk: IMF chief

Champions of super fund to rescue mortgage market seen losing case

(WASHINGTON/ZURICH) World credit markets ‘have lived through an earthquake’ and the question is now whether the global economy has reached a turning point after five years of strong growth, the head of the International Monetary Fund said yesterday.

Addressing the IMF’s 185 member countries, IMF managing director Rodrigo Rato warned of aftershocks in markets, saying the full effects of the credit crunch, which began in the US sub-prime mortgage market, were still not fully understood.

‘We already know that we should not try to regulate crises out of existence: that would be like trying to ban earthquakes,’ he said. ‘But the weaknesses in our infrastructure that have been exposed need to be addressed.’ Mr Rato added: ‘The question is now whether the global economy is at an inflection point.’

The outgoing IMF chief noted that in developed countries, corporate balance sheets were strong and labour markets generally healthy.

‘For these reasons, we expect a slowdown in growth but not a recession in the United States, and a smaller slowdown in other advanced countries,’ Mr Rato said, adding that emerging economies had become a source of stability in the global economy.

Mr Rato said risks to global growth were higher than just six months ago and the market turmoil was a warning that good times may not last forever.

Further disruption in financial markets and falls in housing prices could lead to a steeper global downturn, he warned.

So far, movements in exchange rates have been orderly and in line with fundamentals, Mr Rato said, further warning that if the dollar should abruptly fall, it could provoke a loss of confidence in dollar assets.

There was also a risk that the rise of other currencies, such as the euro, could hurt those regions’ growth prospects, he added.

Furthermore, there was a risk that emerging economies that have relied on external financing to fund large current account deficits could be tipped into crisis by a combination of reduced demand for their exports and tighter financial market conditions.

Meanwhile, whether a US$75 billion fund to rescue the battered mortgage-backed securities market takes off or not, its sponsor US Treasury Secretary Henry Paulson seems to be losing the argument over its merits, strategists and economists said.

The fund, announced recently by Citigroup, Bank of America and JP Morgan with Mr Paulson’s support, aims to prevent structured investment vehicles (SIVs) from making panic sales of bonds linked to US sub-prime mortgages.

Many of the SIVs – off-balance sheet vehicles holding some US$370 billion in assets that rely on short-term financing to make a return – are struggling to stay afloat as investors shy away from buying their commercial paper.

The plan has faced a rising tide of criticism, not least from former Federal Reserve chairman Alan Greenspan, who said last Friday the super fund may do more harm than good.

Financial strategists contacted by Reuters said time is running out for the plan’s champions to regain the initiative and the fund risks being still-born.

‘I think they are losing the intellectual argument,’ Ian Harnett, a director at financial consultancy Absolute Strategy in London said yesterday.

The fund was nevertheless more likely than not to go ahead because of the potential embarrassment for the three US banks and for Mr Paulson himself if the idea is scrapped, said Mr Harnett.

‘I would still put it at 70 to 30 that it does happen because of the reputational risk,’ he said.

A global credit crunch, originating from huge losses in US sub-prime mortgage lending, has put acute pressure on SIVs, as demand dried up among investors for the short-term paper SIVs issue to fund investments in high-yielding asset-backed securities with longer maturities.

A fire-sale of assets by the SIVs, set up mainly by banks, would force banks into a fresh round of writedowns of securities held on their balance sheets and result in them granting fewer of the loans that are the life-blood of the global economy.


Source: Reuters (Business Times 23 Oct 07)

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