IMF Warns World Credit Risks Remain High

Sources:
"Year After Subprime Crash, Risks Remain Elevated, Says IMF"
"IMF Gloom Over 'Fragile' Markets and Global Risk"

In the International Monetary Fund’s (IMF) Global Financial Stability Report Market Update, released July 28, the IMF warned that the U.S. subprime market crisis continues to trigger turmoil in the global financial markets. As a result, the resilience of emerging markets is being tested and policy trade-offs between inflation, growth, and financial stability are becoming increasingly difficult for policymakers around the world. The IMF addressed three areas in the report; 1) slowing global growth, 2) growing U.S. problems, and 3) governmental responses.

The IMF expects global growth to slow considerably in the near future because of high energy prices and concerns about rising inflation. The inflation risks have caused policymakers to become less supportive of actions to stabilize the financial markets which could lead to higher inflation. The IMF also noted that the U.S. housing market has not stabilized and “a bottom for the housing market is not visible.” This combined with a softening of the housing market in Europe will likely lead to future loan losses. According to the IMF, global financial institutions have written off around $400 billion in bad loans since last August and predict that this cycle could total $945 billion in losses. While these institutions have successfully raised large amounts of capital to cover the losses, the IMF cautioned that additional write offs and slowing worldwide growth could make it more difficult to raise capital.

The IMF did praise the extraordinary steps that central banks in mature markets have taken to prevent systematic risk from spreading. This included the support the U.S. has given to Freddie Mac and Fannie Mae, which the IMF noted would have dire consequences if allowed to fail. According to the IMF, further interventions by governmental authorities, especially in the U.S., will be necessary to prevent systematic risk and preserve the financial stability. Jaime Caruana, Director of the IMF’s Monetary and Capital Markets Department said that, “prompt and transparent government responses, however, will go a long way to relieving the uncertainties.”

Questions:
1) With the IMF’s predictions that less then half of the losses associated with the current crisis have been realized, have we seen the worst of the credit crisis or is the major shock yet to come?
2) Should the multilateral financial institutions such as the IMF and World Bank get involved in the policy making decisions to protect the financial stability of the global markets or should these decisions be left only to individual countries?
3) Between the competing interests of controlling inflation and providing governmental assistance to control financial instability, which should be more important? Since this decision will have worldwide effects, should it be left to each individual country or should a international regulator step in and set up the parameters?