Credit Crisis is Broadening, IMF Warns
| Author | Laura Kodres |
| Position | IMF Monetary and Capital Markets Department |
| Pages | 49-57 |
Page 49
The widening and deepening fallout from the U.S. subprime mortgage crisis could have profound financial system and macroeconomic implications, according to the IMF's latest Global Financial Stability Report (GFSR).
At present, the issuance of most structured credit products-instruments that pool and divide credit risk exposures in various ways-is at a standstill, and many banks are coping with losses and involuntary balance expansions, the April 2008 report said. The report examines this and other forces that could push the current credit crisis into a full credit crunch, as well as offering policy recommendations to mitigate the impact.
"Financial markets remain under considerable stress because of a combination of three factors," said Jaime Caruana, head of the IMF's Monetary and Capital Markets Department. "First, the balance sheets of financial institutions have weakened; second, the deleveraging process continues and asset prices continue to fall; Page 57 and, finally, the macroeconomic environment is more challenging because of the weakening global growth."
The crisis has weakened the capital and funding of large systemically important financial institutions, raising systemic risks. Such financial institutions need to raise capital or cut back assets to cope with the strains, the report said. The continued stress increases the downside risks for global financial stability and potentially forces institutions to further curtail credit, it added, noting that the macroeconomic effects could be severe.
But Caruana pointed out that "the recent Fed [U.S. Federal Reserve] actions in solving the Bear Stearns case and also in providing liquidity to a broader range of counterparties have reduced the probability of a tail event in the financial system, although there are still funding pressures that continue."
Credit deterioration, which was first evident in the U.S. subprime market, is now showing up in higher-quality residential mortgages, U.S. commercial real estate, and the corporate debt markets, according to the GFSR. These concerns are further exacerbated by a drop in valuations of structured credit products and a dramatic drying up of market liquidity.
Uncertainty about the size and distribution of bank losses, reduced capital buffers, and the normal...
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