March 2002 Transcripts
Argentina and the IMF
Japan and the IMF
Turkey and the IMF
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Gerd HÄUSLER, Counsellor and Director of the International Capital Markets Department, IMF
Hung TRAN, Deputy Director of the International Capital Markets Department, IMF
Graham HACCHE, Deputy Director, External Relations Department, IMF
MR. HACCHE: Good morning, ladies and gentlemen, and welcome to this press briefing, which sees the launch of a new IMF quarterly report, the Global Financial Stability Report.
The contents of the report and today's briefing are under embargo until 11 o'clock this morning.
The report was prepared in the IMF's International Capital Markets Department under the direction of Gerd Häusler, Counsellor and Director of that department, who is to my immediate right. And to Mr. Häusler's right is Hung Tran, Deputy Director of the International Capital Markets Department.
Mr. Häusler has a few opening remarks about the report and some of its main findings before we take your questions.
MR. HÄUSLER: Thank you, Graham. Delighted to be with you this morning. This is my first press conference here at the IMF. As you know, both Hung and I, we started on the second part of last year when the new department was founded.
Now, why this publication? Most of you are familiar with the International Capital Markets Report, which was a yearly publication, much thicker, and we felt that there should be a more timely coverage of financial markets than just once a year. And as we now see, even a quarterly coverage of events can be quite tricky given that the outlook for financial markets is a fairly fast-moving target, and we have seen a lot of improvement in the outlook as of very late. In fact, I have to remind you that for the data, the cutoff date for this report was on February 8th, for many reasons, and the report also had to be going through some internal procedures.
Now, the other report that this report is replacing is the Emerging Markets Financing Report that you are familiar with on the website, and what I'm telling you now, you'll find the preface anyway. But this report is a more balanced coverage of mature markets as well as emerging markets. So it covers both sides on a quarterly basis.
Now, why have we chosen this format? There are two angles to it. One is the coverage of current events, therefore, a quarterly report. It covers not just the fourth quarter, which is the focus of [—inaudible—], but also some of the highlights of the first quarter, the current events. And at the same time, this report has two features of a more structural nature: the one on early warning systems and the one on some of the features for bond contracts. And it will continue to have special features in the future. That has somehow or other a bearing on the stability of the financial system as such.
So, all in all, before I come to the substance of the report, this is a part—part and parcel, so to speak— of the IMF mandate to strengthen surveillance of international financial markets, and that I think is, in fact, the wording that the Managing Director gave in the foreword to this first report that he was kind enough to add.
Now, how does it relate to other reports? You have, of course, the World Economic Outlook, which tackles more macroeconomic issues and, thus, by definition, the real side of the economy, notwithstanding the fact there are obviously the many links between the real economy and the financial system. And we work very closely with Ken Rogoff and his people in the research side, and we will do so even more so in the future.
And so this is another one—so this is, if you like, a corollary complementary coverage and, therefore, in this report, in our report, you will not find very much about the real side of the economy. In fact, there is a new World Economic Outlook, to my knowledge, coming out very soon, and I think Ken Rogoff is scheduled to have a press conference with you in mid-April, I believe, just ahead of the IMFC.
As you will see, in the same way that you are familiar with from Ken Rogoff's publication, there is a disclaimer in the preface that this is—the responsibility for this report lies squarely with the staff and does not engage the Fund or the shareholders of the Fund.
The last point of introduction here to the format is there has been an Editorial Committee with the International Capital Markets that has worked very hard, and Hung Tran to my right chaired this committee. But there should have been this morning a very large number of people from ICM on this rostrum who have all contributed very much to this report, but for obvious reasons you can't have them all here.
On the substance, let me just give you very quickly some of our findings, and then, of course, I am looking forward to the discussion with you on the questions.
The recovery that we now see almost on a weekly basis stronger and stronger is good news for us. We all like to hear that and like to see it, and, by the way, not just for the outlook for mature markets but also the outlook for emerging markets has improved. And we're gratified to see that there has been no serious contagion over the last couple of months in the emerging markets coming from Argentina. And, in fact, we have very soon after September 11 seen a reopening of the primary markets for emerging market debt. And, in fact, as some had hoped, the September 11 effects were fairly short-lived in financial markets. The turnaround in financial markets, as you know, already occurred in October-November last year.
Now, I have just come back yesterday—this was why we had to delay this conference for a day or two—just come back from a series of meetings in Europe at the BIS, but also the Managing Director had convened the Capital Markets Consultative Group that he has created two years ago and to which he makes reference in his foreword. That is a group where he interacts with the private sector, with private bankers from around the world, and this time around it took place in Europe. And it's noteworthy that, in spite of the good news in the data coming out, the business community, not just the European business community but, as you sometimes can see in the newspapers as well, in this country, was a bit more cautious as to the forecasting profession—compared to the forecasting profession. Maybe they're just looking backwards, but maybe they're all looking more at the micro side of the economy.
And amongst the points they make and the points that you will find in this report, which looks obviously more to the vulnerabilities, are financial imbalances in the household sector, but also in the corporate sectors. And we have to acknowledge that there are record levels of debt even after the slowdown or recession—I think it still will have to be defined what it really was—and the debt servicing at the moment for those sectors accounts for a very large share of current income, especially the household sector, in spite of the current very low interest rates.
The credit cycle, as we know, is lagging the business cycle by about, roughly speaking, two quarters. So assuming we have seen a turnaround in the business cycle, the credit cycle, meaning the amount of defaults, will probably only peak later this year, maybe sometime in the third quarter. And we have seen, as you know, record levels of defaults in 2001 and also in January 2002, with very high numbers. And, in fact, the leverage in the corporate sector that we have seen built up over many years in the 1990s in some countries and in some sectors, specifically and particularly, of course, has not been reversed if we have seen a fairly shallow recession or even a slowdown only, the usual correction has not taken place. And I think also the securities markets will scrutinize all companies, in the equities market, particularly, but also in the bond markets, for any potential creative accounting that might have masked lower profitability or higher leverage. And I think there already is a certain risk factor at play.
As to financial institutions, there were quite some differentiations, but 2001 has not been a very happy year for them, to put this very mildly. Commercial banking was hampered by, as I mentioned before, the corporate defaults and the provisioning thereafter, and investment banking was clearly subdued because of lack of top-line revenues. And 2002 so far for the first two or three months has also not been very promising. This is why you have already seen some subdued forecasts. And I think we have to reckon that some of the financial institutions here and there appear somewhat weakened after a very benign environment in the latter part of the 1990s. So we may see some consolidation in the financial sector ahead of us, including cross-border.
Let me then sort of draw three conclusions from this report and from our findings.
I think the financial community at large would be well advised to strengthen disclosure and transparency mechanisms as the first line of defense in order to bolster the self-correcting mechanisms of the market economy. This is the superior weapon, so to speak, of the market economy, is the self-correcting mechanism, but it requires the necessary transparency, not just in accounting but elsewhere as well. And the disclosure standards need probably to be beefed up here and there, including regulatory changes.
The second conclusion that I draw specifically towards Japan is that the Japanese financial system, as we all know, needs strengthening, but I think specifically—and here again I refer to the micro side of the economy, at the micro level, through a restructuring, a swift restructuring, of the corporate sector along the lines that we are used to in other parts of the world, which requires measures not so much on the macro level but on the micro level, as we know. The good news as to the Japanese financial system is that the interaction between the Japanese financial system, the domestic one, and the rest of the international financial system has become less and less important over the last two to three years.
And last, not least, as to emerging markets, I think we have to anticipate and encourage institutional investors to keep up their discriminating behavior, discriminating between the good and the less so, less good credit. And I think we have to also continue to encourage emerging market countries for adequate coverage and data dissemination on disclosure—again, in order for the investors to be able to do that; retail investors, as we know, as we have seen in the Argentina case, in Europe and Japan are not able to do the same kind of discrimination.
And foreign direct investment—that's my very last point in the introduction—is a very, very strong pillar as to capital flows to emerging market countries, and we can only encourage emerging market countries not to take any risks as to that FDI coming forward.
Thank you very much, and Hung and I are now looking forward to your comments and questions.
MR. HACCHE: Thank you, Gerd. Can I please ask you to identify yourselves in the usual way? The first question here.
QUESTIONER: Hi, Mr. Häusler. Mark Egan with Reuters News Service. I was just reading in your report about—you seem a little bit concerned about corporate earnings and the level of corporate earnings that financial markets are assuming. The reasonably low level that's actually taking place, and then you seem to be saying that if they don't sort of pick up soon, that there's a possibility of an equity market correction.
I wonder if you could expand a little bit on that and maybe if you could attribute what possibility is there of such a correction and how deep could such a correction be.
MR. HÄUSLER: I would just say two sentences on that and ask my colleague, Hung, to say a little more.
What we have said and the point in the report is that equity markets very quickly, towards the turn of the year, towards the end of last year and early this year, were very quickly assuming a sharp rebound of the economy, including the implied earnings—the P/E ratios that you saw as far as earnings ratios implied by markets assumed a sharp rebound. And what we had said, if that was not forthcoming for some reason or another and some of the reasons I have just elaborated on—that could result, potentially could result in a back[ward] drop in equity markets. Would you want to—
MR. TRAN: Yes, I have two points to your question. The first point is that the current level of equity prices, particularly in the U.S., suggests a quick and sharp rebound in corporate earnings going forward. At the moment, according to consensus expectation, the price-to-earnings ratio of the U.S. S&P 500 is about 22, meaning that increase in corporate profit of the order of 20 to 30 percent in the next two quarters is implied.
However, the issue is that if you look at the overall performance of corporate earnings, last year it fell to a very low level from a peak of 10 percent of GDP in 1998 to around 7 percent of GDP last year. Again, by consensus expectation, the first and second quarter of this year probably will see a little bit negative figure in the first quarter and single-digit figure in the second quarter. So the issue we raise is that financial markets by looking forward, by pricing in and discount future developments, could overshoot from time to time, and the actual performance of corporate earnings is something that we will look at very carefully.
The second point I raise and we mention in the report is that in the aftermath of the collapse of Enron, the scrutiny by market participants on the quality of earnings will be stronger than usual, and, therefore, there will be more analysis to see if the upcoming corporate report will satisfy the need for quality earnings growth instead of just headline earning growth.
So both of that suggest to us that it is worthwhile to be cautious.
MR. HACCHE: Next question? The front row here, please.
QUESTIONER: Hi, Emily Schwartz from Bloomberg News. I have a couple questions. One is there has been some concern expressed lately in the United States about Fannie Mae and Freddie Mac and their derivatives situation. Are those some of the things that you're worried about? Your report makes a general reference—the second question. Your report makes a general reference to concern about Argentina's credit default swap risks, and I was wondering what the—what kind of problems do you see coming or what are you watching for as this all unfolds? And, finally, can you be a little more specific about the risks involved with large industrial companies with active financial arms?
MR. HÄUSLER: If you agree, I'll take the first [two questions], and Hung will take the third one. The first is very—the answer is very short. Fannie Mae and Freddie Mac, we have not very much to say at this point. We have—I mean, we know what you know, we read what you read, and I think it would be unfair and improper—it would be inappropriate, also—on my part to make any comments on something that I have not fully digested. So I'll sort of leave that.
On Argentina, the credit default risk, it was mentioned in the context of not a chapter but of a larger piece talking about the credit default or the risk-credit risk transfer mechanism. And what we could see—and that had little or almost nothing to do with Argentina—is that this relatively recent market—this is why we spoke loosely of some teething problems there—this market will need some improvements in the sense of documentation being one, and also this market has not yet gone through a real serious trial time, if you know what I mean, some testing, if you would like.
And the point that we made was it remains to be seen that when there are serious problems like we saw in Enron and Argentina, it remains to be seen whether these credit default swaps, which is the plain vanilla type of credit risk transfer, will really be working as smoothly as was—as those who engage in those contracts expect that to happen. In fact, as we see in Enron, this is not entirely sure, and there is, as you know, some [—inaudible—] at this moment in time.
So we raised it as a question, but we did not say that we have at this moment in time indications that these credit default swaps will not work. But they have been tested yet in this particular context.
MR. TRAN: On your third question about the role of large industrial non-bank, non-financial companies with active financial arms engaging in these markets, particularly the credit risk transfer markets, our concern is generic to the extent that if these industrial companies engaging in these kind of activities and to the extent that they are over the counter with other counterparties, they largely escape regulatory oversight. They are not being regulated—that part of their activities are not being regulated by any regulators. And, therefore, disclosure information about their positioning about what they do, about the volume of business they engage in, about their own counterparties are very sketchy, if not non-existent. And we only learn about these things when something happens, like in the case of Enron.
So, going forward, what we would like to see is more requirement for participants in these markets to supply more information so that all of us in the financial markets as participants can more accurately and on a more timely basis gauge where credit risk lies, where it is concentrated, and how it is being distributed in the financial system. And we think that that is only beneficial to the financial markets.
MR. HACCHE: Second row.
QUESTIONER: If I could ask about Chapter 4, you have an extensive discussion on your IMF early warning system models that you're developing. If I'm reading this correctly, you're looking at these models, but they seem to be giving you a tremendous large number of faults warnings. Is this chapter telling us that this is still in the early stages? You don't have a number now. You talk about in Box 4.1 that if you get to one, then you are going to have a crisis within the next 24 months. Can you tell us what the number is right now?
MR. TRAN: First of all, I can say to you that we can't, so there is no magic number.
The second question is—the second issue is that these are models which help us in terms of putting things in a consistent way, in a disciplined way, so that the analysts will not be biased from time to time by what he or she reads in the current journal, so that the understanding of events will be performed at least in a consistent way.
However, as we mentioned in Chapter 4, there are still many errors associated with the current generation of the models. Sometimes it gives false warning. Sometimes a real crisis was undetected. And, therefore, what we propose to do there is trying to do more research to improve what we have and to extend it to cover not only foreign exchange crisis but bond and banking crisis, and particularly as a methodology, we tried to see if we can make more use of current financial asset prices and to extract more information from there.
The way we use these models in the Fund is, like I said before, strictly as a discipline tool. We use it as one among a very wide range of comprehensive inputs into our analysis of where vulnerabilities are.
MR. HÄUSLER: Let me just add two sentences just as a little bang on this one more time. The models help us in making sure, even the present models, that we don't overlook a crisis, and I think that's pretty much assured. Now, as to the false alarms that you pointed to—and Hung was already saying—this is not a mechanical approach we take. This is just one piece of a—at the end of the day which is a judgment to be formed. And there is—like in every judgment, you have facts and you have models, but at the end of the day you also have experience and fingertips at your hand. Thank you.
MR. HACCHE: Here in the front row.
QUESTIONER: In Chapter 3, you mention the fact that household debt is now higher in the U.K. and Germany than it is in the U.S. How do you explain that, and what do you think would be the long-term consequences?
MR. TRAN: The numbers we use are from the OECD, which look at the overall household liabilities divided by household persons or disposable income, and show that the level is indeed very high not only in the U.S. where attention has been focused on for some time, but also in other major OECD countries.
The potential impact is the same, which is at this high level of household indebtedness, with already high and burdensome level of debt servicing to households, despite low current nominal interest rates going forward, the ability of households to continue to underpin economic growth is something that everyone should pay close attention to.
MR. HACCHE: The second row here, please.
QUESTIONER: Mr. Häusler, going back to your opening statement, one of the conclusions you had drawn was that the Japanese financial system needs strengthening, and you continued to say that the interaction of the Japanese financial system has become less important over the past two or three years.
I was hoping you could elaborate a little bit more on that. My interpretation of that would be that because a lot of Japanese banks have withdrawn considerably from their overseas operations over the past few years, the problems facing Japanese banks has less of a contagion effect on the overall global financial system. Is that correct?
MR. HÄUSLER: Yes, that's pretty much what I wanted to say. There are two points to that. The first point was our conviction that as much as the right macroeconomic policy mix for Japan is important, including monetary policy and all the things that typically Ken Rogoff in his World Economic Outlook would talk about, from my more microeconomic point of view, I think it is extremely important for the Japanese financial system that the NPLs, the non-performing loans, those borrowers who have taken out the non-performing loans need to be restructured, and, therefore, in order for the banks to collect as soon as possible what they can collect and have a clear picture how to move on from there.
Now, the second point is the point about the potential contagion effect. I wanted to point out, and you repeated that, the issue that, yes, the Japanese banks have to a large extent withdrawn from international operations. I'm not sure that this is a very medium-term or very good phenomenon, because that means also that the second largest economy of the world is not contributing to capital flows very much at this moment in time, for instance, to emerging markets in the region. So this I think is not something that we should fully applaud.
But simply from the narrow point of view of contagion and stability, the fact that the Japanese banks are refunding themselves more and more domestically and also that the exposure of non-Japanese banks towards the Japanese financial system has decreased considerably over the last years has made this contagion effect less and less of a concern to us.
MR. HACCHE: Next question? Front row.
QUESTIONER: I'm wondering to what extent do you see this publication as a forum for making recommendations, or is it more something where you want to identify risks in global financial markets? I'm particularly wondering about the points made in the beginning about the risks of the industrial companies being large participants in several derivatives markets and the risks of offshore areas being large centers of financial activity.
Are you making recommendations that the OECD, for example, should mount an effort to bring places like Bermuda, big reinsurance center, into U.S./European style regulation, bring GE capital under the regulation of SEC, CFTC? Or are you simply—you see yourselves as simply identifying risks for policymakers to deal with as they see fit?
MR. HÄUSLER: I think the mandate of the Fund has it that, first of all, we have to be engaging in very solid analysis. It would be ill-advised if we felt we could make any recommendations and give advice on issues which are not solidly on solid foundations. And, therefore, this report will always be the large—the bulk of it will always be an analysis of what we see, including strengths and weaknesses, maybe slight bias towards weaknesses because, as you describe the state of affairs in the financial system, you have to be evenhanded. But I think from the interest—the public interest, of course, is more in the potential weaknesses. That's the point that you want to make.
But I think also it's the mandate of the Fund, this multilateral surveillance, if necessary, to come up with a recommendation or two. But I would be reluctant to go overboard. For instance, to take your example, there is a clear indication that as to the accounting, for instance, the accounting standards. Given the Fund will not and has no mandate in the narrow sense—or does not have the legal obligation to regulate, this is within the hands of national regulators, and there's a clear indication that national regulators certainly inside the United States will react to this and there is something coming. So there is no point in telling people who are already in the process of reviewing and probably upgrading and updating that they should do this. I mean, this is a bit almost cheap, I would say. But in cases where I think this is not so clear, where one has the impression that some people may—could be, hypothetically speaking—drag their feet, I think this report may make a modest contribution to that.
And having said that, let me sort of pick up on point, which is not a short-term point but which is a medium-term point and which you find in the overview. That is the point that globalization and the tearing down of, if you like, borders between financial market segments, between the banking segment, the banking sector, the insurance sector, and the non-financial sector, as we see more and more, will—and this is not a short-term development—will bring to the table one more time the old issue of same business, same risks for everybody, and possibly, if not the same rules, but rules which are at least comparable. They don't have to be the same.
I think this is something that we'll have to look at over time again and again. But this is a complicated issue, and the Fund and this report would be ill-advised if it was sort of trying to pretend there were quick fixes to that.
MR. HACCHE: Front row.
QUESTIONER: A follow-up on your response. I just want to make sure I understand correctly what you're saying here, because I had some of the same questions.
Is this report saying that on top of all the attention being focused on accounting standards, disclosure standards, and criminal penalties for people who misrepresent finances of a company, you're saying that regulators need to take a closer look at collateralized debt obligations, at credit transfers, counterparty risks, that these things are not getting the attention they deserve and pose risks that haven't been—and what kind of risks are you saying overall they pose to the financial system?
MR. HÄUSLER: I did not say that regulators are not taking a close enough look, and I want to be on the record in putting it this way.
What I did say and what I did imply is—and that's an obvious fact—that particularly in this area of credit risk transfer mechanism, credit default risk, and others, you have as market participants not just banks and not even just insurance companies—who are, by the way, a very strong participant in this market—but you also have non-financial institutions or corporates, or call them what you may. And they all go under different regulatory regimes with different capital adequacy regimes, and some of them have no regime at all.
All I'm saying is that in this market you have participants falling under totally different jurisdictions, so to speak, not just in the sense of a national jurisdiction but in a sort of segmented kind of jurisdiction. And this has led to a limited—but, on the other hand, you can't overlook it, to some degree of regulatory arbitrage where those institutions that have less of a capital adequacy burden can engage in more volume than others for the same price; or you can change it around and say the same volume for a more favorable price.
I think this is not of any degree of concern to us at this moment in time, but if this trend continues, there will be a discussion on that, I think, and rightly so.
MR. HACCHE: Any more questions?
QUESTIONER: Mr. Häusler, could you address, first of all, why didn't the Argentine and Turkish problems have contagion effects? And, secondly, in trying to understand what you're saying about Enron and derivatives, do you sense that that has already played itself out in the markets? Or is there a risk of further damage?
MR. HÄUSLER: Well, they're two quite unrelated questions. On the contagion, especially from Argentina, and I think less so from Turkey because Turkey I think is quite a different case. The reason why there was so much less contagion than some people anticipated, broadly speaking, has two reasons. One is we know from experience that when there is a country having serious difficulties, to say the least, when this comes very sudden, overnight almost, the people, the financial market participants become rather more nervous, as opposed to the case of Argentina where the problems were mounting in a fairly—compared to past experience— in a fairly slow way. So this was as a problem and a default that many people could see coming for many months and was discussed in financial markets for many months.
And the other point is financial market participants, certainly professional institutional investors, had concluded for quite some time now that the reason for that Argentina crisis largely lay within Argentina and had to do with domestic politics of all sorts; and, therefore, the reasons were within Argentina and, therefore, were willing and able to, as I said, discriminate and differentiate between Argentina on the one hand and other Latin American countries on the other. In fact, what we saw around the turn of the year was that while Argentina debt—prices where deteriorating in the markets, you saw other Latin American debt, including Brazilian debt, improve.
As to the second question on Enron, I think nobody knows for sure, and I think what the financial markets want to know—and this is why they are crying out for disclosure, and as you have seen, some of the very large companies—you know, at random you can name two—have increased substantially the amount of information, the amount of disclosure they are giving to markets, claiming, and probably rightly so, that they have nothing to hide and they have not engaged in any similar accounting techniques. But in order for the markets to believe them, apparently, they need to disclose a lot more details.
And I think unless and until the market has seen much more of that, they will be from time to time itchy and will suspect that one or the other or a few more or a whole sector of the economy or corporates may have engaged in, if not to the same degree but to a lesser degree, in that accounting. So I think what we need to see is very quickly this level of transparency in order for the corporates to demonstrate to their investors and to the market participants at large what is really the truth.
MR. HACCHE: Thank you. I think we can wrap it up there. But before ending, in case you were wondering what to do after filing your stories on this, let me remind you of another event taking place at the Fund today and tomorrow, the Conference on Macroeconomic Policies and Poverty Reduction. All sessions are being held upstairs in the red level auditorium, the room most of you know pretty well. The conference is open to the public, and you are warmly invited to attend. There is information about the conference on the table at the entrance to this room.
Thank you very much for coming.
IMF EXTERNAL RELATIONS DEPARTMENT