Young job seeker is interviewed at a job fair in Barcelona. Spain's youth unemployment remains among the highest in the European Union. (Photo: Gustau Nacarino/Reuters/Newscom)

Young job seeker is interviewed at a job fair in Barcelona. Spain's youth unemployment remains among the highest in the European Union. (Photo: Gustau Nacarino/Reuters/Newscom)

IMF Survey: Learn from Market Turmoil—de Rato

September 7, 2007

  • Advanced economies should find ways to enable investors to better assess risk
  • Emerging markets should consider response if capital inflows dry up
  • Financial market turbulence will reduce global growth

Policymakers in both advanced and emerging market countries should learn some lessons from the recent turbulence in global financial markets, IMF Managing Director Rodrigo de Rato said.

Learn from Market Turmoil—de Rato

Traders in Frankfurt, Germany: Regulators must devise ways to improve market transparency, IMF says (photo: Kai Pfaffenbach/ Reuters)

FINANCIAL MARKET TURBULENCE

In a speech to the Ambrosetti Forum in Cernobbio, Italy on September 7, de Rato said that "there are practices that should be changed and lessons that should be learned from the recent turbulence."

Fallout from the financial market problems, sparked by a rash of foreclosures in the U.S. subprime market, would result in downward projections for economic growth, particularly in the United States, but also possibly in the euro area and Japan, he told reporters at a separate press conference. A return of trust was critical for a recovery of markets, he added.

Referring to the need for change, he said that in industrial economies, regulators must devise ways to improve transparency in markets, to enable investors to better assess risk in some of the exotic types of securities at the root of the subprime mortgage market crisis. The sudden problems appearing in the subprime market, largely the result of lax underwriting standards in recent years, have caused concerns among investors about possible undetected problems in other financial markets.

In emerging market countries that have relied on capital inflows to finance current account deficits or surges in domestic credit, de Rato said policymakers "need to consider how they will respond if capital inflows dry up or are reversed," although he said "we see little evidence of this happening so far."

Meanwhile, participants "should not take for granted the liquidity of markets."

World credit crunch

Losses emanating from the U.S. subprime mortgage market have hit the balance sheets of banks and funds around the world in recent weeks and created the worst credit and liquidity squeeze in world financial markets in a decade. Central banks in several major economies have stepped in to provide liquidity to the markets.

De Rato warned that events are still unfolding. Based on what has already happened, the IMF's best judgment is "that the financial market turbulence will have some modest adverse effects on global economic growth this year, but that would still leave global growth rates similar to those we have seen in recent years."

Still, the tightening in financial "conditions has not just involved the repricing of credit but also the curtailment of credit to certain borrowers and in certain markets," he said, with the potential for further adverse effects on the real economy—hurting household finance and corporate sectors in mature markets. There are also pockets of vulnerability in emerging markets that have relied heavily on short-term or foreign currency financing to feed domestic credit booms. Moreover, while important banks "began the episode well capitalized and financially strong, they may face new constraints in extending credit," making it harder for banks and other intermediaries to "offset the flow of credit lost through nonbank channels, especially for subinvestment grade borrowers."

IMF warnings

Yet, the "reappraisal of risks in financial markets may also prevent even larger problems from emerging in the future. For months, the Fund and others have been warning about the risks from lower lending standards, higher leverage, and lack of transparency. To the extent that these vulnerabilities are now being taken more seriously, this is good for financial stability," De Rato said, building on an assessment of the effects of the turbulence he made last month in a speech to a financial conference in Brazil.

But in his Italy speech, De Rato addressed for the first time the policy responses he thought were required by the recent turbulence flowing from the subprime market woes.

In industrialized economies, de Rato said, regulators and market participants must come up with ways to improve "transparency" in various markets so that investors can better assess where risks lie. Many subprime mortgages, those made to higher-risk borrowers, were bundled together into securities, generically called collateralized debt obligations. Although these securitized obligations spread the risks of default over a wide number of investors, they also made it difficult to determine who owned those risky securities. Concerns about risks in the subprime market spread to other credit markets as well.

"Uncertainty regarding who holds certain credit exposures and the extent or concentrations of such risks, has played a significant role in the recent financial turbulence, and it has the potential to cause new problems. One of the main reasons why counterparty risk has risen so strongly is that a large part of the exposure to the subprime market has been through off-balance sheet constructions, so that no one knows were future problems might emerge.

"To address this problem, regulators and market participants need to assess how transparency can be improved in various markets, especially for relatively new or illiquid instruments, in order to reduce uncertainty and avoid "surprises"."

IMF ready to help

He said that the Fund "stands ready" to support any emerging market nations that are caught up in the market turbulence although there have so far been no requests for assistance and there has also been little pressure on exchange rates or reserves.

De Rato, who will leave the post of IMF Managing Director in October, said that many of the challenges "policymakers face would benefit from international cooperation" in such areas as monitoring and regulating financial markets. "The International Monetary Fund, together with other international institutions, has to play a role here, as we did in catalyzing the formulation of plans by major economies to address global imbalances."

The IMF would continue work on its crisis-prevention instruments to provide timely support to the institution's members, if needed.