IMF Survey: Forceful Action Needed to Contain Crisis, Panel Agrees

IMF News, October 14, 2008

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Policymakers "must act quickly and forcefully, with a coordinated and comprehensive package" to contain a crisis that has frozen credit markets in most advanced economies and threatens a global recession.
"Time is of the essence," said George Soros; authorities have "consistently been behind the curve" and "now they have to get ahead of it."
Panel consensus: talk is not enough — steps must be:
- explained to the public,
- coordinated among governments,
- comprehensive in covering all problems,
- perceived as forceful enough to succeed.

Recent announcements by authorities in the United States, the United Kingdom, and the European Union to:
- inject capital into banking systems weakened by deteriorating asset quality,
- remove many of the bad assets from the books of these institutions,
- expand the provision of liquidity to the financial system,
- provide guarantees to lenders and depositors.
Shift in approach noted by Mohamed El-Erian: from reactive and sequential actions to simultaneous, packaged measures and from a U.S.-centric to a global solution.
Policymakers must communicate measures clearly to build public confidence and restore market functioning.

The IMF's World Economic Outlook (referenced by the panel) predicted virtually no economic growth for advanced economies and a sharp slowdown in developing economies over the next year.
A recession "appears to be inevitable" but "can be made less severe by proper countercyclical economic policies," said Christine Cumming.
Short-term market fragility: "Markets are extraordinarily frail and fearful and the short-term risks of a further implosion are high," said Lewis Alexander; liquidity strains (e.g., money market funds restricting withdrawals) can sharply amplify risk aversion and economic decline.
Historical precedent: decisive action when demand declines (learning from the 1930s) can mitigate severity.

Meltdown traced to a confluence of global trends encouraging risk-taking and the spread of innovations such as asset-backed securities and structured credit products that markets and regulators did not fully understand.
Structured products:
- Designed to spread risk by slicing asset pools into tranches representing different repayment likelihoods.
- Complexity led investors to fear even the least risky tranches, drying up markets and leaving institutions with securities they could neither sell nor value properly.
Interbank market impact: banks curtailed lending to one another, confining lending to very short loans until the failure of Lehman Brothers, after which short-term credit markets largely froze.

Hundreds of billions of dollars of private capital were injected into the system in late 2007 and early 2008; $60 billion of it came from sovereign wealth funds.
These injections were "stunning" compared with previous crises but remained insufficient because the size of the problem was not initially understood.
Lack of transparency and "inability to size the problem" hindered earlier policy responses.

Panel view on regulatory priorities:
- "Regulation has to get back to basics—creating incentives for managers to behave prudentially and warning them when there are changes they are not taking into consideration," said Roger Ferguson.
- Continuously assess the amount of leverage in the system.
- Push on quality of information, transparency, and updating of risk-management tools.
- Keep regulators up to date with market changes despite practical difficulties.
Post-crisis financial industry characteristics anticipated:
- Smaller,
- More highly regulated,
- More heavily capitalized,
- "It will look much more like a utility," said Mohamed El-Erian, driven by societal rejection of socializing losses while privatizing gains.

IMF Survey: Forceful Action Needed to Contain Crisis, Panel Agrees — October 14, 2008