The U.S. will need to tackle reform of housing finance, including Fannie Mae (photo: Karen Bleier/AFP)
Financial Sector Reform
The IMF’s report was issued on July 30 under the Financial Sector Assessment Program, which provides an in-depth analysis of a country’s financial system and its vulnerabilities. Created in the wake of the Asian crisis in 1999, over three quarters of the IMF’s 187 member states have volunteered to undergo an assessment.
The global financial crisis began in the United States with the meltdown of the sub-prime housing market in 2007, which spilled over into the U.S. financial sector, and spread quickly around the world.
The IMF said reforms to the financial system signed into law in the Dodd-Frank Act were an important step forward to address the weaknesses exposed by the global financial crisis.
However, the IMF says that the law missed the opportunity to streamline the complex web of agencies that oversee banks and other financial institutions. The legislation establishes a new oversight council of regulators, who face two significant implementation challenges:
• Improve the cooperation of U.S. regulatory agencies and enable a more timely response to emerging systemic risks
• Write the specific rules needed to help contain systemic vulnerabilities and reverse perceptions that some financial institutions too big and complex to fail.
The IMF also released a report on its annual check-up of the U.S. economy, known as the Article IV consultation, which found that the United States’ economy is recovering, with debt and unemployment the next challenges.
Unfinished business
Key decisions on reforms to the U.S. system of housing finance, and the mortgage giants Fannie Mae and Freddie Mac, are still pending. The IMF said the government’s support for the housing market is costly, inefficient, and complex, with subsidies that do not translate into a higher homeownership rate.
Given the key role played by the United States’ financial sector in the global financial system, coordination at the international level will continue to be important. With U.S. firms linked to many other countries through cross-border operations and trades, the United States will need to continue to play a leading role in international crisis coordination, as well as helping to shape new international rules on bank supervision and regulation.
Risks exposed in stress tests
The IMF’s assessment of the U.S. financial system included stress tests, carried out to see how banks and other financial institutions would fare if economic conditions worsened.
In 2009, the United States conducted and published the results of its own detailed stress tests of the largest 19 banks and financial institutions. As a result, U.S. banks raised over $205 billion in additional capital.
The IMF stress tests acknowledged the improved capital positions of U.S. banks but noted that the system would likely remain under pressure due to expected further losses in the commercial real estate sector. And in a scenario in which growth dropped and unemployment remained high, a significant number of U.S. bank holding companies—especially small and medium-sized and regional banks—would need additional capital.
The IMF tests also illustrated the significant linkages within the banking system, cautioning that a shock to one bank could spill over to the system overall. The linkages extended abroad and not only could distress in U.S. banks affect banks in Europe, but the effect also could flow the other way.
