IMF Weighs in on US Sub-Prime Meltdown

In its semi-annual review of global financial issues, The International Monetary Fund (IMF) stated that although global economic fallout from the U.S. sub-prime mortgage meltdown is likely to be "protracted," governments shouldn't "rush to regulate everything."   
  
The IMF concluded that the "threat to financial stability increased" is in good measure because of the uncertainty over how credit problems are transmitted globally and how deeply the credit crunch will bite in markets around the world.   
  
During good times, the complexity of the financial system helps spread risk to a variety of different institutions and countries -- lessening the problem that any one sector will become battered. But in bad times, that same complexity makes it hard to figure out where problems will materialize.  
  
"While potentially helping protect the financial system from concentrations of credit risk in banks," the IMF’s top financial review official, Jaime Caruana, concluded, "the dispersal of structured credit products has substantially increased uncertainty about the extent of the risks and where they are ultimately held."   
  
With few developing countries facing financial crises that prompt them to borrow from the IMF, reviews of global economic problems have become an increasingly important part of the agency's role. During the late 1990s, the IMF played a central role in trying to rescue and revive countries ranging from Russia to Thailand to Brazil -- and got very mixed reviews for its efforts. As the global economy recovered, Asian and Latin American nations paid off their IMF loans ahead of time and built up huge financial reserves, partly to free themselves from IMF's mandates.  
  
Now, the IMF says it's trying to help head off future crises by highlighting potential problems ahead of time. "The new element [in the global economy] is the complexity of the new financial system," said Mr. Caruana, a former Spanish central banker. "What's surprising is how different risks have interacted, and the speed with which they have developed."  
  
Mortgages, for instance, are packaged in so many different kinds of financial instruments that are held by so many different kinds of investors, that individual investors lose incentive to do sufficient due diligence – figuring someone else in the chain has already done so. Ratings agencies also have a hard time properly understanding the risks.  
  
"Investors need to look behind the ratings," the IMF report said. "They should not assume that the simple letter rating provided by ratings agencies show equivalent risks as those for other asset classes."  
  
As analysts better understand how the problems in the U.S. housing market began to affect banks in Europe and elsewhere, there is bound to be areas where regulation needs to be strengthened, said Mr. Caruana, but it's too early to tell where those areas are now. "Given the complexity, policymakers face a delicate balancing act," he said.