IMF Tells It Like It Is

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By Greg Peel

In its last Global Financial Stability Report, the International Monetary Fund made a controversial call that total loan losses in this current crunch cycle could reach US$945bn when both write-downs on subprime instruments and losses on traditional loans are included. Write-downs to date have totaled about US$400bn.

Last night the IMF reiterated its estimate in its July update. This time the market has come to realise it was not such a far-fetched call after all. What was once a mere subprime crisis has morphed into a wide-spread crisis in the nature of butterflies and storms. The IMF is warning of the “second wave” of losses which is building in all loan classes, driven on by declining house prices and a slowing economy. Subprime losses, for the most part, have been written down sufficiently.

(This call is belied to some extent by the 90% of subprime exposure provisions made last week by the National Bank ((NAB)). Not all global banks have made write-downs to such an extent. And Merrill Lynch is already going again – see below).

The IMF suggests global financial markets remain fragile and systemic risk remains elevated. The next step is to be felt in emerging markets as they struggle with tight financial conditions and rising inflation. House prices have also begun to soften in Europe, and particularly in the UK, suggesting more problems ahead in those markets.

Across the globe bank balance sheets are under renewed stress, and tumbling share prices are not helping. New capital has become even more difficult to raise. In the meantime central banks have been forced to grapple with finely balanced policy decisions in their attempts to trade off between rising inflation, falling economic growth, and ongoing financial market instability.

The IMF lauded moves by the US Treasury and Fed to shore up Fannie and Freddie as having so far succeeded in containing systemic risk, but hinted that more needed to be done. “The policy challenge is to find a clear and permanent solution,” the report suggested.

Late in the day yesterday #3 US investment bank Merrill Lynch announced a series of measures  intended to “significantly reduce the company’s risk exposures and further strengthen its capital position”.

The bank intends to raise another US$8.5bn in ordinary capital, and write-down another US$4.4bn in CDO valuations in the September quarter, along with another US$1.3bn in CDO-related hedges. What was it that the IMF was saying about subprime write-downs?

The real test will be as to how quickly Merrills can actually secure buyers for its new capital. Recent experience in the UK suggests the mere announcement of a capital raising, even at a discount, does not guarantee a rush of willing lambs to the slaughter.

Merrills is also under threat of losing a good deal of the staff it would like to keep, having already jettisoned the excess in cost-cutting measures. Merrills’ stockbroking team has arguably the best reputation on Wall Street, and talk is that brokers who once smugly brushed off poaching attempts from more stable rivals are making some red-faced return calls. It would not be surprising if the bulk of the team upped and left for one rival en masse, sources suggest.

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