The IMF Weighs In

The IMF has just published its research on the current financial crisis. They estimate that losses so far on ‘US originated assets’ have now surpassed a whopping $2 trillion worldwide, and a headed for an almost numbing total of $4 trillion before the crisis abates.

Besides being extraordinarily sobering, that’s an eye-popping amount of carnage inflicted on the world’s banking system courtesy of our obsession with real estate and the terrible things we did to spread homeownership.

It will take years for this mess to be cleansed fully, and I doubt that banking will ever be the same again – notwithstanding Goldman Sachs agitated opposition to changing regulation.

Buried in the IMF analysis, their report is almost 250 pages long, are a few policy recommendations I think are worth keeping in mind as we watch as new regulations are crafted here. I will simply repeat them verbatim:

‰Û¢ A more active role of supervisors in determining the viability of institutions and
appropriate corrective actions, including identifying capital needs based on
writedowns expected during the next two years.

‰Û¢ Full and transparent disclosure of the impairment of banks‰Ûª balance sheets, vetted by supervisors based on a consistent set of criteria.

‰Û¢ Clarity by supervisors regarding the type of capital required‰ÛÓeither in terms of the tangible common equity or Tier 1‰ÛÓand the time periods allotted to reach new
required capital ratios.

These three ‘immediate actions items’ get straight to the heart of the crisis.

We need much more urgency in policy action. Here in the US we have been undertaking a slow motion series of steps: the crisis has now been in full bloom for nearly three consecutive quarters and we still don’t have adequately re-capitalized banks. It seems as if the administration has been hoping that time alone will ameliorate the situation so that cleaning everything up becomes less painful. That won’t work at all. More likely: it will exacerbate things. Banks suffering through a long a lingering near death are of no use either to their shareholders, whose shares are worth practically nothing now anyway, or to the economy at large because what we need is new lending not slow and careful capital rebuilding.

The IMF appears to support the kind of swift and dramatic intervention I have been advocating since the start. Call it what you will, but forcing a failed bank through state sponsored bankruptcy, and returning to private ownership quickly is still the most viable and sensible policy option we have.

The second policy the IMF urges is also tough for the administration: transparent demonstration of the actual damage each bank has. This is controversial simply because by going public with such information exposes the weak banks to potential investor and depositor flight. People will naturally want to get their money out from a bank that is declared ‘impaired’. Even if such a ‘run on the bank’ is avoided the cost of borrowing for an ‘impaired’ bank will inevitably rise as the credit markets impose a risk premium on it. This will create a double jeopardy: not only will the public know that a particular bank is impaired, but its competitive position will be eroded simultaneously. So a weak bank’s ability to recover will be diminished. Hence the need to force them quickly through bankruptcy or nationalization.

The final policy imperative is far less controversial. It simply asks that bank regulators impose a clear and even handed standard for measuring capital adequacy. Having such clarity will enable investors and depositors to make informed decisions about the soundness of the banks they do business with.

There is no real news in this third policy recommendation.

But I look forward to progress on the other two.