IMF, Rogers vs. Goldman on Financial Stability

By happenstance, Bloomberg has an interesting trio of prognostications for the financial markets. Admittedly, they have differing degrees of authority. Most would give the IMF considerably more credence than either Jim Rogers or Goldman. However, all three have a following with investors.

Not surprisingly, Goldman’s report is upbeat, the IMF’s is cautious tending towards the negative (which is rare for government bodies, since they prefer anodyne presentations) and Rogers’ is grim.

The Goldman forecast comes from CFO David Viniar in context of the firm’s prospects. Viniar (the man who famously said that the recent market turmoil was a 25 standard deviation event) is a less credible source than Goldman analysts (who nevertheless have reason to take a bullish posture). From Bloomberg:

“We are a lot closer to the bottom than where we were at the end of last quarter,” Chief Financial Officer David Viniar said in an interview assessing the third-highest earnings in Goldman’s history and the industry’s only increase last quarter. “There are going to be opportunities in the mortgage business,” he said, and “there are certainly going to be opportunities to buy distressed assets.”

At the other end of the spectrum, Rogers continues to sound the tocsin. Like Viniar, he can be accused of talking his own book, since Rogers runs commodities funds, but his alarm sounds genuine:

The Federal Reserve’s interest rate cut was a mistake that will prompt “skyrocketing” agricultural prices worldwide, exacerbate a decline in the dollar and quicken inflation, investor Jim Rogers said.

The “clowns in Washington” have “signaled to the world they don’t care about the U.S. dollar,” Rogers said in an interview from Singapore. The Fed reduced its benchmark rate by half a percentage point to 4.75 percent last week.

Finally, the IMF weighted in with a report that stressed that the financial system is not yet in the clear and the downside risks are substantial. From the report’s executive summary:

Credit and market risks have risen and markets have become more volatile. Markets are recognizing the extent to which credit discipline has deteriorated in recent years—most notably in the U.S. nonprime mortgage and leveraged loan markets, but also in other related credit markets. This has prompted a retrenchment from some risky assets and deleveraging, causing a widening of credit spreads in riskier asset classes and more volatile bond and equity markets. The absence of prices and secondary markets for some structured credit products, and concerns about the location and size of potential losses, has led to disruptions in some money markets and funding difficulties for a number of financial institutions, as some counterparties have been reluctant to extend credit to those thought to hold lower quality, illiquid assets. The resulting disruption has required extraordinary liquidity injections by a number of central banks to facilitate the orderly functioning of these
markets.

The potential consequences of this episode should not be underestimated and the adjustment process is likely to be protracted. Credit conditions may not normalize soon, and some of the practices that have developed in the structured credit markets will have to change. At the same time, the global economy entered this turbulent period exhibiting solid growth, especially in emerging market countries. Systemically important financial institutions began this episode with adequate capital to manage the likely level of credit losses. So far, despite the significant ongoing correction in financial markets, global growth remains solid, though some slowdown could be expected. Downside risks have increased significantly and even if those risks fail to materialize, the implications of this period of turbulence will be significant and far reaching. Eventually, lessons for both the private sector and the regulatory and supervisory arenas will have to be drawn in order to strengthen the financial system against future strains.

There is some juicy stuff in the report (for example, it discusses whether the widespread use of “Value at risk” risk management approaches may have made matters worse); I hope to say more about it later.

Note that the last sentence of the quote above and other statements in the report ( “Credit conditions may not normalize soon, and some of the practices that have developed in the structured credit markets will have to change”; one section is called “Weaker Credit and Market Discipline Warrants Increased Surveillance in Emerging Markets”) allude to the need for greater oversight.

Predictably, the whiff of greater regulation hit a nerve at the Wall Street Journal. Rather than provide a down the middle summary of the report, it instead called the IMF and presents a pretty evenhanded statement about regulation in a way that undermines the views presented in the report. This is disingenuous, since these documents are carefully crafted before they are released. And the title of the story “IMF Weighs In on Mortgage Meltdown,” is misleading also, since the IMF report is about global financial stability, not simply the US mortgage mess.

From the Journal:

Although global economic fallout from the U.S. subprime mortgage meltdown is likely to be “protracted,” governments shouldn’t “rush to regulate everything,” said the International Monetary Fund’s top financial review official, Jaime Caruana….

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.