It's going to be an almost trillion-dollar meltdown. That's the message on the likely magnitude of the US sub-prime-related crisis from the International Monetary Fund (IMF). In its Global Financial Stability Report released in Washington yesterday, the IMF points out that the crisis is spreading beyond the US sub-prime market, to the prime residential and commercial real estate markets, consumer credit and the corporate debt markets.
The IMF loss estimates are in line with those put out by some private economists who have closely tracked the crisis, such as George Magnus of UBS, although others, such as New York University professor Nouriel Roubini, cite US$1 trillion as a minimum loss figure, with the maximum going as high as US$2.7 trillion in the worst case.
According to the IMF, of the US$945 billion of total losses, US$565 billion will be due to residential mortgage debt, US$240 billion will come from commercial real estate debt, US$120 billion from corporate debt and US$20 billion from consumer credit debt.
US$720 billion, or about 76 per cent of the total losses, will come from securitised debt - that is, debt that has been packaged into tradable securities.
Banks will bear roughly half of the sub-prime mortgage-related losses, with insurance companies, pension funds, money market funds, hedge funds and other institutional investors accounting for the rest. Globally, banks are estimated to have US$740 billion of net sub-prime exposure, 53 per cent of which is held by US banks and 41 per cent by European banks. Asian (including Japanese) banks hold about 5 per cent.
The IMF estimates potential losses of US$144 billion for US banks and US$121 billion for European banks. Losses of Asian banks are likely to be less than one-tenth of losses in Europe, it says.
It points out that most sub-prime-related losses appear to have been reported already, noting that through mid-March 2008, banks had reported US$190 billion in losses on US mortgage market exposure. However, it adds that much of that represents mark-to-market losses (losses arising from loans being valued at low prevailing market prices) and some could yet be recoverable in the future.
Still, the IMF says that US banks and government-sponsored enterprises could report a further US$49 billion in additional writedowns, while European banks could report as much as US$43 billion.
Nonbank financial institutions, including insurance companies, may yet also report sizeable additional writedowns.
However, the IMF urges that loss estimates should be treated with caution, because:
They depend on the quality of disclosure, and are sometimes based on estimates of exposures;
Aggregate losses are highly sensitive to bank exposures to different types of loans, which are again estimates. Different tranches of securities are also valued differently;
The timing of loss recognition is uncertain and the norms vary across countries; and
Loss estimates could be lowered by remedial measures such as the modification of mortgage loan terms.
On the ripple effects of the crisis, the IMF points out that emerging-market countries have been 'broadly resilient' so far. But it adds that some remain vulnerable to a credit pullback, especially where domestic credit growth has been fuelled from external funding and large current account deficits need to be financed.
However, this is not so much the case in Asia, where most countries have current account surpluses. Eastern European countries are the most exposed.
The IMF's report comes ahead of tomorrow's meetings of Group of Seven finance ministers. This will be followed by the spring meetings of the IMF and the World Bank, where the sub-prime crisis is expected to top the agenda.
With regard to policy measures, the IMF says 'the immediate challenge is to reduce the duration and severity of the crisis. Actions that focus on reducing uncertainty and strengthening confidence in mature market financial systems should be the first priority'.
Comparing the magnitude of the US sub-prime crisis to previous financial crises, the IMF points out that in absolute dollar terms, it is slightly larger than Japan's banking crisis of the 1990s.
But relative to GDP, the losses stemming from the sub-prime crisis would be around 7 per cent, which makes it much smaller than either the Japanese crisis or the Asian financial crisis of 1997/98, where the total losses came to 15 per cent and 35 per cent of GDP, respectively.
The IMF loss estimates are in line with those put out by some private economists who have closely tracked the crisis, such as George Magnus of UBS, although others, such as New York University professor Nouriel Roubini, cite US$1 trillion as a minimum loss figure, with the maximum going as high as US$2.7 trillion in the worst case.
According to the IMF, of the US$945 billion of total losses, US$565 billion will be due to residential mortgage debt, US$240 billion will come from commercial real estate debt, US$120 billion from corporate debt and US$20 billion from consumer credit debt.
US$720 billion, or about 76 per cent of the total losses, will come from securitised debt - that is, debt that has been packaged into tradable securities.
Banks will bear roughly half of the sub-prime mortgage-related losses, with insurance companies, pension funds, money market funds, hedge funds and other institutional investors accounting for the rest. Globally, banks are estimated to have US$740 billion of net sub-prime exposure, 53 per cent of which is held by US banks and 41 per cent by European banks. Asian (including Japanese) banks hold about 5 per cent.
The IMF estimates potential losses of US$144 billion for US banks and US$121 billion for European banks. Losses of Asian banks are likely to be less than one-tenth of losses in Europe, it says.
It points out that most sub-prime-related losses appear to have been reported already, noting that through mid-March 2008, banks had reported US$190 billion in losses on US mortgage market exposure. However, it adds that much of that represents mark-to-market losses (losses arising from loans being valued at low prevailing market prices) and some could yet be recoverable in the future.
Still, the IMF says that US banks and government-sponsored enterprises could report a further US$49 billion in additional writedowns, while European banks could report as much as US$43 billion.
Nonbank financial institutions, including insurance companies, may yet also report sizeable additional writedowns.
However, the IMF urges that loss estimates should be treated with caution, because:
They depend on the quality of disclosure, and are sometimes based on estimates of exposures;
Aggregate losses are highly sensitive to bank exposures to different types of loans, which are again estimates. Different tranches of securities are also valued differently;
The timing of loss recognition is uncertain and the norms vary across countries; and
Loss estimates could be lowered by remedial measures such as the modification of mortgage loan terms.
On the ripple effects of the crisis, the IMF points out that emerging-market countries have been 'broadly resilient' so far. But it adds that some remain vulnerable to a credit pullback, especially where domestic credit growth has been fuelled from external funding and large current account deficits need to be financed.
However, this is not so much the case in Asia, where most countries have current account surpluses. Eastern European countries are the most exposed.
The IMF's report comes ahead of tomorrow's meetings of Group of Seven finance ministers. This will be followed by the spring meetings of the IMF and the World Bank, where the sub-prime crisis is expected to top the agenda.
With regard to policy measures, the IMF says 'the immediate challenge is to reduce the duration and severity of the crisis. Actions that focus on reducing uncertainty and strengthening confidence in mature market financial systems should be the first priority'.
Comparing the magnitude of the US sub-prime crisis to previous financial crises, the IMF points out that in absolute dollar terms, it is slightly larger than Japan's banking crisis of the 1990s.
But relative to GDP, the losses stemming from the sub-prime crisis would be around 7 per cent, which makes it much smaller than either the Japanese crisis or the Asian financial crisis of 1997/98, where the total losses came to 15 per cent and 35 per cent of GDP, respectively.
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