U.S. CREDIT CRISIS NOW A YEAR OLD, NO END IN SIGHT

by Abid Aslam

(IPS) WASHINGTON -- The credit crisis unleashed by the U.S. housing slump a year ago continues to poison the global economy and central banks appear short of antidote, says the International Monetary Fund (IMF).

Banks and finance firms around the world likely have acknowledged most of their exposure to subprime mortgages and securities based on these risky loans, but U.S. delinquencies and foreclosures continue to pile up and banks are restricting credit in anticipation of further losses, the IMF says in its latest global financial stability update.

A "negative feedback loop" has emerged in which tight credit conditions and economic stagnation reinforce each other, says Jaime Caruana, director of the fund's monetary and capital markets department.

"As economies slow, credit deterioration is widening and deepening; and as banks deleverage and rebuild capital, lending is beginning to be squeezed, restricting household spending and clouding the outlook for the real economy," says Caruana.

So far, the credit crunch and banking problems have roiled financial and housing markets and slowed economies mainly in the United States and Europe, where central banks are unable to cut interest rates for fear of fueling inflation.

"The scope for monetary policy to be supportive of financial stability appears to be more constrained than before amid high and volatile commodity prices," says Caruana.

The trouble is beginning to afflict emerging markets, where international investors grow wary of trade and financial deficits amid surging prices.

"Some emerging markets are coming under increased investor scrutiny, especially those with large external imbalances and inflation risks," says Caruana.

In particular, according to the IMF update: "Outflows from EM [emerging market] equity funds have been concentrated on Asian markets where inflation and downside growth risks are most elevated."

Financial institutions have written off more than 400 billion dollars in bad mortgage-related investments, the IMF says, and total losses -- including from ongoing loan delinquencies and a slump in mortgage-backed securities -- likely will reach the 945-billion-dollar estimate it issued in April.

Risk is spreading to other types of credit. "Credit quality across many loan classes has begun to deteriorate, with declining house prices and slowing economic growth," says the IMF update.

The key to financial stability lies in the U.S. housing market. Halting its decline "would remove a key component of the feedback loop, as this would help both households and financial institutions recover," says Caruana.

However, he adds, "a bottom for the housing market is not yet visible" amid rising foreclosures and falling home prices.

Home foreclosure filings rose 14 percent during the second quarter of 2008 and more than doubled from the same period last year, according to real estate data firm RealtyTrac.

One out of every 171 U.S. households received a foreclosure notice from their mortgage lender between April and June, the firm says.

Authorities here appear to have averted a worse collapse by engineering a reprieve for government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac. But a "clear and permanent solution" will be needed, the IMF says, noting in its report that "further examination of the GSEs' business model and oversight will be needed once conditions have stabilized."

A wide-ranging housing rescue bill approved by Congress last week and awaiting President George W. Bush's signature will establish an independent regulator for the mortgage financiers, which underpin about half of all U.S. mortgages.

The U.S. Federal Reserve has begun to back away from cutting interest rates for fear of stoking inflation but the government's ability to rein in prices by raising interest rates also is constrained, in this case by rising unemployment and a slowing economy.

Additionally, the government's capacity to stimulate the economy is limited by a yawning federal budget deficit. This will reach a record 482 billion dollars in fiscal 2009, which begins this October, the White House said Monday as the IMF issued its latest assessment.

White House budget director Jim Nussle blamed the surging red ink on unexpectedly slow economic growth, sharp declines in housing prices, and an unanticipated increase in inflation. While government revenues are plunging, outlays -- including on war spending and tax rebates -- also have grown.

Next year's figure will exceed the record of 413 billion dollars set in fiscal 2004. Even so, it will amount to 3.3 percent of gross domestic product -- a smaller proportion than those seen under Ronald Reagan and George H. W. Bush.