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Economic and Social Council of the Bretton Woods Institutions

Christopher Towe Monetary and Capital Markets Department

April 14, 2008

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Outline… Outline…

Risks of a further deteriorationRisks of a further deterioration Key policy requirementsKey policy requirements The multilateral responseThe multilateral response

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Outline… Outline…

Risks of a further Risks of a further deteriorationdeterioration

Key policy requirementsKey policy requirements The multilateral responseThe multilateral response

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The global conjuncture and threats to The global conjuncture and threats to systemic stability remain worrisome… systemic stability remain worrisome…

Markets have stabilized somewhat in recent Markets have stabilized somewhat in recent weeks…weeks…

But only in response to a massive policy response:But only in response to a massive policy response: Extraordinary liquidity provision by central banksExtraordinary liquidity provision by central banks Cuts in official interest ratesCuts in official interest rates Fiscal stimulusFiscal stimulus Reform proposalsReform proposals

And private market participants have also had to And private market participants have also had to bolster capital…bolster capital…

But interbank markets still impaired and there is a But interbank markets still impaired and there is a significant “tail risk” of self-sustained debt spiralsignificant “tail risk” of self-sustained debt spiral

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Risks

Monetary and financial

Conditions

Emerging market risks Credit risks

Market andliquidity risks

Macroeconomicrisks

Risk appetite

Closer to center signifiesless risk or tighter conditions

October 2007 GFSRApril 2008 GFSR

Our Global Financial Stability Map shows Our Global Financial Stability Map shows where the risks are most worrisomewhere the risks are most worrisome

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Leveraged loans

Corporate credit

Consumer credit

Commercial real estate

Prime residential real estate

Non-prime residential real estate

IMF estimates of potential losses IMF estimates of potential losses illustrate it’s not just a “sub-prime” illustrate it’s not just a “sub-prime”

problem…problem…

Estimates of Potential Write-downs to Holders ofU.S.-Issued Securitized and Unsecuritized Debt

56%

4%

25%

$945 billion

2%

8%

4%

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The U.S. remains a key concern, with default rates rising now in “prime” markets

0

5

10

15

20

25

30

0 10 20 30 40 50 60

Subprime

20062000

2005

2007

2004

2003

0.0

0.5

1.0

1.5

2.0

2.5

0 10 20 30 40 50 60

Prime

2006

2000

2005

2007

2003

2004

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Non-U.S. real estate markets are also vulnerable to a downturn

50

100

150

200

250

300

1995

Q1

1996

Q1

1997

Q1

1998

Q1

1999

Q1

2000

Q1

2001

Q1

2002

Q1

2003

Q1

2004

Q1

2005

Q1

2006

Q1

2007

Q1

United KingdomSpainEuro areaFrance IrelandUnited States

Residential Housing Price Trends

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Interbank liquidity problems increasingly Interbank liquidity problems increasingly reflect solvency concerns…reflect solvency concerns…

United States

-10

0

10

20

30

40

50

60

70

80

90

Jan-07 Apr-07 Jul-07 Oct-07 Jan-08

Non-creditstrains (mostlyliquidity)

Credit strains

Euro area

-10

0

10

20

30

40

50

60

70

80

90

100

110

Jan-07 Apr-07 Jul-07 Oct-07 Jan-08

Non-credit strains (mostlyliquidity)Credit strains

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Bank losses are spreading beyond the U.S….Bank losses are spreading beyond the U.S….

0

20

40

60

80

100

120

140

160

Europe United States Asia

Conduits / SIVs

ABS CDOs

ABS

Nonprime loans

Note: Losses aggregated over a two year period. ABS = asset-backed securities; CDOs = collateralized debt obligations; SIVs = structured investment vehicles.

Expected Nonprime-Related Bank Losses (In billions of U.S. dollars as of March 2008)

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Macroeconomic Indicators and Default Rates-3.5

-2.5

-1.5

-0.5

0.5

1.5

2.5

3.5

1983 1988 1993 1998 2003 2008

0

2

4

6

8

10

12

14Recessions

Lending standards 1/

Default rate (rhs) 2/

1/ Net survey balances; standardized over 1990-present.2/ Issuer-weighted.

Slowergrowth;tighterlending

standards

The U.S. corporate sector is The U.S. corporate sector is vulnerable to rising credit vulnerable to rising credit

strains…strains…

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Emerging market economies are feeling the Emerging market economies are feeling the pressure of the global financial crisispressure of the global financial crisis

0

5

10

15

20

25

30

35

Q106 Q306 Q107 Q307 Q108

AsiaEMEALatam

Emerging Market Private Sector Bond I ssuance(billions of U.S. dollars)

100

150

200

250

300

350

400

450

Jan-06 Jul-06 Jan-07 Jul-07 Jan-08

AsiaEMEALatam

Emerging Market Corporate Spreads(in basis points)

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In summary, we still see significant In summary, we still see significant threats to systemic stability from:threats to systemic stability from:

A spreading of the U.S. sub-prime crisis in A spreading of the U.S. sub-prime crisis in several dimensionsseveral dimensions To other real estate markets, both in the U.S. To other real estate markets, both in the U.S.

and abroadand abroad Beyond the banking sector, including to Beyond the banking sector, including to

investment banks and monoline insurersinvestment banks and monoline insurers Beyond the industrial world and into the Beyond the industrial world and into the

emerging markets and developing countriesemerging markets and developing countries To the macro-economies of both mature and To the macro-economies of both mature and

developing countriesdeveloping countries

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Outline… Outline…

Risks of a further deteriorationRisks of a further deterioration Key policy requirementsKey policy requirements The multilateral responseThe multilateral response

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In the short term, the focus must In the short term, the focus must remain on avoiding a self-sustained remain on avoiding a self-sustained

credit crunchcredit crunch Support for interbank marketsSupport for interbank markets Enhance bank disclosureEnhance bank disclosure Encourage bank recapitalizationEncourage bank recapitalization Early action by supervisors to deal stressed Early action by supervisors to deal stressed

institutions institutions Develop contingency plans for dealing with Develop contingency plans for dealing with

potentially large stocks of impaired assetspotentially large stocks of impaired assets

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But steps over the medium term are also But steps over the medium term are also needed avoid future such episodes…needed avoid future such episodes…

The causes of the crisis were multi-faceted, so too The causes of the crisis were multi-faceted, so too must be the policy responsemust be the policy response Strengthen credit discipline:Strengthen credit discipline: Tighten regulation and Tighten regulation and

oversight over mortgage originators to improve oversight over mortgage originators to improve underwriting standardsunderwriting standards

Stricter application of consolidated supervision:Stricter application of consolidated supervision: Basel II reduces the incentives to move off-balance sheet, Basel II reduces the incentives to move off-balance sheet, but vigilance will still be requiredbut vigilance will still be required

Fair value accounting:Fair value accounting: Care is needed to minimize the Care is needed to minimize the procyclicality of this systemprocyclicality of this system

Improve liquidity risk management:Improve liquidity risk management: Supervisors need Supervisors need to more actively stress testto more actively stress test

Crisis managementCrisis management Enhance central bank liquidity frameworksEnhance central bank liquidity frameworks Improve interagency coordination and information sharingImprove interagency coordination and information sharing Clarify enforcement responsibilityClarify enforcement responsibility

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Outline… Outline…

Risks of a further deteriorationRisks of a further deterioration Key policy requirementsKey policy requirements The multilateral responseThe multilateral response

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These messages have been given These messages have been given strong endorsement during the strong endorsement during the

weekend…weekend… By the Fund’s International Monetary and Financial By the Fund’s International Monetary and Financial

CommitteeCommittee

The G7, too, called for:The G7, too, called for: A 100-day planA 100-day plan

Enhanced disclosureEnhanced disclosure Review of (fair-value) accounting standardsReview of (fair-value) accounting standards New liquidity risk and credit rating guidelinesNew liquidity risk and credit rating guidelines

And by end 2008: And by end 2008: Tighter capital requirements for structured credit Tighter capital requirements for structured credit

productsproducts Enhanced transparency guidelinesEnhanced transparency guidelines More fundamental changes in the use of credit ratingsMore fundamental changes in the use of credit ratings

And cross-border supervisory cooperation is set to And cross-border supervisory cooperation is set to be strengthened in Europe and beyondbe strengthened in Europe and beyond

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And for the Fund…?And for the Fund…?

We will be responding on the multilateral front:We will be responding on the multilateral front: Our Global Financial Stability Report (GFSR) Our Global Financial Stability Report (GFSR)

provides a critical vehicle for disseminating our provides a critical vehicle for disseminating our analysis and pressing our policy advice to a wide analysis and pressing our policy advice to a wide audienceaudience

We will work closely with the Financial Stability We will work closely with the Financial Stability Forum to help forge the consensus on specific Forum to help forge the consensus on specific policy responsespolicy responses

We will be actively engaged with the key We will be actively engaged with the key standard setters (e.g., Basel Committee) and key standard setters (e.g., Basel Committee) and key private industry groupsprivate industry groups

And on the bilateral side:And on the bilateral side: The lessons above will inform our FSAP and The lessons above will inform our FSAP and

Article IV assessments, and our dialogue with Article IV assessments, and our dialogue with national policymakersnational policymakers

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Economic and Social Council of the Bretton Woods Institutions

Christopher Towe Monetary and Capital Markets Department

April 14, 2008