IMF Pegs U.S. Credit Losses at $1.4 Trillion

The latest estimate of losses in the Global Financial Stability Report is well above the figure of $945 billion the fund predicted in April, which was considered high at the time by some economists. It also tops the $1.3 trillion forecast given by IMF Managing Director Dominique Strauss-Kahn just two weeks ago.

"With financial markets worldwide facing growing turmoil, internationally coherent and decisive policy measures will be required to restore confidence in the global financial system," the IMF said in the report. "Failure to do so could usher in a period in which the ongoing deleveraging process becomes increasingly disorderly and costly for the real economy."

In its downbeat assessment, the IMF said "threats to systemic stability became manifest" last month, with the failure or near-collapse of major U.S. institutions.

The fund estimates that write-downs on U.S. assets totaled $760 billion through September, suggesting the period of financial pain is only around the halfway mark a little over a year after the blowout in the U.S. subprime mortgage sector turned into a global credit crunch.

While European institutions are getting hit mostly by exposure to toxic U.S. assets, mortgage markets in the U.K. and Spain are also coming under increasing pressure.

"Global losses could be higher should credit quality worsen and write-downs mount on non-U.S. loans," the report said. "Already, fundamentals are deteriorating in some European economies, where house price appreciation has slowed considerably or turned negative, lending standards have tightened, and mortgage rates have risen."

Emerging markets, which have so far proven resilient to the crisis, are now feeling the heat, as well.

Some developing countries "face challenges as global growth slows and the lagged pass-through of domestic inflationary pressures continues -- and all this against the backdrop of lower confidence and the reversal of earlier flows into these markets," the report said. That raises the risk of a credit cycle downturn in their domestic markets.

The world economy is already hurting as its lifeblood of financial market liquidity dries up, and the IMF is poised once again to ratchet down its economic forecasts. On Wednesday, the fund will release its latest global economic estimates, and is expected to reverse at least part of July's upward revision in its 2008 forecast to 4.1% growth.

"The strains afflicting the global financial system are expected to deepen the downturn in global growth and restrain the recovery," the report said.

The biggest concern is that the "adverse feedback loop" between the economy and financial system could accelerate, according to the IMF.

Noting that the private sector is unlikely to be able to address the problems alone and that "piecemeal interventions" haven't eased market jitters, the IMF welcomed broader efforts to tackle the root causes.

"Such a comprehensive approach -- if well-coordinated among countries -- should be sufficient to restore confidence and the proper functioning of markets and avert a more protracted downturn in the global economy," the report said.

Laying out an extensive menu of policy prescriptions, the fund recommended ways to make the necessary deleveraging process already underway more orderly by focusing on "insufficient capital, falling and uncertain asset valuations, and dysfunctional funding markets."

Estimating that major global banks will need about $675 billion in fresh capital just to support modest private-sector credit growth, the IMF said governments may need to provide increasingly scarce capital.

"While there are many ways to accomplish this, it is preferable that the scheme provide some upside for the taxpayer, coupled with incentives for existing and new private shareholders to provide new capital," the report said.

On the other hand, the orderly resolution of nonviable banks would demonstrate a commitment to a healthy system, it said.

To help prevent "fire-sale" asset liquidations, governments can offer the use of public balance sheets, or allow more flexible use of mark-to-market accounting rules to reduce pressure on valuations, according to the IMF.

Meanwhile, the fund welcomed efforts by central banks to continue to inject liquidity into funding markets, which have remained "stressed for an unprecedented period."

The IMF also encouraged ongoing cooperation and coordination between central banks, adding that "continued convergence of their operational procedures would also aid in achieving this goal."

Under "extreme circumstances," additional measures such as temporarily increasing insurance on retail bank deposits or guaranteeing debt liabilities may also be considered, the report said.

The private sector also must play a role, the IMF said. Financial firms should shore up balance sheets with new capital, strengthen risk-management practices, improve valuation techniques and create better clearing and settlement mechanisms for over-the-counter securities, it said.

-- Tom Barkley, Dow Jones Newswires