By Ambrose Evans-Pritchard
The Telegraph, London
Thursday, January 24, 2019
The International Monetary Fund has warned that the system of global cooperation that saved world finance in the 2008 crisis may break down if there is another major shock or a deep recession.
David Lipton, the IMF’s second-highest official, said it is unclear whether the US Federal Reserve would again be able to extend $1 trillion of dollar “swap lines” to fellow central banks — the critical measure that halted a dangerous chain-reaction after the collapse of Lehman Brothers and AIG.
“I fear that if at any time we have a worse than garden variety recession there will be anger and limitations in the way governments can respond,” he told a group at the World Economic Forum in Davos today.
“If there is a substantial crisis we may need central banks to act again in an extraordinary way. For the Fed this requires a fiscal backstop from the US Treasury, and at the beginning there may be some reluctance. I wonder whether they will be so willing to extend the swap lines,” Mr Lipton said.
It is a polite way of saying that the Trump administration might ask why it should “bail out” the Europeans who have been less than friendly to this White House, and why they should rescue the rest of the world. By the time the explosive consequences became clear it would be too late.
“So we have got to be very careful. There must not be unforced errors. We must ensure that the next recession when it comes is a garden variety,” said Mr Lipton, a leading figure in regulatory circles.
The lines are vitally needed because the world has built up $12.8 trillion of offshore dollar debt outside the Fed’s jurisdiction.
European, Japanese, and Canadian banks, among others, borrow on the capital markets at short-term maturities for worldwide lending in dollars. These markets can freeze up suddenly, as they discovered in October 2008.
Their own central banks are unable to print dollars and mostly have insufficient dollar reserves to provide emergency liquidity and stabilize the financial system in such circumstances. Only the Fed can act as the ultimate lender-of-last resort to the globalised dollar economy.
Mr Lipton said there was deep residual anger from the 2008 crisis. “People are hurt and they are less impressed than we that we did a clean-up afterwards,” he said.
He fears a nasty cocktail in the next downturn because much of the damage is likely to come from hidden leverage in asset management companies, with asset slumps hitting household wealth directly.
Mark Carney, the governor of the Bank of England, said at a separate Davos session that banks were now much safer than a decade ago, but risks of potentially systemic scale were building up elsewhere.
He raised a red flag over the money that has flooded into asset management, driven by a hunger for high yields after quantitative easing and low interest rates made it hard to generate returns.
The Achilles’ heel is the buildup of $30 trillion of assets held in funds, which are supposed to offer daily liquidity to investors but are invested heavily in underlying assets that not liquid. These assets are hard to sell “even in good times and very illiquid in bad times,” Mr Carney warned.
It is a classic example of borrowing short to invest long — the perennial cause of crises over the ages. There may also be further icebergs hidden from view. “Is there additional leverage in these entities that may add to the dynamics? That’s one of the big issues in global finance at the moment,” he said.
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