Confusion over U.S. economic policy could wipe out trillions of dollars of investments around the world and risk the equivalent of a bank run in parts of the U.S. home mortgage market, the International Monetary Fund said Wednesday.
The warning came in the fund’s semiannual report on global financial stability, a heavily technical document that delves into the risks facing — and sometimes generated by — world banking, insurance, government debt and related markets. And it highlighted the IMF’s growing unease over the deadlock on Capitol Hill.
Topic A: The sudden sense of drift at the top of the world’s largest economy, where the government is shut down, the leadership of the Federal Reserve is changing at a critical time for monetary policy and uncertainty exists over whether one branch of government will allow the other to pay its bills.
“I want to be very clear. What is happening is not good news. It shows some difficulty in the U.S. political establishment, in the U.S. machinery, to produce a good outcome,” said Jose Vinals, head of the IMF’s monetary and capital markets division. “It is completely of the essence that the U.S. political machinery gets its act together and ends this impasse.”
The IMF, like most analysts and foreign officials, still considers the probability of a U.S. debt default as extremely low, and assumes the shutdown will be short-lived.
But the fund also thinks that those who control large pots of money around the world — the executives at banks, money-market firms, insurance companies and pension funds — are on a hair trigger. The years of loose monetary policy encouraged them to invest in unconventional ways, such as pumping hundreds of billions of dollars into foreign and corporate bonds in developing countries, and buying longer-duration bonds that repay their principle years down the road.
A rise in long-term U.S. interest rates, a likely consequence when the Fed begins to end its quantitative easing program, would cut the value of those bonds for any investor who needed or wanted to sell. Bonds prices move in the opposite direction as interest rates. In a sober calculation of how U.S. economic decisions affect the rest of the world, the IMF said that even a 0.1 percentage-point rise in U.S. long-term rates would cut bond values by 5.6 percent globally, the equivalent of about $2.3 trillion in lost value.
As a consequence, the fund is concerned that investors might be quick to exit, with a fast and unpredictable fallout.
Europe could sink back into a sovereign debt crisis if borrowing costs spike for countries such as Italy or Spain, which have enjoyed months of relative calm. Developing countries such as Turkey or Indonesia could be thrown into turmoil if foreign cash disappears. The U.S. housing recovery, and the nation’s economic rebound in general, could be at risk if mortgage real estate investment trusts (REITs) are caught by a rapid rate change.
The IMF said it is concerned about the large increase since the crisis in mortgage REITs, which now hold about $500 billion in mortgage-backed securities. The trusts are too small on their own to cause a problem. But after the financial crisis of 2008 and the collapse of Lehman Brothers, the IMF said, it is worried about any investment pool that might be forced into a “fire sale” of assets simply because it is overly sensitive to interest rate increases.
Some tremors have already occurred. The IMF said comments in May by Federal Reserve Chairman Ben S. Bernanke, that the Fed would probably be pulling back on its stimulus program, caused investors to pull more than $400 billion from world bond and stock markets.
Since the government shutdown began last week, U.S. short-term borrowing costs have jumped in what the IMF’s Vinals called a sign that markets will tolerate the congressional impasse only so long before they prepare for worse to come.