Credit Squeeze Seen Slowing Global Growth

Source : The Business Times, September 12, 2008

GLOBAL financial market turbulence will persist despite the US government taking over mortgage giants Fannie Mae and Freddie Mac, a former US Treasury official warned yesterday.

Mr Dallara: Raps banks, underwriters, ratings agencies for the crisis

Charles Dallara, now managing director of the Washington-based Institute of International Finance (IIF), said the credit squeeze will tighten, leading to a 'period of extended malaise in major economies and slower growth in emerging economies'.

Speaking in Tokyo, he lambasted banks, underwriters, ratings agencies and other financial institutions for bringing about the US sub-prime mortgage crisis and consequent financial sector meltdown. But he praised their subsequent efforts to clean up the mess by cooperating with an IIF move to introduce new principles of conduct for the financial sector.

Mr Dallara said the IIF, whose members include more than 380 of the world's top financial institutions, is setting up a 'markets monitoring group', comprising leading banks and other institutions, to try to forestall future financial system crises. The group will meet periodically to check whether asset prices are moving out of line with economic fundamentals and to look for other signs of systemic stress, he said.

Thirteen months after the outbreak of the sub-prime crisis, 'I cannot say that market turbulence is behind us', Mr Dallara told the Foreign Correspondents Club of Japan. He warned of 'stress ahead' as financial institutions in the US and Europe continue to 'shrink their balance sheets' and struggle to raise capital in an 'extremely difficult environment'.

There has been a 'generalised breakdown in discipline in credit risk assessment and underwriting practices', he said. 'Bankers took their eyes off the ball, credit rating agencies did not do their job' and investors were guilty of similar laxity. Credit tightening has now spread from mortgages market to areas such as auto loans and credit cards, he noted.

One of the most pernicious effects has been that capital-starved banks in North America and Europe have become risk-averse and are unwilling to lend even to sound business borrowers, he said.

An extended slowdown can therefore be expected in the world's major economies for two to three years. And emerging market growth in Asia and elsewhere will inevitably slow as a result.

Mr Dallara said Japanese banks are in relatively good shape because of their limited exposure to the sub-prime fallout. They have begun to rebuild foreign lending and could pursue loans growth overseas, as well as mergers and acquisitions involving distressed foreign financial institutions.

The IIF managing director is holding meetings in Japan and South Korea with senior government officials and heads of financial institutions to gather support for compliance with principles of conduct and best-practice recommendations drawn up by 60 leading financial firms over nine months in the aftermath of the sub-prime crisis.