October 6, 2010 – The International Monetary Fund warned of elevated risks to global economies, real estate and the banking sector in its latest World Economic and Financial Survey.
The IMF’s pessimistic outlook for economic recovery zeroed in on the risks associated with excessive levels of sovereign, commercial and household debt in an environment of slowing economic growth and high unemployment. Too much debt and too little income will require a delicate balancing act by world governments to prevent another downward spiral in real estate markets and the financial sector.
The IMF noted that the US rate of economic expansion is beginning to slow, after a modest recovery due to “unprecedented macroeconomic policy stimulus” and “emergency financial stabilization measures”. The weakness of the US recovery is due to weak personal consumption caused by sharply deteriorated household net worth, falling home prices and high unemployment.
Weak consumer spending is also due to elevated levels of personal savings as consumers wisely chose to rebuild tattered balance sheets and build reserves in the face of declining income and employment uncertainty. Weak labor markets and declining real estate values make banks reluctant to lend as they “struggle to reduce leverage and restore balance sheets”.
The IMF is forecasting a slow US recovery with GDP growth of 2.3% in 2011, implying that the unemployment rate will remain at double digits. Despite the IMF projection of GDP growth in 2011, risks remain “elevated” and real estate markets remain fragile. Further loan losses at smaller banking institutions elevate the risk of continuing banking failures which will inhibit the recovery of normal credit conditions.
The IMF suggests that “US authorities will need to find a way to exit from extraordinary policy intervention without undermining the fledgling recovery, while dealing with the long-term legacies of fiscal imbalances…and a weakened banking sector”.
Citing the massive increase in US government debt, a key challenge for the US government will be to “ensure that the public debt is put on a sustainable path without jeopardizing the recovery”. The IMF suggests that the challenge of addressing the government deficit be given priority and difficult areas such as tax policies and entitlement spending should be examined by the President’s Fiscal Commission in 2011.
In the IMF’s estimation, the banking system remains “vulnerable” (see Americans Lack Confidence In US Banking System). Financial reforms under the Dodd-Frank Act are a start but complex specifics still need to be worked out. The IMF said that “Unless financial and structural policies are significantly strengthened, potential output in advanced economies is likely to remain appreciably below precrisis levels”.