IMF downgrades US growth forecast

4th July 2012

"The United States remains vulnerable to contagion from an intensification of the euro area debt crisis, which would be transmitted mainly via a generalized increase in risk aversion and lower asset prices, as well as from trade channels" said IMF Managing Director Christine Lagarde during a press conference in Washington, D.C.

On the domestic front, the fund said the failure to reach an agreement on near-term tax and spending policies would trigger a severe "fiscal cliff" in 2013. If the fiscal cliff were to transpire, the IMF suggests that it could have grave repercussions for domestic economic growth. Lawmakers on Capitol Hill therefore need to make sure that the speed of its deficit reduction does not weaken the economic recovery.

The IMF also brought up the significance of promptly raising the debt ceiling to prevent the same financial market turmoil that occurred during last year's political paralysis surrounding the same issue, which led to the downgrade of U.S. government debt by ratings firm Standard & Poor's.

The IMF forecasts that U.S. growth will remain reticent over the next two years, hampered by an ailing housing market, the expiration of fiscal stimulus measures, and continued low global demand, particularly in Europe. Growth is projected at 2% in 2012 and about 2.5% in 2013.

Meanwhile, good progress has been made in reforming the U.S. financial system, but vulnerabilities remain, the IMF said, highlighting four specific areas for further progress:

Regulation of the shadow banking system: Given the size of the industry and prominence in short-term funding, strengthening regulation of Money Market Mutual Funds remains critical.

The Volcker rule: A ban on proprietary trading by banks should, in principle, reduce systemic risk.

Housing Finance: Measures to help the recovery of private securitization would ease mortgage market conditions.

Funding for regulatory agencies: Adequate implementation of domestic and international reforms requires appropriate funding to the regulatory and supervisory agencies.

Incidentally, the Federal Deposit Insurance Corp. yesterday on its website released summaries of the so-called "living wills" (roadmaps for how the government could break up and sell off their assets if they are in danger of bankruptcy) of nine of the largest banks in America.

These are the plans, legally required by Dodd-Frank, that allow regulators to have the power to seize and dismantle banks that threaten the broader financial system.

Bloomberg's Alex Veiga says the government is trying to prevent another situation in which taxpayers are asked to provide bailouts to banks, which is what happened during the 2008 financial crisis. At the time, regulators didn't have rules in place to unwind banks considered "too big to fail."

But some experts are warning that the banks may just be planning their own demise by completing government-mandated "living wills."

Matt McCormick, a portfolio manager at Bahl & Gaynor said: "When you look at a living will on a personal situation, when you implement it, it still results in death. If any one of these banks go out, the consequences for all banks as well as the market are catastrophic."


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