Capital Gold Group Report: IMF Warns of New Phase in Global Financial Crisis

By Tom Barkley and Bob Davis

WASHINGTON—Greece's upheaval could mark the starting point of a "new phase" in the global financial crisis, one marked by escalating concerns about sovereign debt, the International Monetary Fund warned Tuesday.

"Higher debt levels have the potential for spillovers across financial systems, and to impact financial stability," the IMF said, noting that debt levels among advanced countries have already risen to levels not seen since the end of World War II.

Mounting risks of sovereign default can reverberate through the global economy, the IMF said, including by pushing up interest rates on government debt, which in turn causes interest rates on commercial debt to rise as well. A diminished faith in the value of government guarantees can also push up borrowing costs across nations as the market demands higher interest rates for commercial debt.

Tuesday's warnings come at a time when the global concern over bank losses appears to have ebbed. In its semiannual Global Financial Stability Report, the IMF projected that global banks would book losses of $2.3 trillion for the 2007-2010 period, down from its October 2009 projection of $2.8 trillion in losses. About $1.6 trillion has already been written off, it said, with another $700 billion in losses still to be recognized. The report estimated that banks could cover those losses through their anticipated earnings.

"Banks have been raising significant amounts of capital so that now they can cope with the losses that are coming in a way that puts them in a rather comfortable position," Jose Vinals, director of the IMF's monetary and capital markets department, said in a discussion with reporters.

Two former senior IMF economists, Kenneth Rogoff, now at Harvard, and Carmen Reinhart, now at the University of Maryland, have been warning that banking crises frequently lead to sovereign debt crises several years later, in part because governments spend so heavily to restore their banking systems to health. Essentially, the IMF report was adding detail to the work of Mr. Rogoff and Ms. Reinhart.

"Careful management of sovereign risks is essential: governments need to design credible medium-term fiscal consolidation plans in order to curb rising debt burdens and avoid taking the credit crisis into a new phase," the IMF said in its report. Greece's struggles to get out from under a mountain of debt should serve as a "wake-up" call to governments, said Mr. Vinals.

Still, Mr. Vinals was quick to describe Greece as a special case that shouldn't be lumped together with other countries whose deficits have come under the market's glare—Spain, Portugal and Ireland. Those countries started out with better fiscal situations and institutions than Greece, he said, and have already taken measures to address budget concerns.

Speculation in sovereign credit-default swaps, which Greek Prime Minister George Papandreou has blamed for helping push the country deeper into crisis, may sometimes exaggerate public debt strains, said Mr. Vinals. He said proposals to ban naked CDSs—betting on the default of a credit without having an underlying interest in the bonds—would be counterproductive given the difficulty of defining illegitimate activities.

The IMF report noted that money is now flooding into Asia and other emerging markets, particularly because interest rates are so low in the U.S. and Europe. Some markets are showing evidence of overheating, and not only in developing countries, the IMF said. These include residential real estate in Australia, China, Hong Kong and France, and sovereign debt in Japan.

"But we find little evidence that bubbles have formed in these segments in the near term," the IMF found.

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