By Simon Kennedy and Timothy R. Homan
April 27 (Bloomberg) -- The Group of Seven finance chiefs’ ability to handle banks’ toxic assets will determine the strength of the economic recovery they now say will begin this year.
In warning that the world economy could still take another turn for the worse, the finance ministers and central bankers who met over the weekend in Washington singled out the banks’ impaired balance sheets as the biggest threat to a sustainable recovery.
Their remarks indicate it will be critical to follow through on commitments to deploy taxpayer funds to buy distressed assets, even as some gauges of financial stress ease. U.S. officials aim to finance the purchases of as much as $1 trillion of loans and securities, and Germany is pushing a plan to remove 853 billion euros ($1.1 trillion) from balance sheets.
“A healthy financial system is a pre-condition for a healthy economic recovery,” said Torsten Slok, an economist at Deutsche Bank AG in New York. “Policy makers realize the banking system is the core of the problem and are looking to solve it.”
Displaying a more upbeat tone than when they met in February, the G-7 officials said after April 24 talks that they now expect a “weak” recovery in coming months, while noting that it might take longer. The group’s communique repeated a pledge “to continue to act,” and policy makers individually underscored the need to shore up financial institutions.
Top Issue
“Our central objective is to make sure that we have a financial system that’s working for recovery, not against recovery,” U.S. Treasury Secretary Timothy Geithner said. Canadian Finance Minister Jim Flaherty said in an interview that “the number-one issue is to repair the financial system,” and “fix the banks.”
U.S. officials are set to announce next week how much more capital their nation’s 19 biggest banks need to ensure they keep lending even if the downturn worsens. Citigroup Inc., Bank of America Corp., GMAC LLC, American Express Co. and several regional lenders are included in the group.
Weeks later, the Treasury, Federal Reserve and Federal Deposit Insurance Corp. aim to start up the public-private investment program to purchase banks’ distressed assets.
Policy makers met after some signs that the seizure in credit markets is lessening. The Libor-OIS premium that indicates banks’ reluctance to lend to each other fell to 0.87 percentage point on April 24, the lowest level since before Lehman Brothers Holdings Inc. collapsed in September, according to data compiled by Bloomberg.
Yield Premiums
The extra yield investors demand to buy European investment-grade corporate bonds instead of government debt fell to 3.95 percentage points last week from a record of 4.63 percentage points in March. In the U.S., companies have raised a record $468 billion in U.S. bond sales this year.
The improvement didn’t stop the International Monetary Fund from warning last week that banks worldwide face hundreds of billions of dollars of further losses to come. The carnage from distressed loans and securitized assets may reach $4.1 trillion by the end of next year, according to the fund. Bank of France Governor Christian Noyer questioned the numbers as too high.
Mounting losses would threaten to prevent lenders from extending new credit to consumers and companies, preventing a sustained economic recovery that leads to job creation.
Germany’s Plan
Under Germany’s plan, banks tapping government support will need to open their own separate bad-bank units to manage debts that will be guaranteed by the government in exchange for fees. The initiative, which consists of one main model applicable to both private and public banks, will be hammered out in detail before going to Cabinet for approval in May, the government said last week.
Having committed 1.4 trillion pounds ($2.1 trillion) to supporting its banking system, the U.K. may need to extend aid to building societies. Prime Minister Gordon Brown’s government last week also offered to guarantee some mortgage-backed bonds, adding as much as 50 billion pounds to its bailout. Brown is battling to win back public support for his government ahead of an election that must be held by mid-2010.
“All ministers go back committed to speed up the process,” IMF Managing Director Dominique Strauss-Kahn told reporters. Success in the effort may mean that the fiscal stimulus plans governments have already introduced this year “may be enough,” he added.
Estimate of Stimulus
The IMF yesterday estimated the Group of 20 countries will implement stimulus packages averaging 2 percent of gross domestic product this year, an increase from a 1.8 percent projection of last month. Similar measures will total 1.5 percent of GDP next year, up from 1.3 percent, the fund said.
The fund said the budget deficit of the G-20 would average 6.6 percent of GDP this year and 6.5 percent in 2010. The U.K. gap would be the biggest at 10.9 percent next year, up from 9.8 percent in 2009, it said.
Japan’s shortfall will rise to 9.6 percent from 9.4 percent this year and Germany and France will each have deficits above 6 percent in 2010, it said. The U.S. imbalance will fall to 8.8 percent next year from 9.1 percent, the IMF said.
Simon Johnson, a former chief economist at the IMF, questioned the resolve of the G-7 to tackle toxic assets. He warned that governments are relying on an economic recovery to solve the banking problem for them.
“They have missed their opportunity,” said Johnson, now a senior fellow at the Peterson Institute for International Economics in Washington. The expectation of a global economic recovery this year is “totally wishful thinking,” he said.
Chinese Rebound
Jim O’Neill, chief economist at Goldman Sachs Group Inc. in London, said he was more confident given his view that the Chinese economy, the world’s third largest, will soon rebound. “We’re way through the worst even without the banks being sorted out,” he said.
Data this week may back the G-7’s observation that “some signs of stabilization are emerging.” A U.S. report in two days may show that while the economy plunged in the first quarter, a backlog of unsold goods diminished and consumer spending halted its slide. In the euro area, figures the same day are forecast to show confidence among businesses and consumers rising for the first time since May.
Company reports last week highlighted how some are beginning to escape the gloom as others falter. AT&T Inc., the biggest U.S. phone company, posted first-quarter profit that topped forecasts and Debenhams Plc, the U.K. retailer, announced improving sales and margins. Meantime, Caterpillar Inc., the world’s largest producer of bulldozers, posted its first quarterly net loss in 16 years and Germany’s Robert Bosch GmbH, the biggest car-parts maker, projected a 2009 loss.
IMF Bonds
At its spring members meeting over the weekend, the IMF sought progress in its push for more resources as the crisis forces countries from Hungary to Pakistan to seek its aid. Strauss-Kahn said the fund is working on a plan to sell bonds to several developing countries as Brazil and China seek more power over its decisions.
“I’m sure that this vehicle will be used,” Strauss-Kahn said. “Now we’re discussing with different creditors the way to implement it and the amount that we put in it.”
Bonds would offer “flexibility,” he said, and their interest rate would be pegged to the value of the IMF’s basket of currencies, known as Special Drawing Rights or SDRs.
The IMF said it has received $324.5 billion in commitments from Group of 20 countries since mid-March, more than half the $500 billion in extra resources that leaders promised to provide on April 2.
To contact the reporters on this story: Simon Kennedy in Washington at skennedy4@bloomberg.netTimothy R. Homan in Washington at thoman1@bloomberg.net
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