Macroscope | A warning of financial crisis is not enough. The IMF should prevent it
- The International Monetary Fund has warned of the financial stability risk posed by mutual funds, and other rising threats to financial systems
- Before a bear market causes pain to myriad investors, the IMF’s ruling body should coordinate policies to stabilise the international monetary system
Financial crises have a way of starting (although not ending) in unexpected places. They detect weak links in the chain of institutions and instruments that make up modern financial systems. In 2008, the link that snapped was the subprime mortgage market; this time it could be open-end investment funds.
These represent one such link – though by no means the only one – that could destabilise financial asset prices and perhaps trigger a systemic financial crisis. The threat was identified in an International Monetary Fund report on the eve of this week’s World Bank Group and IMF annual meetings in Washington.
Open-end investment funds, which are better known as mutual funds, have grown dramatically to the point where they hold a huge US$41 trillion in assets. They are at risk of sudden liquidity crisis as they offer redemptions on demand even though some of their assets are long-term and relatively illiquid – a classic mismatch.
The IMF alert is timely for investors appear to believe that stock prices are near bottom. By their nature, the workings of financial systems are usually not transparent until things go wrong (except to regulators who try to avoid precipitating crises by warning of them).
As the IMF notes, pressures from investors wanting out from open-end funds could “force funds to sell assets quickly, which would further depress valuations. That in turn would amplify the impact of the initial shock and potentially undermine the stability of the financial system”. You cannot put it much more clearly than that.