Rogoff fears more banking misery

Kenneth Rogoff, the former chief economist of the International Monetary Fund (IMF), warns that the subprime fallout is far from over.

Kenneth Rogoff, a former chief economist of the IMF, has said SWFs may not make huge profits.

SINGAPORE // Kenneth Rogoff, the former chief economist of the International Monetary Fund (IMF), warned yesterday that a major US bank could fall victim to the global credit crisis. "We're not just going to see midsized banks go under in the next few months, we're going to see a whopper, we're going to see a big one, one of the big investment banks or big banks," said Mr Rogoff, speaking at a conference in Singapore.

"The financial sector needs to shrink. I don't think simply having a couple of medium-sized banks and a couple of small banks going under is going to do the job. We're really going to see a consolidation even among the major investment banks." The US housing slump last year sparked a credit market crunch that is still rippling through the global economy. Higher interest rates are causing property-led expansions to crumble in the US and Europe, and financial institutions worldwide have posted about US$500 billion (Dh1.8 trillion) of credit losses and markdowns since the start of 2007.

Bear Stearns, the fifth-largest US securities firm, collapsed in March and was sold to JPMorgan Chase for $10 a share. "Like any shrinking industries, we are going to see the exit of some major players," said Mr Rogoff, declining to name the banks he expects to fail. "The Fed and the Treasury cannot and should not come in and try to freeze everyone where they are." Henry Paulson, the US treasury secretary, asked the US Congress on July 13 for emergency powers to inject "unspecified" amounts of government funds into mortgage-finance companies, including Fannie Mae and Freddie Mac, if necessary.

Mr Rogoff's remarks came as investors dumped shares of the largest US home funding companies after a newspaper report said government officials may have no choice but to nationalise the US housing finance titans. A government move to recapitalise the two companies by injecting funds could wipe out existing common stock holders, the weekend Barron's story said. Preferred shareholders and even holders of the two government-sponsored entities' $19 billion of subordinated debt would also suffer losses.

Mr Rogoff said multibillion dollar investments by sovereign wealth funds from Asia and the Middle East in western financial firms may not necessarily result in large profits, because they had not taken into account the broader market conditions that the industry faces. "There was this view early on in the crisis that sovereign wealth funds could save everybody. Investment banks did something stupid, they lost money in the subprime, they're great buys, sovereign wealth funds come in and make a lot of money by buying them.

"That view neglects the point that the financial system has become very bloated in size." Among his audience were representatives of local wealth funds GIC and Temasek, who between them have invested more than five billion US dollars in Merrill Lynch and Citigroup. In response to the sharp US housing retrenchment and turmoil in credit markets, the Federal Reserve has reduced interest rates by a cumulative 3.25 percentage points to two per cent since last September.

Mr Rogoff said the Fed was wrong to cut interest rates as "dramatically" as it did. "Cutting interest rates is going to lead to a lot of inflation in the next few years in the United States," he said. * With Bloomberg and Reuters