IMF Concludes Article IV Consultation With United States

by Glen Shapiro, LawAndTax-News.com, New York

26 June 2007

It emerged on Friday that the International Monetary Fund (IMF) has concluded its Article IV Consultation with the United States.

The IMF began by observing that:

"Fortunately for the global economy, the recent cooling of US activity from the robust pace of recent years has coincided with a pick up in growth elsewhere. The US slowdown has mainly reflected a drag from residential investment due to the ongoing housing market correction. Consumption, by contrast, has remained strong, supported by solid employment and wage growth."

"This resilience reflects the benefits of flexible markets backed by stable monetary policies and an improving fiscal position. Benign US financial conditions have minimized spillovers elsewhere and, with global activity supported by faster growth in the Euro area and Asia, the US current account deficit has stabilized, albeit at high levels."

The report pointed to four key macroeconomic challenges facing the US, namely:

• Facilitating a soft landing for the economy;
• Maintaining a sound and innovative financial sector;
• Raising domestic savings and lowering the current account deficit, while resisting protectionism; and
• Tackling the key longer-term fiscal challenge of rising entitlement spending.

Commenting with regard to the US financial system, the IMF stated that:

"Financial innovation and stability have underpinned US economic success and funding of the current account deficit. The system has been highly resilient, including to recent difficulties in the subprime mortgage market, spreads and market volatility are near historical lows, and profits and capital adequacy are strong."

"Innovation has helped disperse risk, as the core players of the system — the large commercial and investment banks — have embraced an "originate to distribute" model in which they bundle loans into securities with varying risk characteristics for sale to investors; derivative markets too have increased the liquidity of securitization. Overall, innovation has been instrumental in attracting capital inflows, with foreigners increasingly buying US private debt instruments."

"However, rapid innovation has also created new regulatory challenges. We agree that prudential oversight should focus on core commercial and investment banks, while relying on market discipline to limit risk elsewhere. However, even as new instruments have made it more difficult to asses vulnerabilities, benign market conditions have encouraged risk-taking, which can lower lending standards, as occurred with subprime mortgages:"

It continued:

"With several federal and many more state regulators overseeing this evolving system, we welcome the current emphasis on improving regulatory effectiveness. Shared responsibility can encourage informed debate, but it can also slow responses to pressing issues (e.g., to issuing guidance on hybrid subprime loans). Therefore, we support:

• Increasing the use of general principles as a guide to rule making. Such principles can ease interagency coordination and shorten reaction times to developments. The scope for rationalizing the regulatory structure could also be explored, including by building on the options discussed by the report of the Government Accountability Office.
• Other measures to improve regulatory effectiveness. Taking forward several proposals would help, notably instituting a national insurance charter (to reduce compliance costs with state-by-state norms); reforming oversight of government-sponsored housing enterprises (to limit risks from their portfolios); and modifying the industrial loan company charter (to avoid deposit-taking without consolidated supervision)."

"Competition from foreign financial markets has helped spur other initiatives to lower the costs of regulation. We welcome new guidance reducing the compliance burden of parts of the Sarbanes-Oxley Act and rules making it easier for foreign companies to delist from U.S. markets. We also support moves by the Securities and Exchange Commission to consider recognizing International Financial Reporting Standards for foreign companies and to allow for mutual recognition of comparable regulatory regimes."

With regard to meeting the fiscal challenges ahead, the IMF announced that:

"We also welcome recent fiscal performance and the Administration's medium-term goal of budget balance by FY 2012, which is garnering broad support. The FY 2007 deficit will likely fall below 1½ percent of GDP in FY 2007, again outperforming expectations on the back of revenue buoyancy from robust profit growth and tight expenditure control. Congress has also adopted this time frame for budget balance and passed supporting pay-as-you-go rules. However, achieving broad consensus on the means to achieve budgetary balance remains a major challenge, especially given the uncertainties attached to war funding and the cost of temporary fixes to the Alternative Minimum Tax."

In conclusion, the IMF assessment stated that:

"The US economy continues to show remarkable dynamism and resilience, but important challenges lie ahead. This performance reflects important strengths, including high levels of flexibility and innovation in markets for goods, labor, and financial assets, as well as monetary stability and a strong recent fiscal performance. The commitment of policymakers to embrace globalization has ensured that these benefits are shared with the rest of the world. Even so, policymakers will need to come to grips with the need to maintain a robust financial system, eliminate the fiscal deficit, reform the tax system and, most importantly, make entitlement programs sustainable."

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