Worst is yet to come in US warns Rogoff

Published on Tuesday 19 August 2008 21:09

ONE of the US's giant banks is set to fail within the next few months, a former International Monetary Fund chief economist predicted yesterday.

Kenneth Rogoff, who is an economics professor at Harvard University, also warned that the worst of the global financial crisis has yet to come.

Rogoff told a conference in Singapore: "The US is not out of the woods. I think the financial crisis is at the halfway point, perhaps.

"I would even go further to say 'the worst is to come'."

He added: "We're not just going to see mid-sized 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."

Asked whether there were early signs of an end to the crisis, Rogoff – who worked for the IMF from 2001 to 2004 – commented: "We have to see more consolidation in the financial sector before this is over."

And he predicted that, despite assurances from US treasury secretary Hank Paulson, the troubled US home funding companies, Fannie Mae and Freddie Mac, were "not going to exist in their present form in a few years".

Rogoff's comments came as investors dumped shares in Fannie Mae and Freddie Mac after a newspaper report said US government officials may have no choice but to effectively 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 story claimed.

Preferred shareholders and even holders of the two government-sponsored entities' $19 billion of subordinated debt would also suffer losses.

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.

He explained: "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 and needed to shrink."

Singapore wealth funds GIC and Temasek have invested billions in Merrill Lynch and Citigroup.

In response to the sharp US housing retrenchment and turmoil in credit markets, the US Federal Reserve has reduced interest rates by a cumulative 3.25 percentage points to 2 per cent since mid-September.

Rogoff said the US Federal Reserve was wrong to cut interest rates as "dramatically" as it did.