• Crisis switches to real economy

There are two ways the current banking crisis affects hotel investors: firstly, the availability of, and price of, finance. Secondly, when changes to the former feed through to the broader economy and affect demand.

While the pieces to alleviate the stress in the first problem are being put in place by the world's central banks, it is the second point which now looks set to haunt investors.

The International Monetary Fund on Wednesday described the current financial conditions as the worst since the 1930s.

Many commentators have read this as proof we are now in a 1930s style crash. We are not.

In the IMF's World Economic Outlook published on Wednesday, the organisation radically revised down its growth projections. But the growth forecast remains positive. It is now, on a global basis, 3.0% in 2009 compared to the 3.9% forecast in July.

The projections for advanced economies were marked down by 0.9 percentage points to just 0.5%. While this is not recession, at least for the full year, it is almost there with the US forecast to deliver just 0.1%, the Euro area 0.2% and the UK to shrink by 0.1%.

Of course, the question is whether the projections will be revised even further in a few months. Some clues to this lie in another IMF report, published on Tuesday. The Global Financial Stability Report did not make for a pretty read.

Having shocked a few people back in April by suggesting that losses on US loans might reach $945bn the organisation is now predicting the final figure will be $1.4 trillion.

The amount of capital needed by the major global banks over the next few years is likely to be $675bn as the banks seek to rebuild their capital base, said the IMF. This is on top of the $430bn they have raised already since the start of the credit crisis.

More than half (55%) of known potential losses in the IMF's base case have already been recognised with banks shouldering the lion's share of the $760bn reported so far. Non-banks have recognised $180bn of losses with insurance companies having $100bn.

The IMF also ran some numbers on what it called a "stress scenario" and this sees bank losses some 20% higher. The biggest losses are set to be in residential real estate, with $170bn under the base case and $210bn under the stress scenario.

In comparison, commercial real estate is set to suffer $90bn in base and $100bn in stress. Corporate loans are $110bn and $130bn respectively.

The total dollar cost of the current crisis is likely to be more than the previous financial crises over the last two decades, reckons the IMF, although these costs are more broadly spread across countries and institutions.

Outside of the US, things are slightly less bleak. In the UK, the IMF says that defaults on UK residential loans are unlikely to breach the previous peak in the 1990s and are set to be less severe than in the US, proportionally.

The IMF is forecasting an economic recovery in late 2009 (albeit "unusually gradual") with the markets reopening for banks to raise capital some time next year as well. In the meantime, governments will be needed to prop the system up.

There was an implied criticism of the US $700bn bailout in that the IMF said banks should "be focused on strengthening their balance sheets – preferably by attracting new capital rather than selling assets". Although it recognised the US's Troubled Asset Relief Program should be part of any rescue package.

The IMF also delved into the tricky issue of valuations, particularly the pro-cyclical role of fair value accounting. In other words it was concerned that the current mark to market principles were exacerbating the downturn.

But rather than abandoning the principle of fair value accounting it suggested instead that there should be more information on valuation including the expected variation on valuations, modelling techniques and assumptions.

In the final chapter of the 173 page report the IMF warned that the vulnerability of emerging markets should not be underestimated.

The press release accompanying the report was a call-to-arms for governments. The IMF said that failing to act decisively on the turmoil in financial markets would "usher in a period in which the ongoing deleveraging process becomes increasingly disorderly and costly for the real economy".

The most worrying element of the IMF report was its discussion of a "negative feedback loop" where problems in the financial markets feed through to the wider economy, which causes asset prices to drop, causing more problems for banks and so on into spiral downwards.

Leaving aside the stock market reaction, there are some signs that the latest round of government interventions is having an effect. Even before the coordinated 0.5 percentage point cut in base rates by most key central banks, indexes that track subprime debt were beginning to lift.

The ABX index that is a benchmark for the securities issued on the back of the dodgy home loans in the US have been rising, up around 13% in the past fortnight. It is in these loans, some of which were issued to so-called NINJA borrowers (no income and no job), where the current crisis started. Perhaps this will mark a turning point.

In terms of the wider banking market, recent government interventions should certainly help. The US's $700bn bailout in the form of TARP will help rebuild confidence as troubled assets are moved off the balance sheets of banks.

The injection of £50bn of capital by the UK government in the form of buying preference shares in the banks will also help.

Arguably the most encouraging thing about these interventions is that the authorities seem increasingly aware of breaking the negative feedback loop. They are telling the banks to lend to businesses and to consumers on reasonable terms.

Whether this is enough to prevent a major recession, nobody knows for certain. But with falling interest rates and still, by historical standards, strong employment the so-called "real economy" need not be as damaged as many fear.

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