GLOBAL - The International Monetary Fund (IMF) has said the rising price of supposedly safe investment options is "not an undesirable outcome" of the ongoing sovereign debt market turbulence, as it published a new report on the topic.

Despite this, the organisation warned that a lack of safe assets could result in a "scramble" from investors, leading to short-term volatility spikes, herding behaviour and a run on sovereign debt.

Speaking at a press conference in Washington yesterday, assistant director for the monetary and capital markets department Laura Kodres said the increasing demand for safe-haven investments would increase prices.

"This is not an undesirable outcome, in part because the price of safety was arguably too low before the crisis," she said. "Nonetheless, it's important to make sure the adjustment process proceeds smoothly."

Kodres said regulators should pursue an approach where assets were no longer simply deemed either 'safe' or 'unsafe', instead stating that they should be differentiated "by their safety features along a continuum" of asset prices, ranging from low credit and market risks, through high market liquidity and the level of inflation and exchange rate risk.

"In addition, regulations should be implemented so that institutions' holdings of safe assets build up slowly and steadily to avoid destabilising price effects that may result if the timing of changes is too abrupt," she said.

The report - "Safe assets: Financial system cornerstone" - added that individual investors placed differing emphasis on each of the above criteria.

"For example, investors with long-term liabilities - such as pension funds and insurance companies - place limited emphasis on market liquidity and thus consider less liquid, longer maturity assets as safe," she said.

The report further touched on the changing perception of what is now deemed safe, noting that securities with a AAA rating were found to have a much higher default risk than warranted by the rating.

"For example," it said, "as of August 2009, 63% of AAA-rated straight private-label residential mortgage-backed securities issued from 2005 to 2007 had been downgraded, and 52% were downgraded to BB or lower."

Topics