Could
IMF Have Prevented This Crisis?
By Hector R.
Torres
WASHINGTOND.C.¯ Until recently, the International Monetary Funds main job
was lending to countries with balance-of-payment problems. Today, however,
emerging countries increasingly prefer to self-insure by accumulating
reserves (and sharing them through regional pooling arrangements).
As a result, the
fund must change, reinforcing its supervisory role and its capacity to oversee
members compliance with their obligation to contribute to financial stability.
So its failure to press the United Statesto redress the mortgage-market
vulnerabilities that precipitated the current financial crisis indicates that
much remains to be done.
Indeed, in its
2006 annual review of the U.S.economy, the IMF was extraordinarily benign
in its assessment of the risks posed by the relaxation of lending standards in
the U.S.mortgage market. It noted that borrowers
at risk of significant mortgage payment increases remained a small minority,
concentrated mostly among higher-income households that were aware of the
attendant risks, and concluded that indications are that credit and risk
allocation mechanisms in the U.S.housing market have remained relatively
efficient. This, it added, should provide comfort.
Likewise, the
problem was not mentioned in one of the IMFs flagship publications, the Global
Financial Stability Report (GFSR), in September 2006, just 10 months before the
subprime mortgage crisis became apparent to all. In the IMFs view, Major
financial institutions in mature ... markets [were] ... healthy, having
remained profitable and well capitalized, and the financial sectors in many
countries are in a strong position to cope with any cyclical challenges and
further market corrections to come.
The IMF began to
take notice only in April 2007, when the problem was already erupting, but
there was still no sense of urgency. On the contrary, according to the IMF,
Weakness has been contained to certain portions of the subprime market (and,
to a lesser extent, the Alt-A market), and is not likely to pose a serious
systemic threat.
Moreover, The
U.S. housing market appears to be stabilizing ... Overall, the U.S.mortgage
market has remained resilient,
although the subprime segment has deteriorated a bit more rapidly than had been
expected.
The GFSR
confidently noted that stress tests conducted by investment banks show that,
even under scenarios of nationwide house price declines that are historically
unprecedented, most investors with exposure to subprime mortgages through
securitized structures will not face losses.
Why has the
funds surveillance of the U.S.economy been so ineffective?
Suppose that the
vulnerabilities piling up in the U.S.mortgage market ¯ right under the IMFs
Washington-headquartered nose ¯ had taken place in a developing country. It is,
frankly, inconceivable that the fund would have failed so miserably in
detecting them. The IMF has been criticized for burdening borrowers with
unnecessary and sometimes perverse lending conditions, but its highly qualified
staff has not been shy in blowing the whistle when it perceived domestic
vulnerabilities in other countries. So why didnt they scrutinize the
U.S.economy with equal zeal?
The answer may be
found in the IMFs governance structure. Currently, the distribution of power
within the IMF follows the logic of its lending role. The more money a country
puts in, the more influence it has. This may be prompting the fund to turn a
blind eye to the economic vulnerabilities of its most influential members ¯
precisely those whose domestic policies have large, systemic implications.
This
money-for-influence model of governance indirectly impairs the IMFs capacity
to criticize the economies of its most important members (let alone police
compliance with their obligations). In any event, if its staffs criticism ever
becomes too candid, these countries can always use their leverage to water down
the public communiques issued by the IMFs board.
The fund can help
to prevent future crisis of this kind, but only if it first prevents undue
influence on its capacity to scrutinize, and if necessary, criticizes
influential countries policies and regulations. This requires a different
governance structure in which power is more evenly distributed, so that the IMF
can effectively exercise surveillance where it should, not just where it can.
**
Hector R. Torres is alternate executive director at the IMF and former chair of
the G-24 Bureau in Washington, D.C.
Project
Syndicate http://www.project-syndicate.org/commentary/torres1
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