Wednesday, February 16, 2011

IMF Failed to Give Timely Warning of the Financial Crisis

Washington Post: Watchdog: IMF's Trust in Markets, Regulators Blocked Sight of Financial Crisis
WSJ: Auditor: IMF Failed to Alert on Pre-Crisis Risks
BBC: IMF Downplayed Risks of Crisis
FT: Watchdog Says IMF Missed Crisis Risks

In its review of the International Monetary Fund’s (IMF) performance in the years leading up to the financial crisis, the IMF’s internal auditing body, the Independent Evaluation Office (IEO), concluded that the IMF was slow to detect and acknowledge the warning signs that a crisis would occur. As the organization responsible for monitoring global economic and monetary stability, the IMF’s failure to detect the oncoming of the financial crisis is a painful blow to the organization’s credibility.

The financial crisis that erupted in 2008 originated in the financial markets of developed nations, and ultimately resulted in a global recession. Among other things, bubbles in house prices and poor regulation of rapidly evolving complex financial instruments caused the crisis. According to the IEO’s report, the IMF initially paid little attention to these trends and failed to warn of the risks associated with them, even after some officials within the IMF, including its chief economist, had expressed such concerns.

The report pointed to several reasons for the IMF’s oversight. The report blamed a “groupthink” mentality, where the views of those who had warned of a crisis were overshadowed by the dominant opinion held by IMF officials that the markets of developed countries were too advanced to experience a crisis and that the financial institutions involved were big enough to withstand such a crisis if it occurred. The IEO’s report also indicated that IMF economists were in “awe” of the expertise and reputations of the financial authorities and economists from the regulatory agencies and central banks in developed countries. As a result, IMF officials would often defer to these experts and their conclusions that the financial markets in developed countries were in good health. IMF officials were further reluctant to question the stability of financial markets in developed countries due to political reasons, where criticism of developed nations would often mean criticizing the most powerful members of the IMF. The IMF distributes voting powers among its members based on their economic strength. To determine economic strength, the IMF considers a country’s GDP, openness to trade, economic variability, and amount of international reserves. Based on these factors, developed nations typically have the strongest economies. To avoid upsetting the authorities of the most powerful nations in the IMF, the IEO’s report stated that IMF staffers were told to tone down messages that were critical of those nations.

The conclusions of the report raise concerns about the IMF’s competence to perform its duties of ensuring a stable international economy. Since its creation shortly after World War II, the IMF has traditionally been responsible for ensuring stability in the international monetary system, but its role has since expanded to act as a provider of funds to economically distressed nations. Consequently, the ability of the IMF to identify crises is critical to its role in maintaining a healthy international economy. Cognizant of this, the head of the IMF, Dominique Strauss-Kahn, insisted that the IMF would pursue reforms to ensure that the IMF would not ignore the warning signs of a future crisis.

Discussion Questions:
1.)Does the fact that IMF officials were in “awe” of the expertise of officials from other countries create a cause for concern regarding the competency of the IMF and its staff?
2.)Does the IMF’s reluctance to criticize developed nations validate the argument raised by some that the IMF operates under the de facto authority of the developed world? What reforms could be implemented to ensure that the IMF acts objectively and independent of the interests of any member nations?

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