Wed, Apr 28, 2010 - Page 9 News List

The failed dogma of deregulation

Blind faith in the market’s capacity to regulate itself appears to be at the root of the IMF’s failure to see signs of a crisis brewing

By Hector Torres

Now that the global financial crisis is abating, it is time to take stock of our mistakes and ensure that they are not repeated. Beyond regulatory improvements, preventing payment incentives from rewarding reckless risk taking and building Chinese walls between originators of securities and rating agencies, we need to discover what made this crisis so difficult to predict.

The IMF is our global watchdog and many believe that it failed to foresee the crisis because it was distracted or looking in the wrong places. I disagree. The problem is that the IMF was unable to interpret the evidence with which it was confronted.

I served on the IMF board in June 2006 when it discussed its annual review of the US. The staff “saw” the relaxation of lending standards in the US mortgage market, but said 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.”

A few months later, in September 2006, just 10 months before the subprime mortgage crisis became apparent to all, the Global Financial Stability Report, one of the IMF’s flagship publications, wrote: “Major financial institutions in mature ... markets [were] ... healthy, having remained profitable and well capitalized.” Moreover, “the financial sectors in many countries” were supposedly “in a strong position to cope with any cyclical challenges and further market corrections to come.”

The IMF’s radar started blinking only in April 2007, virtually when the problem was already hitting its windshield, but still with little sense of urgency. Clearly the fund’s surveillance of the US economy was ineffective and its multilateral surveillance of financial markets no better. Admittedly, the IMF was not alone in failing to interpret the underlying facts that triggered the crisis, but that is little consolation.

Before the crisis, the IMF’s best-known function — lending to countries with balance-of-­payment problems — was becoming irrelevant. Many emerging markets preferred to self-insure by accumulating reserves rather than borrow from the fund. Ironically, this was leading the IMF to focus on its supervisory role. So, in searching for the causes of the IMF’s failure, we can rule out distraction by more urgent matters.

The fund normally expects that problems come from the usual suspects — economically volatile developing countries — but this time the crisis was developing a few kilometers from its headquarters. Perhaps this proximity was at the root of the IMF’s failure to interpret the evidence right under its nose.

If so, it is a failure that raises two key questions. First, is the fund’s governance structure suited to exercising arms-length surveillance of its main shareholders? And, second, did ideological blinders prevent the IMF from acknowledging that deregulation could contribute to a disastrous outcome?

It is inconceivable that the fund, with its qualified and dedicated staff, would have failed so miserably in detecting and calling attention to the vulnerabilities piling up in the US mortgage market had they occurred in a developing country. However, power in the IMF currently follows the logic of its lending role. The more money a country puts into the pool of resources, the more influence it gets.

This story has been viewed 2277 times.

Comments will be moderated. Keep comments relevant to the article. Remarks containing abusive and obscene language, personal attacks of any kind or promotion will be removed and the user banned. Final decision will be at the discretion of the Taipei Times.

TOP top