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.
I, for one, am not happy with the way in which “quotas” to the IMF are calculated, but I have to admit that exchanging money for votes is a perfectly adequate governing structure for a lending institution. However, it is not adequate for an institution that is meant to exercise arms-length surveillance of its members — particularly its most influential member, whose domestic policies have global systemic implications.
That “money-for-influence” governance structure indirectly impairs the fund’s capacity to criticize its most important members’ economies — let alone police compliance with their obligations. And, as I have witnessed several times, if the IMF staff ever do become too candid in their criticism of powerful members, the target governments use their leverage to water down the public communiques issued by the board.
Let us now consider the second question — whether the fund suffered from a mindset that blinded it to the causes of what was happening. As early as August 2005, Raghuram Rajan, the IMF’s chief economist at the time, was warning of weaknesses in the US financial markets. Rajan saw that something potentially dangerous was happening, warning that competition forces were pushing financial markets “to flirt continuously with the limits of illiquidity” and concealing risks from investors in order to outperform competitors.
Perhaps most revealingly, though, Rajan nonetheless optimistically argued that “deregulation has removed artificial barriers preventing entry of new firms, and has encouraged competition between products, institutions, markets, and jurisdictions.” In other words, he clearly believed that regulation created “artificial barriers” and that “competition between jurisdictions” — that is, between regulators — was to be welcomed.
Such beliefs come naturally to those committed to the view that markets perform better without regulation, and Rajan’s statement is a good illustration of the IMF’s creed at the time. And it was this boundless faith in markets’ self-regulatory capacity that appears to be at the root of the fund’s failure to find what it was not looking for.
There are now encouraging signs of change at the IMF, but this should not reassure us. As the political economist Fred Block has said, “societies invariably draw back from the brink of full-scale experimentation with market self-regulation.” Unfortunately, this also makes self-regulation a faith that is very difficult to dispel, because its priests can always claim that its failures result not from theological bankruptcy, but from insufficient orthodoxy.
Hector Torres is a former executive director of the IMF and a former chair of the G-24 Bureau in Washington.
COPYRIGHT: PROJECT SYNDICATE
When US budget carrier Southwest Airlines last week announced a new partnership with China Airlines, Southwest’s social media were filled with comments from travelers excited by the new opportunity to visit China. Of course, China Airlines is not based in China, but in Taiwan, and the new partnership connects Taiwan Taoyuan International Airport with 30 cities across the US. At a time when China is increasing efforts on all fronts to falsely label Taiwan as “China” in all arenas, Taiwan does itself no favors by having its flagship carrier named China Airlines. The Ministry of Foreign Affairs is eager to jump at
The muting of the line “I’m from Taiwan” (我台灣來欸), sung in Hoklo (commonly known as Taiwanese), during a performance at the closing ceremony of the World Masters Games in New Taipei City on May 31 has sparked a public outcry. The lyric from the well-known song All Eyes on Me (世界都看見) — originally written and performed by Taiwanese hip-hop group Nine One One (玖壹壹) — was muted twice, while the subtitles on the screen showed an alternate line, “we come here together” (阮作伙來欸), which was not sung. The song, performed at the ceremony by a cheerleading group, was the theme
Secretary of State Marco Rubio raised eyebrows recently when he declared the era of American unipolarity over. He described America’s unrivaled dominance of the international system as an anomaly that was created by the collapse of the Soviet Union at the end of the Cold War. Now, he observed, the United States was returning to a more multipolar world where there are great powers in different parts of the planet. He pointed to China and Russia, as well as “rogue states like Iran and North Korea” as examples of countries the United States must contend with. This all begs the question:
In China, competition is fierce, and in many cases suppliers do not get paid on time. Rather than improving, the situation appears to be deteriorating. BYD Co, the world’s largest electric vehicle manufacturer by production volume, has gained notoriety for its harsh treatment of suppliers, raising concerns about the long-term sustainability. The case also highlights the decline of China’s business environment, and the growing risk of a cascading wave of corporate failures. BYD generally does not follow China’s Negotiable Instruments Law when settling payments with suppliers. Instead the company has created its own proprietary supply chain finance system called the “D-chain,” through which
RSS