[stop-imf] IMF: Incompetence by design or default?

[robert weissman]

http://www.rediff.com/money/2008/apr/29mrv.htm

Rediff India Abroad
IMF: Incompetence by design or default?
M R Venkatesh | April 29, 2008

They no longer use bullets and ropes. They use the World Bank and the
IMF -- Jesse Jackson

The seeds of the present consternation in the global financial
architecture can be traced to its very design and evolution since the
seventies when the post World War II Breton Woods arrangement was given
up. That led to the collapse of the fixed exchange rate mechanism and
gave rise to the flexible exchange rate mechanism. All these and its
consequent impact were briefly explained in the first part to this series.

It may not be out of place to mention that the IMF repeatedly
pontificated on the virtues of financial sector liberalisation and its
calculated effect of rewarding the productive and the prudent while
ruthlessly punishing the unproductive and the profligate. Unsuspecting
countries, which approached the IMF for financial assistance under the
structural adjustment programme, were persuaded to liberalise their
financial sector.

Given such enormous stakes it was therefore of extreme importance to
monitor the global financial architecture, capturing the risks to the
movement of global capital as well as the risks arising of the sudden
reversals in the flow of global capital. And the entire global financial
architecture has been constantly monitored and certified by the IMF
giving rise to the collective belief that all is well in the world of
finance. But as events turn out we all now know that it has been a case
of misplaced trust.

The GFS report

The IMF presents a biannual report titled the Global Financial Stability
Report (GSFR) as a part of its surveillance programme. Yet, in its
latest GSFR report released by the IMF in April 2008, it points out that
the events of the past six months have demonstrated the "fragility of
the global financial system" and raised "fundamental questions about the
effectiveness of the response by institutions."

What is indeed appalling to note here is that the IMF suggests that the
global financial system seems to have come under increasing strain since
"October 2007." The key and recurrent themes that are captured in this
report include:

- There was a "collective failure" to appreciate the extent of leverage
taken on by a wide range of institutions.

- There was a "supervisory failure" to comprehend the evolving risks
through appropriate risk management systems, update disclosure norms and
improve financial sector supervision so as to meet the rapid innovations
and shifts in business models

- There was a failure to detect the transfer of risks off balance sheets
by banks. Consequently, as risks have materialized, it has placed
enormous pressures back on the balance sheets of banks.

Naturally, this lack of appropriate supervision and risk management,
according to the IMF, encouraged extreme leveraging. And as
deterioration of the credit quality "exacerbated the de-leveraging
process," the global financial system is increasingly coming under
extraordinary strain.

Resilience? Gathered Strength? De-risked?

Strange as it may seem, especially with the benefit of hindsight, one
can safely state that the IMF has been completely oblivious to the
negative developments in the global financial architecture since the
past couple of years. Quite the contrary, the IMF has been virtually
certifying all the developments as positive.

In fact the April 2006 GSFR states "The positive assessment contained in
the September 2005 GFSR that the global financial system has yet again
gathered strength and resilience has been validated by recent developments."

It does not stop there. It further states "In particular, the emergence
of numerous, and often very large, institutional investors and the rapid
growth of credit risk transfer instruments have enabled banks to manage
their credit risk more actively and to outsource the warehousing of
credit risk to a diverse range of investors. A wider dispersion of
credit risk has "de-risked" the banking sector."

And wherever it has mentioned the potential risks arising from the
lending to sub-prime borrowers or for that matter any other risks, it
remained muted and suppressed -- akin to the statutory health warning on
cigarette packets. And as events in 2008 turn out and given the positive
language of assurance contained in the GSFR 2006 report, one is certain
that global economic surveillance of the IMF has indeed misled the world
of finance.

But this is not an exception. In the past decade the world has been
witness to the six major financial crisis -- the East Asian crisis, the
collapse of LTCM, the Russian crisis, the Argentinean crisis, Dotcom
bubble and of course the latest sub-prime crisis of the US. And on every
occasion the IMF simply failed to identify the crisis well on hand.

In retrospect it is clear that there was a failure on part of the IMF in
identifying these risks even as they were manifesting. And now
innocently terming the extant crisis as "collective failure" points out
to something more than it meets the eye.

But why?

The crucial question that arises from all these is a simple one -- Is
the IMF incompetent to monitor or is it a case of incompetence
compounded by a conspiracy.

It is in this connection one is constrained to quote Joseph Stigtitz.
Writing the preface to his celebrated book - Globalisation and its
discontents - he states, "There are no smoking guns here. You won't find
hard evidence of a terrible conspiracy by Wall Street and the IMF to
take over the world. I don't believe such a conspiracy exists." Yet he
goes on to add, "The truth is subtler. Often it's a tone of a voice, or
a meeting behind closed doors, or a memo that determines the outcome of
discussions."

Who are those who by their very tone of a voice or in such other methods
as explained by Stiglitz are able to decide the future turn of events.
And to understand the same, a reference once again to the US financial
system and the power of its corporate is inevitable.

It is common sense that there would be very little opportunity for
speculative profit in a stable financial market. The greater the
volatility of financial markets, the greater opportunity it is for the
players in these markets. This view was accepted by George Soros himself
in a testimony to the Banking committee of the US House of
Representatives in early nineties.

The riskier and more destabilising forms of modern investments are
through the new instruments -- popularly called the Hedge Funds managed
by Soros, Goldman Sachs, Merrill Lynch et all. This process has turned
investment banks into highly leveraged machines that trade heavily on
their own accounts leveraging investor money several times over.

It is not merely a question of leverage that is central to the
discussion on hand. The potency of these firms and the disproportionate
clout that they wield on the financial markets is central to the issue
on hand. And it is these players in the US financial markets that
dominate the global financial architecture.

For instance, a recent article in The Economist, quotes a study of BCA
Research, a Canadian economic-research firm that traces the rise of the
American financial sector. The total corporate profits, the report
points out, grew from 10 per cent in the early 1980s to 40 per cent last
year and its share of stock market value grew from 6 per cent to 19 per
cent. It may be further noted that financial services account for only
for 15 per cent of corporate America's GDP and a mere 5 per cent of
private-sector jobs.

This clearly illustrates the disproportionate influence of the financial
sector on the US economy and its continued interest in ensuring the
continuance of the global financial architecture -- one that allows
gyrations, volatility and of course in the process provides significant
opportunities to these players to make profits, even at the cost of
taking the entire global economy to the very brink.

To amplify, should the US financial system collapse; it is the
developing countries that would lose heavily. After all, developing
countries have lent approximately USD 3 trillions to the US. Remember,
the US is too big for the world to risk a collapse. And in such a
scenario, it is the rest of the world that would rush to protect the US
and its Dollar. Needless to emphasise, in case of profits, the
beneficiaries would be these few fund managers. Globalising losses and
privatising profits! And it is this system that as the sanction nay
blessing of the IMF.

Given this paradigm, to assume that IMF would act independently would be
churlish to say the least. Naturally, the IMF having designed the global
financial architecture is loath to write a word against its apparent
systemic failures. It cannot even critique or for that matter even
review it. And should it do anything that would remotely destabilise the
system, it could at-once close the flow of funds from the developing
countries to the US. Powerful vested interests -- the beneficiaries of
this system, it can be logically concluded, would ensure its continued
silence.

Globalisation requires global systems and global governance. In the
absence of a global government, multilateral arrangement has been worked
out a substitute by all nations. But experiences of the past decade now
tell us that this unaccountable and unsure system is untrustworthy,
unworkable and hence unacceptable.

That explains the continued diffusion of the IMF while global financial
architecture swings from one crisis to another. Till date, the debate on
IMF has primarily been on its incompetence. Time has come to evaluate
the conspiracy angle far seriously.

The author is a Chennai based Chartered Accountant. He can be contacted
at mrv1000@rediffmail.com