Part I: Is the IMF incompetent or...
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
Other articles by the author:
Is the US economy heading for a collapse?
Derivatives: The time bomb in our financial system
Pay panel, an attempt to destabilise India
Anything multiplied by zero is zero indeed!
