The International Monetary Fund was overly influenced by developed countries including the U.S. and the U.K. when assessing their economies, and ended up missing signs of fragility that led to the 2008 global financial crisis, an internal audit found.
A report gauging the IMF’s performance from 2004 through 2007 said its economists were sometimes “in awe of” the authorities’ reputation and expertise in larger nations.
“IMF staff felt uncomfortable challenging the views of authorities in advanced economies on monetary and regulatory issues, given the authorities’ greater access to banking data and knowledge of their financial markets, and the large numbers of highly qualified economists working in their central banks,” according to the IMF audit released today.
The Washington-based IMF, which was created after World War II to help ensure the stability of the global monetary system, paid too little heed to deteriorating banks’ balance sheets and financial regulatory issues, according to the audit. The report lists various ways the fund can avoid similar mistakes in the future, including through changes in governance to make room for candid and dissenting views.
IMF staff “often seemed to champion the U.S. financial sector and the authorities’ policies,” the audit said.
“This is a political institution. At the end those are important shareholders and it’s difficult to challenge them,” Moises Schwartz, the director of the audit unit, said in an interview yesterday.
Advanced economies were not part of a so-called “vulnerability exercise” to spot crisis-prone countries, the IMF report said.
The report “confirms what we, developing countries, had been thinking about the practice of fund’s surveillance” including a “double standard,” said Paulo Nogueira Batista, Brazil’s executive director at the IMF who also represents eight other countries. “The crisis was a major wakeup call that has led to the beginning of several changes in the institution,” though “the problem has not been overcome.”
The report identified other issues that prevented the IMF from detecting mounting risks, including the lack of incentives to work across units or to express contrarian opinions.
While identifying some risks, the institution’s main message was optimistic until October 2007, after financial turbulence had started, when it adopted a “more cautionary tone,” according to the audit. Less than a year later, the bankruptcy of Lehman Brothers Holdings Inc. triggered the deepest international recession since World War II.
IMF Managing Director Dominique Strauss-Kahn said in a written response to the report that the IMF has acknowledged the failure “to warn about a systemic crisis in a sufficiently early, pointed, and effective way,” and has already started responding to it.
“The focus of the reform agenda being implemented is precisely on strengthening surveillance and financing for systemic stability,” he wrote in a Jan. 26 statement prepared for a meeting of the fund’s board of directors.
The audit pointed to a “group-think” attitude among IMF economists that prevented them from challenging shared ideas, for instance, that crises were unlikely to happen in developed economies.
There also wasn’t enough effort to link macroeconomic and financial analysis, even though it was a problem already raised after the Asian crisis, the audit said. That was due in part to IMF’s “long-standing problem” of operating “in silos” and not using other departments’ work and expertise, it said.
Incentives Not Aligned
Governance was an issue as well as “incentives were not well aligned to foster the candid exchange of ideas that is needed for good surveillance,” the auditors said. “Many staff reported concerns about the consequences of expressing views contrary to those of supervisors, management, and country authorities.”
While staff and management who responded to auditors said there was “no overt pressure” from the U.S. to change the IMF conclusions, “explicit pressure to tone down critical messages” did happen “in some other large advanced economies,” auditors said.
“In contrast, teams seemed more comfortable in presenting hard-hitting analysis to smaller advanced and emerging markets, confirming some authorities’ belief that there was a lack of evenhandedness in surveillance,” according to the report.
The report recommended a series of measures to encourage candor, such as involving outside analysts in board and management discussions. It suggested strengthening incentives to “speak truth to power.”
Strauss-Kahn said that new work the IMF has undertaken, such as an analysis of imbalances for the Group of 20 and reports of spillover risks, “will go a long way to enhance the candor and traction of surveillance.” He said that the fund “should consider carefully the idea of allowing direct inputs by eminent outside experts.”
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