The Irony of the IMF Global Financial Stability Report

Paul Niven, Head of Asset Allocation at F&C Investments, comments: "With estimates of the impact of the credit crisis seemingly rising by the day the IMF, in its twice yearly Global Financial Stability Report, has now topped the league with the conclusion that the carnage will cost close to $1 trillion on a mark to market basis (based on mid March pricing). Like many others, the IMF has admitted to being 'humbled' in failing to recognise the severity of the crisis as it has unfolded in recent months. In a neat summing up of the error made in appreciating the seriousness of the situation, the IMF stated that there had been a 'collective failure to appreciate the extent of the leverage taken on by a wide range of institutions and the associated risks of a disorderly unwinding.' On a positive note, the process of writedowns is well advanced as the IMF estimates that banks have so far recognised and accounted for around two thirds of likely losses.

In assessing where the blame for the crisis lay, the IMF have concluded that banks, investors, regulators, ratings agencies and even central banks all share responsibility for the ensuing problems. In terms of the solutions to the issues which are currently vexing policymakers the IMF does not simply see easier monetary policy as a panacea for the credit crisis. With the upcoming G7 meeting this weekend, the IMF proposes solutions involving, amongst other elements, capital raisings, improved supervision, attempts to ease stress in the US mortgage market, and direct public intervention.

While the IMF report is both timely and instructive, those with a long memory will no doubt find some irony in the advice being given by the IMF to resolve the current crisis. Back in the 1990s the IMF 'encouraged' predominantly Asian authorities to hike local interest rates and cut government spending in order to boost confidence from investors and regain access to overseas lending. While there are numerous differences between the Asian crisis of the 1990s and the current credit crisis both were borne out of reckless lending leading to a collapsing asset bubble (and currencies) but the US has been adopting rather different set of solutions to domestic problems through aggressive rate cuts, provision of liquidity and fiscal expansion. Not the IMF prescribed medicine of a decade ago. In addition, the IMF saw the Asian crisis as occurring, in part, from explicit or implicit government guarantees which contributed to reckless lending practices. This time, such guarantees are being used as part of the solution (despite the fact that they were also part of the initial problem).

The IMF, and policymakers, learned many lessons from the Asian crisis and many would now argue that the measures used a decade ago to 'solve' the crisis in developing countries were, in reality, in real danger of 'killing the patient'. The real irony, however, is that the current crisis, arguably has at least part of its roots in the IMF policies of a decade ago which led to many developing economies swearing that they would never again go cap in hand to the Fund and be beholden to external parties in the time of a crisis. This determination to build huge foreign reserves in Asian economies led, in part, to depressed interest rates in the US and fuelled reckless mortgage lending there. While the IMF will not have a direct hand in solving this particular crisis, the policy response being seen in the US, and elsewhere, today, will have broad and longstanding implications. The seeds for the next bubble, boom and subsequent bust may well be being sown amidst the current gloom."