Established in July 2001, the Independent Evaluation Office (IEO) provides objective and independent evaluation on issues related to the IMF. The IEO operates independently of IMF management and at arm’s length from the IMF’s Executive Board. Its goals are to enhance the learning culture within the IMF, strengthen the IMF’s external credibility, promote greater understanding of the work of the IMF throughout the membership, and support the Executive Board’s institutional governance and oversight responsibilities. For further information on the IEO and its work program, please see its website (www.ieo-imf.org) or contact the IEO at +1-202 623-7312 or at info@ieo-imf.org.
IEO
Independent Evaluation Office
of the International Monetary Fund
EVALUATION REPORT
IMF Performance in the Run-Up to the Financial and Economic Crisis
IMF Surveillance in 2004–07
2011
© 2011 International Monetary Fund
Production: IMF Multimedia Services Division
Cover: Randy Lyhus
Cataloging-in-Publication Data
IMF performance in the run-up to the financial and economic crisis: IMF surveillance in 2004–07 / prepared by an IEO team led by Ruben Lamdany and Nancy
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Wagner. – Washington, D.C.: International Monetary Fund, c2011.
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p.; cm.
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At head of title: IEO, Independent Evaluation Office of the International Monetary Fund. Includes bibliographical references.
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ISBN 978-1-61635-078-9
1. International Monetary Fund – Evaluation. 2. Global Financial Crisis, 2008–2009. 3. International finance. 4. Risk assessment. I. Lamdany, Ruben, 1954– II. Wagner, Nancy L. (Nancy Louise) III. International Monetary Fund. Independent Evaluation Office.
HG3881.5.I58 I448 2011
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Contents
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Foreword
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Abbreviations
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Executive Summary
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1 Introduction
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A. Evolution of the Crisis
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B. IMF Surveillance Objectives
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C. Outline of Report
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2 Evaluation Framework
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A. Scope of Evaluation
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B. Evaluation Questions
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C. Evaluation Methods and Sources
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3 IMF Messages in the Run-Up to the Crisis
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A. Overview of Main Findings
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B. Multilateral Surveillance
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C. Bilateral Surveillance of Systemic Financial Centers
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D. Bilateral Surveillance of Other IMF Member Countries
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4 Why Did the IMF Fail to Give Clear Warning?
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A. Analytical Weaknesses
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B. Organizational Impediments
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C. Internal Governance Problems
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D. Political Constraints
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5 Toward More Effective IMF Surveillance
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Boxes
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1. Multilateral Surveillance: A Rosy Picture of the Global Economy
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2. Bilateral Surveillance of the United States: Sanguine on Financial Innovation and Behind the Curve on Risks
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3. What Did the IMF Regard as Best Practice for Financial Sector Surveillance?
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4. Iceland: What Was the IMF Saying in 2007–08?
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Figures
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1. Timeline of Crisis in Advanced and Emerging Markets
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2. U.S. Mortgage Loans
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3. Key Vulnerabilities and Concerns Highlighted in World Economic and Market Developments Sessions, 2004–08
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4. Trends in U.S. Current Account, Household Saving/Investment Balance, and Fiscal Balance, 1990–2009
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5. Vulnerability Exercise
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Annexes
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1. Timeline of Relevant Events
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2. Factors That Contributed to the Crisis According to IMF Staff
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3. Country Coverage
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4. Early Analysis and Diagnosis of Factors Leading to the Crisis
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5. Weaknesses in FSAPs in Advanced Economies
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6. Conclusions/Recommendations from Previous Reports and Evaluations
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7. How Did Country Authorities View the IMF’s Performance?
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8. Area Department Survey of Staff
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References
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Statement by the Managing Director, Staff Response, and the Chairman’s Summing Up
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Statement by the Managing Director
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Staff Response
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The Chairman’s Summing Up
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CD
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The following are included in the accompanying CD and are also on the IEO website at www.ieo-imf.org.
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Main Report
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IMF Performance in the Run-Up to the Financial and Economic Crisis: IMF Surveillance in 2004–07
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Statement by the Managing Director
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Staff Response
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The Chairman’s Summing Up
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Background Papers
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Summary of Views of the Advisory Group (BP/10/01)
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Multilateral Surveillance (BP/10/02)
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Bilateral Surveillance in Selected IMF Member Countries (BP/10/03)
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Bilateral Surveillance of the United States (BP/10/04)
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Bilateral Surveillance of the United Kingdom (BP/10/05)
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Bilateral Surveillance in Switzerland (BP/10/06)
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The following conventions are used in this publication:
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In tables, a blank cell or N/A indicates “not applicable,” ellipsis points (…) indicate “not available,” and 0 or 0.0 indicates “zero” or “negligible.” Minor discrepancies between sums of constituent figures and totals are due to rounding.
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An en dash (–) between years or months (for example, 2008–09 or January–June) indicates the years or months covered, including the beginning and ending years or months; a slash or virgule (/) between years or months (for example, 2008/09) indicates a fiscal or financial year, as does the abbreviation FY (for example, FY2009).
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“Billion” means a thousand million; “trillion” means a thousand billion.
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“Basis points” refer to hundredths of 1 percentage point (for example, 25 basis points are equivalent to ¼ of 1 percentage point).
As used in this publication, the term “country” does not in all cases refer to a territorial entity that is a state as understood by international law and practice. As used here, the term also covers some territorial entities that are not states but for which statistical data are maintained on a separate and independent basis.
Some of the documents cited and referenced in this report were not available to the public at the time of publication of this report. Under the current policy on public access to the IMF’s archives, some of these documents will become available five years after their issuance. They may be referenced as EBS/YY/NN and SM/YY/NN, where EBS and SM indicate the series and YY indicates the year of issue. Certain other documents are to become available 10 to 20 years after their issuance, depending on the series.
Foreword
Warning member countries about risks to the global economy and the buildup of vulnerabilities in their own economies is arguably the most important purpose of IMF surveillance. This IEO evaluation found that the IMF fell short in delivering on this key objective in the run-up to the financial and economic crisis that began to manifest in mid-2007 and that reached systemic proportions in September 2008. During the period 2004–07, the banner message of IMF surveillance was characterized by overconfidence in the soundness and resiliency of large financial institutions, and endorsement of financial practices in the main financial centers. The risks associated with housing booms and financial innovations were downplayed, as was the need for stronger regulation to address these risks.
The IEO found that the IMF’s ability to identify the mounting risks was hindered by a number of factors, including a high degree of groupthink; intellectual capture; and a general mindset that a major financial crisis in large advanced economies was unlikely. Governance impediments and an institutional culture that discourages contrarian views also played important roles. To address these factors, the report stresses the need to modify institutional structures and incentives to strengthen accountability and to foster better assessment of risks, candor and clarity in messages, and the ability to “speak truth to power.” More broadly, the IMF must cultivate a culture which is proactive in crisis prevention, continuously scanning for risks and emphasizing vulnerabilities—including in advanced economies. While the IEO report focuses on financial sector issues because of the nature of the recent crisis, most of its recommendations deal with institutional changes that would improve the IMF’s capacity to detect other types of risks and vulnerabilities that could be at the center of a future crisis.
I am encouraged by the broad agreement with the conclusions and recommendations of this report expressed by the Managing Director and the Executive Board. The report has also led to a vigorous debate among IMF staff. This introspection is an important catalyst for change. The IMF has already taken a number of initiatives to address the weaknesses revealed by the crisis. However, the IEO believes that additional changes are needed to reform the IMF’s culture, governance, and practices, so that the IMF is better prepared to confront future challenges.
The international community needs a strong, effective, and well-equipped IMF to face the many economic and financial challenges that lie ahead. Yet the problems uncovered by this evaluation are long-standing and difficult to solve; addressing them will require close collaboration between authorities in member countries and the IMF Management and its Board. I hope this evaluation will contribute to this endeavor.
Moises J. Schwartz
Director
Independent Evaluation Office
IMF Performance in the Run-Up to the Financial and Economic Crisis: IMF Surveillance in 2004–07
This report was prepared by an IEO team led by Ruben Lamdany and Nancy Wagner. The IEO team included Angana Banerji, Sanjay Dhar, Alisa Abrams, Andrew Martinez, Chris Monasterski, and Roxana Pedraglio. The team was assisted by contributions from Biagio Bossone and David Peretz. The evaluation benefited from discussions with participants at three workshops held in July 2009, November 2009, and April 2010, and from comments from Jack Boorman, John Hicklin, Joanne Salop, Marcelo Selowsky, and Shinji Takagi. However, the final judgments are the responsibility of the IEO alone. Sarah Balbin, Arun Bhatnagar, and Annette Canizares provided administrative assistance. Rachel Weaving, Chris Monasterski, Roxana Pedraglio, and Esha Ray provided editorial and production management assistance. The report was approved by Moises Schwartz.
The evaluation also benefited from comments from an Advisory Group comprising Hamad Al-Sayari, Otmar Issing, Jin Liqun, Tito Mboweni, Rachel Lomax, Guillermo Ortiz, Yaga Venugopal Reddy, Eisuke Sakakibara, Edwin Truman, and William White. The Advisory Group met on October 5, 2010 and discussed a preliminary version of this report and prepared a summary of its views, which is being issued as a background paper to this evaluation (“Summary of Views of the Advisory Group,” BP/10/01; see www.ieo-imf.org).
Abbreviations
| BIS |
Bank for International Settlements |
| CFTC |
Commodity Futures Trading Commission |
| DMD |
Deputy Managing Director |
| DSGE |
Dynamic Stochastic General Equilibrium |
| ECB |
European Central Bank |
| EIU |
Economist Intelligence Unit |
| EMBI |
Emerging Markets Bond Index |
| EU |
European Union |
| EWE |
Early Warning Exercise |
| FAD |
Fiscal Affairs Department |
| FCL |
Flexible Credit Line |
| FOMC |
Federal Open Market Committee |
| FSAP |
Financial Sector Assessment Program |
| FSB |
Financial Stability Board |
| FSSA |
Financial Sector Stability Assessment |
| G-7 |
Canada, France, Germany, Italy, Japan, United Kingdom, and United States |
| G-20 |
A grouping composed of major industrial countries and systemically |
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important developing and emerging market countries |
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| GFSR |
Global Financial Stability Report |
| ICM |
International Capital Markets Department |
| IMFC |
International Monetary and Financial Committee |
| MAP |
Mutual Assessment Process |
| Management |
Managing Director, First Deputy Managing Director, and two Deputy Managing Directors |
| MBS |
Mortgage-backed securities |
| MCM |
Monetary and Capital Markets Department (combined ICM and MFD) |
| MD |
Managing Director |
| MFD |
Monetary and Financial Systems Department |
| OECD |
Organization for Economic Cooperation and Development |
| OTC |
Over-the-counter |
| PDR |
Policy Development and Review Department (old name for |
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reviewing department) |
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| RES |
Research Department |
| SEC |
Securities and Exchange Commission |
| SIP |
Selected issues paper |
| SNB |
Swiss National Bank |
| SPR |
Strategy, Policy, and Review Department (new name for reviewing department) |
| TED |
Acronym formed from T-bill and Eurodollar futures |
| TSR |
Triennial Surveillance Review |
| VE |
Vulnerability Exercise |
| VEA |
Vulnerability Exercise for Advanced Economies |
| WEMD |
World Economic and Market Developments |
| WEO |
World Economic Outlook |
Executive Summary
This evaluation assesses the performance of IMF surveillance in the run-up to the global financial and economic crisis and offers recommendations on how to strengthen the IMF’s ability to discern risks and vulnerabilities and to warn the membership in the future. It finds that the IMF provided few clear warnings about the risks and vulnerabilities associated with the impending crisis before its outbreak. The banner message was one of continued optimism after more than a decade of benign economic conditions and low macroeconomic volatility. The IMF, in its bilateral surveillance of the United States and the United Kingdom, largely endorsed policies and financial practices that were seen as fostering rapid innovation and growth. The belief that financial markets were fundamentally sound and that large financial institutions could weather any likely problem lessened the sense of urgency to address risks or to worry about possible severe adverse outcomes. Surveillance also paid insufficient attention to risks of contagion or spillovers from a crisis in advanced economies. Advanced economies were not included in the Vulnerability Exercise launched after the Asian crisis, despite internal discussions and calls to this effect from Board members and others.
Some of the risks that subsequently materialized were identified at different times in the Global Financial Stability Report, but these were presented in general terms, without an assessment of the scale of the problems, and were undermined by the accompanying sanguine overall outlook. These risks were not reflected in the World Economic Outlook or in the IMF’s public declarations. The IMF did appropriately stress the urgency of addressing large global current account imbalances that, in the IMF’s view, risked triggering a rapid and sharp decline in the dollar that could set off a global recession. But the IMF did not link these imbalances to the systemic risks building up in financial systems.
The IMF’s ability to detect important vulnerabilities and risks and alert the membership was undermined by a complex interaction of factors, many of which had been flagged before but had not been fully addressed. The IMF’s ability to correctly identify the mounting risks was hindered by a high degree of groupthink, intellectual capture, a general mindset that a major financial crisis in large advanced economies was unlikely, and inadequate analytical approaches. Weak internal governance, lack of incentives to work across units and raise contrarian views, and a review process that did not “connect the dots” or ensure follow-up also played an important role, while political constraints may have also had some impact.
The IMF has already taken steps to address some of these factors, but to enhance the effectiveness of surveillance it is critical to clarify the roles and responsibilities of the Board, Management, and senior staff, and to establish a clear accountability framework. Looking forward, the IMF needs to (i) create an environment that encourages candor and considers dissenting views; (ii) modify incentives to “speak truth to power;” (iii) better integrate macroeconomic and financial sector issues; (iv) overcome the silo mentality and insular culture; and (v) deliver a clear, consistent message on the global outlook and risks.