Blog

December 1, 2011

by Martin S. Edwards, Member of New Rules and Associate Professor at Seton Hall University

New Analysis on the review of IMF Surveillance.

The Fund’s recent Triennial Surveillance Review (hereafter TSR) was released at end of October of this year. A series of fourteen documents, it deepens a trend stared in the 2008 TSR of allowing external commentary. [1] Whereas the 2008 Review had a paper written by an external consultant on the Article IV process in Europe, the 2011 review had three additional external studies (one on consistency and coherence of surveillance, one on the interaction between IMF surveillance and other international financial institutions, and one summarizing interviews with country authorities) plus another one on Europe. The 2011 review also had comments by Joseph Stiglitz and Martin Wolf, a review of the entire package by a team of external advisors, and an action plan to address the findings by Managing Director Lagarde.

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The resignation of DSK is a sad, even tragic ending, to an IMF leader who did manage to begin to pry open the institution. New ideas were infiltrating the Fund on capital controls, macro-economy, finance and even accountability. Of course all was not well in terms of transparency, awareness of the impact of policies on the poor or the environment--whether before policies were required or after the fact. The distribution of power among countries remains highly skewed in favor of status quo powers, with little space for the myriad small and poor to speak or better to influence the institution. But, like the G20, the IMF Board has elevated the emerging major economic powers--all without the need for another world war.

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“Let me tell you something about the very rich. They are different from you and me” – F. Scott Fitzgerald.

“Yes, they have more money” – Ernest Hemingway.

In 2010, Bob Diamond of Barclays, Britain’s highest paid bank chief, earned $10.9m, roughly 260 times the average UK income. The two highest paid members of his staff earned more than $15m each in salary and bonus last year plus a further $45m worth of shares under past incentives schemes. The average pay of the bank’s top 230 employees was nearly $4m, according to analysis by Megan Murphy and colleagues at the Financial Times*.

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At Davos last week senior bankers were vigorously opposing radical reforms of financial services (such as breaking up the largest banks or tightening the Basel III capital requirements.) They know they were let off lightly last year and they want to resume business as usual, bonuses and all.

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Lord Turner, chairman of Britain’s Financial Services Authority, has bowed to pressure and will now publish a report on his agency’s confidential investigation of the management decisions that led to the collapse of Royal Bank of Scotland. In a democracy, nothing less would be acceptable. Since British taxpayers are the majority (if unwilling) owners of RBS, they deserve to know why their bailout was required.

The published report should shed further light on the FSA’s decision not to bring any enforcement proceedings against RBS directors. Lord Turner says he cannot apply sanctions because no rules were broken*: RBS failed because of poor business judgments, rather than as a result of reckless or unprofessional conduct.

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As the European sovereign debt crisis gathers momentum, many market participants say the euro is doomed. They argue the eurozone will fragment, with the weaker peripheral countries, such as Greece, Ireland and Portugal, eventually being forced out of the common currency. The collapse of the euro, the argument runs, will then place intolerable strains on the European Union, putting into reverse half a century of European integration.

Although this reasoning seems plausible – especially to American observers – it is almost certainly wrong. Sceptics should instead heed the words of Angela Merkel, the German chancellor, who argued recently the eurozone – and wider EU – will emerge stronger, rather than weaker, from this crisis. Nor is this observation contradicted by her rejection this week of two proposals for resolving the sovereign debt crisis – a larger bailout fund and “European” bonds – bonds jointly backed by all the eurozone nations.

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Whenever liberal policymakers make a serious plea for global economic cooperation, it elicits a knee-jerk reaction from conservatives. Don’t interfere with free markets which require freely adjusting exchange rates.

Tim Geithner’s proposed numerical targets for current account deficits and surpluses met just this response. And Chinese communists, ironically, allied themselves with traditional conservatives. Cui Tiankai, a Chinese deputy foreign minister and leading G20 negotiator, said the 4 per cent proposed ceiling for surpluses and deficits harkened back “to the days of planned economies”.

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There were multiple causes of the global financial crisis of 2007-09. But one insufficiently investigated explanation of the crash is the weakness of corporate governance in the financial sector.

The proximate cause of the failure of most of the world’s largest banks was senior executives’ unrestrained appetite for risk. The biggest losses occurred in proprietary trading: the sale and purchase of complex securities, such as credit default swaps. Yet who, in a limited liability company, is supposed to monitor and control risk taking by employees? The answer, of course, is the board of directors acting on behalf of the companies’ owners, its shareholders.

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A few weeks ago I accused the banking regulators in Basel of “intellectual cowardice”. I was driven to this intemperate language by their obstinate decision to plough ahead with a regulatory model that is a proven failure and their refusal to consider truly radical reform of the dysfunctional financial services industry.

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