The IMF apologizes on Gordon’s behalf

As mystery continues to surround the identity of the person in the charge of the UK economy since 1997, the IMF has come up with a carefully phrased admission that it got the UK and US economies wrong in its assessments over the last few years.  What they politely don’t say is that, had they come up with any assessments less positive than they did, the respective Treasuries would have talked them out of it. 

But anyway.  It comes in one of a batch of papers issued by the Fund today which focus on various aspects of crisis prevention but inevitably get a little into diagnosis.   The paper looks at why the IMF surveillance (and indeed that of other international organizations) missed the financial crisis in its build up phase.   Among the key points is that surveillance failed to see the extent to which housing sector risk had returned to commercial banks despite its apparent securitization via the special purpose vehicles sponsored by the banks which were holding these securities.  More broadly, the Fund says, surveillance suffered from —

Rosy bottom line. The result was a generally optimistic view on advanced countries and financial innovation. This was especially noticeable at their intersection, the seemingly successful US and UK economies at the center of the global financial system. Fund surveillance echoed the conventional view that advanced countries with relatively low and stable inflation together with highly profitable and well capitalized banking sectors could withstand the unwinding of any froth in housing and capital markets. While this is understandable, more time should have been spent on “tail risks” from these domestic vulnerabilities.

Indeed, Gordon Brown boasted in 2005 that house prices are adjusting free of recession but it would be tad awkward to cite that.   This provides another perspective on an interesting New York Times article about the seeming lack of response of macroeconomics as taught in colleges to the crisis.   Arguably, the issue is not so much what people were learning about economics in college, but the extent to which a London-New York conventional wisdom had co-opted key institutions.  Maybe that’s related to the teaching of economics, since some of those students go on to work on these institutions.   But perhaps also one can see a complacency coming from a political instinct to take credit when things seem to be going well and therefore be resistant to criticism.  If even now, Gordon can’t acknowledge what might have gone wrong, imagine what it would have been like to try to argue the case with him 4 years ago?

4 thoughts on “The IMF apologizes on Gordon’s behalf

  1. Two interesting articles which (finally!) are going to the root of the problem:

    http://www.nytimes.com/2009/02/28/business/28nocera.html?_r=2

    “At its peak, the A.I.G. credit-default business had a “notional value” of $450 billion”

    http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=1

    “If you’re an investor, you have a choice these days: You can either lend directly to borrowers or sell investors credit default swaps, insurance against those same borrowers defaulting. Either way, you get a regular income stream—interest payments or insurance payments—and either way, if the borrower defaults, you lose a lot of money. The returns on both strategies are nearly identical, but because an unlimited number of credit default swaps can be sold against each borrower, the supply of swaps isn’t constrained the way the supply of bonds is, so the CDS market managed to grow extremely rapidly… The CDS and CDO markets grew together, feeding on each other. At the end of 2001, there was $920 billion in credit default swaps outstanding. By the end of 2007, that number had skyrocketed to more than $62 trillion. The CDO market, which stood at $275 billion in 2000, grew to $4.7 trillion by 2006”

    In short, too many fools in our world believe that it is possible to insure any risk and live happily ever after (selling to each other gambling insurances).

  2. O’Neill is on to a key point for international economic cordination and supervision. The US and UK Treasuries (and to a lesser extent other Ministries of Finance and Economics) have had what amounts, in practice, to a veto over all expressions of opinions about their economies by international bodies. (That was so even when the UK was in hock to the IMF in the late 1970s.) Effective international economic alerting to major risks and imbalances will be impossible unless that changes.

  3. Then, the IMF was in the habit of predicting doom doom doom for the UK economy all the way back to 1997. It was wrong on one side, and then it was wrong on the other. (BTW, the housing market did adjust downwards in 2005 – it just took off again after that, in the classic second-stage-of-the-rocket bubble pattern.)

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