Watchdog: IMF's trust in markets, regulators blocked sight of financial crisis

Washington Post Staff Writer
Wednesday, February 9, 2011; 7:41 PM

The International Monetary Fund was hobbled by a "groupthink" that put too much trust in markets and the oversight of regulators in developed nations such as the United States, undercutting its ability to foresee the recent financial crisis, the agency's outside watchdog concluded in a new report.

The IMF's Independent Evaluation Office reviewed public comments and reports issued by the agency's staff between 2004 and 2007, a period when big financial firms expanded the use of complex financial investments and tethered themselves to the fate of a U.S. and European housing boom that was doomed to collapse.

Dominique Strauss-Kahn, the IMF's managing director, noted in his response to the study that his agency had acknowledged its failure to raise the proper warnings "in a sufficiently early, pointed, and effective way."

He said some changes have already been made, including requiring his staff to conduct an analysis of all major economies - the United States, until recently, did not allow the IMF to gain access to private information about its financial system - and involving his agency in efforts by major countries to monitor each other.

During the run-up to the financial crisis, the warning signs were plentiful, the report concluded. But the IMF opted to discount the worst outcomes and promote the vision of a healthy world economy benefiting from an era known then as the "great moderation," for its combination of strong growth, low unemployment and low inflation.

The boom was built on a dubious foundation, but "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," the report concluded.

Staff members interviewed for the study portrayed an institution afraid to offend its member governments, particularly its largest shareholders, creating a culture of self-censorship. Even when staff members wanted to highlight potential problems, they "believed there were limits as to how critical they could be."

In general, top IMF officials were "sanguine" about the growing complexity and dispersion of mortgage-related investments and "praised the United States for its light-touch regulation and supervision that permitted the rapid financial innovation that ultimately contributed to the problems in the financial system."

The agency at the time was going through its own crisis - cutting staff at a time when some conjectured it would become irrelevant in a crisis-free world. The IMF was formed after World War II to oversee the existing system of fixed world exchange rates, but in recent decades has evolved more into a crisis lender for distressed countries.

Successive reports from 2004 to 2007 supported the image of a healthy system, describing the world economy as "among the rosiest" in years. As late as 2008, the IMF was advising that the worst events "are behind us."

The study said the agency has tried to address some of the issues it raised. U.S. Treasury Secretary Timothy F. Geithner has raised similar concerns, saying the IMF should speak more forcefully about specific country's policies.

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