IMF Survey: IMF Presses Four-Step Plan to Halt Financial Spiral
October 10, 2008
- Some explicit guarantee of financial system liabilities is unavoidable
- High degree of international cooperation has become urgent
- Could boost legitimacy by extending G-8 to at least China, India, Brazil
IMF Managing Director Dominique Strauss-Kahn called on world financial leaders meeting in Washington to address the crisis of confidence in financial markets with coordinated international action.
In an October 10 speech at the Peterson Institute for International Economics (PIIE), he proposed a four-point action plan to help stem the downward spiral in world markets and begin to rebuild confidence. The plan would include a temporary government guarantee of liabilities, government action to take out troubled assets and force the recognition of losses, government provision of capital to the financial system, and a high degree of international cooperation.
He was speaking at a conference titled "The Euro at 10: the Next Global Currency." But while there was some talk of the euro's role, speakers and the audience were more preoccupied with the financial crisis raging in all corners of the world, not least Europe.
In his remarks, Strauss-Kahn said that "world leaders have some hard decisions to make, and must start making them soon." He said he hoped the G-7 meeting of advanced-economy finance ministers later on October 10 and the October 11 meeting of the IMF's steering committee, the International Financial and Monetary Committee, would "result in a shared approach to address the crisis of confidence."
Four lines of action
Even if international cooperation had improved in recent days, "regional and global cooperation is still lagging behind the curve," Strauss-Kahn said. He called for cooperation along four main lines:
• A temporary government guarantee of liabilities. "The fragility of public confidence has reached a point where some explicit public guarantee of financial system liabilities is unavoidable," Strauss-Kahn said. "This means guaranteeing not only retail bank deposits but probably also interbank and money market deposits as a means to restart activity in these key markets. Such a step should be temporary, and include safeguards such as heightened supervision and limits on deposit rates offered."
• Recognize losses. "The government needs to take out troubled assets and force the recognition of losses," Strauss-Kahn said, adding that asset purchases should be done at fair value. "If capital is to be attracted to banks, it is better to pay a lower price now, recognize losses, and give banks an upside if the implied loss turns out to be smaller than expected."
• Provide government capital. "Because private money is scarce in today's environment, support from the government is needed," Strauss-Kahn said. One strategy that has worked in past crises is to match new private capital subscriptions with government capital, which imposes a market test for the use of public funds.
• Promote a cooperative approach. A high degree of international cooperation has become urgent. During the past week the collapse in confidence in the markets has been almost matched by a collapse in confidence between countries, Strauss-Kahn said. "We saw a very bad trend toward unilateral measures taken with national interests in mind."
The speech got a warm reception. "The most thoughtful and important call for action I have heard from the IMF," was how PIIE Director Fred Bergsten characterized Strauss-Kahn's speech at the economic think tank.
Lessons of the crisis
Turning to the lessons to be drawn from the crisis, Strauss-Kahn highlighted the need to strengthen the regulation and supervision of the financial sector, and to press ahead with reform of the international financial architecture.
"The crisis is the result of three failures: a regulatory and supervisory failure in advanced economies; a failure in risk management in the private financial institutions; and also a failure in market discipline mechanism," he said, adding that in remedying these shortcomings, "I think the IMF can help to coordinate this effort, drawing on the expertise of others."
Reform of the international architecture will call for enhancing the legitimacy and effectiveness of the system. "Legitimacy must be conferred by reliance of broader groups. One very simple change that could be made is to extend the G-8 to at least China, India, and Brazil, and perhaps others. But I think this needs to be accompanied by greater reliance on multilateral institutions with near universal membership, so that no country that wants to participate in the international system is left out."
Effectiveness, he added, can be achieved by better coordination between international organizations and better follow-up on international agreements.
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