No End in Sight: Early Lessons on Crisis Management

IMF Blog, March 9, 2011

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Crises have a beginning, middle, and an end; lessons can be learned along the way.
In the most recent global economic crisis policymakers moved quickly to stabilize the system, providing massive financial support, which is the right response in the beginning of any crisis.
Without restructuring financial institutions’ balance sheets and their operations, as well as their assets ‒ loans to over-indebted households and enterprises ‒ the economic recovery will suffer, and the seeds will be sown for the next crisis.
The recent crisis followed the same phased pattern as previous crises, but policymakers made different choices because this crisis was truly global and more complex due to larger and more interconnected financial institutions and markets.

Rapid responses to contain risks and restore confidence were justified by the complexity and severity of the crisis.
Less deep restructuring early on lowered short-term costs but may produce higher costs in the years ahead.
The chosen policy mix precluded thorough due diligence, and may reduce incentives to restructure assets.
Risk of a muddling-through approach: accounting and regulatory forbearance, guarantees, and implicit public support can stall addressing nonviable banks and nonperforming assets.
Structural characteristics that contributed to systemic risks largely remain in place; moral hazard has increased.
For the 12 crisis countries examined, the assets of the five largest banks have gone from 307 to 335 percent of GDP.
Large-scale public support provided to institutions and markets—a contingent liability equivalent to one-fourth of GDP at the peak of the crisis—has exacerbated perceptions of too-important-to-fail.

Diagnose the problem to learn about the viability of financial institutions and support only those that are viable, and close or restructure the nonviable ones.
Stress tests were conducted and the results published in the U.S. in May 2009 and in Europe in July 2010, but only after initial government recapitalization.
While these stress tests restored short term investor confidence, their long term impact has been uneven, especially in Europe.
Uneven impact in Europe was partly due to differing perceptions about the credibility of assumptions used, remedial actions announced in conjunction, and subsequent events.
European authorities were compelled to engage in a new round of stress tests as a result.

Restructuring the global financial system requires tools and policies that reach across country borders and requires global policymaker cooperation.
Since the crisis, several countries have adopted more effective resolution schemes for large financial institutions, which should allow future losses to be borne by uninsured creditors.
Many countries still lag in resolution schemes, including in how to allocate losses.
The new resolution schemes remain untested for failures of large cross-border institutions.
Much more needs to be done to enhance the supervision of cross-border exposures and related risks.

The end of this story hasn’t been written yet; there is a rare opportunity to change how the global financial system operates for years to come.
Policy emphasis: combine early stabilization with diagnosis-based resolution and early asset restructuring to avoid sowing seeds for future crises.

Stijn Claessens, Ceyla Pazarbasioglu — March 9, 2011 — https://www.imf.org/en/blogs/articles/2011/03/09/early-lessons-on-crisis-management

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