Not even IMF believes in self-regulating markets anymore

19 Oct, 2011 at 11:39 | Posted in Economics, Politics & Society | Comments Off on Not even IMF believes in self-regulating markets anymore

Deputy Director Ajai Chopra of IMF, in a speech delivered last week, said:

It is well accepted that the financial crisis that started in 2007-2008 was rooted in a combination of common global factors and vulnerabilities in individual countries. In the decade that preceded the crisis, global financial markets were characterized by high liquidity and low risk premia in a stable economic environment. Financial integration in the euro area was accelerating. European banks, including Irish ones, expanded their balance sheets through unprecedented access to wholesale funding. The new funding structures created deep fragilities that came to the fore when liquidity dried up.

Ideology also played a role. There was a belief that “light-touch” regulation and market discipline would suffice to ensure efficient and stable financial markets. The crisis proved this belief was wrong. Mechanisms of self-regulation and market discipline—such as corporate governance, internal risk management, private audits, and discipline by creditors—failed to prevent the build-up of risk. Market players also anticipated bailouts of “too big to fail” institutions. In addition, in many countries including Ireland, authorities wrongly considered that macroeconomic risks and unsound bank behavior were not sufficiently alarming to require assertive policy responses.

Modest reforms are not sufficient in the current environment. The crisis requires convincing skeptical markets that Europe can make bold and unified decisions. The issues involved are exceedingly complex, but clarity about the goal of establishing an integrated EU crisis management and resolution framework, supported by a more effective supervisory and regulatory regime, will make it easier to deal with these complexities. As the Roman philosopher Seneca said, “If one does not know to which port one is sailing, no wind is favorable.”

It is better late than never. IMF:s waking up from its market-fundamentalist Walt Disney-worldview is welcome.

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