IMF awe of rich nations fuelled crisis failure

The International Monetary Fund failed to spot the financial crisis brewing in part because it was "overly influenced" by rich nations, the fund's internal watchdog said on Wednesday.

The Independent Evaluation Office also said there was a mind-set among IMF economists that advanced economies were unlikely to provide a spark for a major financial crisis, given their presumed expertise in monetary and regulatory issues.

"The IMF was overly influenced by and sometimes in awe of the authorities' reputation and expertise," the IEO said.

The IEO report said IMF staff were uncomfortable challenging advanced economies because the IMF had only limited access to banking data and less insight about what was going on in particular financial markets.

The report questioned why many advanced economies were excluded from a "vulnerability exercise" meant to identify crisis-prone countries, while emerging market economies were not.

It found IMF staff more at ease prescribing policies to emerging market countries, lending support to claims by China and other developing countries there was a lack of even-handedness in the IMF's surveillance.

The report said IMF staff generally agreed with views of the United States, Britain and other developed nations that their financial systems were sound and crisis-proof.

"The prevailing view among IMF staff -- a cohesive group of macroeconomists -- was that market discipline and self-regulation would be sufficient to stave off serious problems in financial institutions," the IEO said.

Loose mortgage lending standards in the United States fuelled a housing boom whose collapse left a trail of bad loans worldwide, sparking a credit crisis that raged from 2007 to 2009.

The IMF, which acts as a global economic policeman, has acknowledged its surveillance either missed or underestimated risks, while its warnings were too scattered and unspecific to force policymakers to act.

Political pressure 

The IEO report said IMF staff were often pressured politically in advanced economies to alter or tone down messages in reports. The watchdog did not name the culprits.

It noted, however, there was no "overt pressures" from the United States, which is the fund's largest member.

"In some other large advanced economies, however, staff noted that the authorities took a heavy handed approach, exerting explicit pressure to tone down critical messages," the report said.

One staff member who worked on a large advanced economy told the IEO, "it was hard to give difficult messages to the authorities even if the team had the analysis ... the concluding meetings were really just negotiation sessions on language."

The report said in many cases staff censored themselves because they believed there were limits to how much they could speak out about large member countries, even in the absence of direct pressure.

In some instances when staff was critical of a country's policies, IMF management would side with the country's authorities instead of with the views of its staff, the report said.

The IEO said pressure from member countries to adopt certain initiatives distracted management during the lead up to the crisis.

One of the initiatives in 2007 led to the IMF revising its rules on currency surveillance, which China said was a ploy by the United States to push for a rise in the value of the yuan.

More action needed

IEO Director Moises Schwartz said the aim of the report, which looked at the IMF's performance between 2004 and 2007, was to analyze what went wrong in IMF surveillance so that the institution can be better prepared next time.

He said changes previously identified by the IMF to fix surveillance problems were unfinished.

The report recommended five measures to encourage more candour in IMF surveillance, including the involvement of outside experts in board and management discussions. It also urged the IMF to strengthen incentives to "speak truth to power" that clarified the roles of the IMF board of member countries and management.

"The IMF has started to address some of the vulnerabilities uncovered by the crisis but how effective those are remains to be seen," Schwartz told a news conference. "We are calling for a more fundamental change," he added.

In a written response to the report, IMF Managing Director Dominique Strauss-Kahn said the IMF had acknowledged its failures and was implementing changes to strengthen surveillance of economies and the financial system.