FINANCIAL CRISIS

IMF Presses Four-Step Plan
to Halt Financial Spiral

IMF Survey online

October 10, 2008

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.
Comments on this article should be sent to imfsurvey@imf.org
https://www.imf.org/external/pubs/ft/survey/so/2008/NEW101008A.htm