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  Off Balance

  Off Balance: The Travails of Institutions That Govern the Global Financial System

  © 2013 The Centre for International Governance Innovation

  ALL RIGHTS RESERVED. No part of this publication may be reproduced, stored in a retrieval system or transmitted by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of the publisher, application for which should be addressed to The Centre for International Governance Innovation, 57 Erb Street West, Waterloo, Ontario, Canada N2L 6C2 or [email protected].

  ISBN 978-0-9867077-6-6 (paper)ISBN 978-0-9867077-7-3 (ebook)

  The opinions expressed in this publication are those of the author and do not necessarily reflect the views of The Centre for International Governance Innovation or its Operating Board of Directors or International Board of Governors.

  Published by The Centre for International Governance Innovation.

  Printed and bound in Canada.

  Cover and page design by Steve Cross.

  The Centre for International Governance Innovation 57 Erb Street West Waterloo, ON Canada N2L 6C2

  www.cigionline.org

  Contents

  List of Acronyms vii

  Author’s Note and Acknowledgements ix

  Ungovernable? 1

  The Hegemon Cometh: A Concise History of the Global Financial System’s Governing Institutions 13

  Concise History, Continued: New Players, New Institutions, New Rules, New Worries 33

  A Flop and a Debacle 51

  Fundamental Misalignment and Its Discontents 67

  Global Watchdogs, Missing a World of Trouble 93

  Cluelessness: A Matter of Degree 115

  The Worsening of the Worst Case 127

  Still Wanting 145

  List of Acronyms

  AEI American Enterprise Institute

  BRIC Brazil, Russia, India and China

  BIS Bank for International Settlements

  CDOs collateralized debt obligations

  CGFS Committee on the Global Financial System

  CIGI The Centre for International Governance Innovation

  FM fundamental misalignment

  FDIC Federal Deposit Insurance Corporation

  FSA Financial Services Authority

  FSAP Financial Sector Assessment Program

  FSB Financial Stability Board

  FSF Financial Stability Forum

  G5 Group of Five

  G7 Group of Seven

  G10 Group of Ten

  G20 Group of Twenty

  GATT General Agreement on Tariffs and Trade

  G-SIFIs global systemically important financial institutions

  IAIS International Association of Insurance Supervisors

  IASB International Accounting Standards Board

  ICRIER Indian Council for Research on International Economic Relations

  IOSCO International Organization of Securities Commissions

  IMF International Monetary Fund

  MAP Mutual Assessment Process

  PDR Policy Development and Review

  RMB renminbi

  ROSCs Reports on the Observance of Standards and Codes

  SIV structured investment vehicle

  TARP Troubled Asset Relief Program

  VaR value at risk

  WTO World Trade Organization

  Author’s Note and Acknowledgements

  This is my fourth book about behind-the-scenes developments at international economic institutions. I will admit that when I was writing about institutions that are fairly well known — that is, the International Monetary Fund (IMF) and the World Trade Organization (WTO) — I didn’t think I would ever bother with some of the more obscure ones, such as the Financial Stability Forum (FSF). But then along came the global financial crisis of 2008, which showed how badly the world needs the FSF and other international bodies like it to perform their duties competently. With the crisis as a backdrop, delving into the inner workings of the FSF proved to be surprisingly interesting and rewarding.

  As readers will see, the book (except for its historical and concluding chapters) is heavily based on confidential documents from the institutions whose operations I have scrutinized. To obtain those documents, I conducted scores of interviews with current and former policy makers in North America, Europe and Japan, and found that a number of them were willing to grant access to memos, notes of meetings and emails. I am immensely grateful to these people, who for obvious reasons shall not be named, for enabling me to write a much more authoritative narrative. They recognized that, given a decent interval between the events in question and the publication of the book, little harm would result from their disclosure of this information, and that the cause of historical accuracy would be well served by my being able to rely on contemporaneous records rather than the hazy and sometimes selective memories of interested parties. When people are quoted as saying things in closed-door meetings, their words come directly from notes or confidential summaries taken by participants, unless otherwise specified in the narrative or in footnotes. Many interviewees, to be sure, were unable or unwilling to furnish documents, but they graciously spared the time to enlighten me on their recollections of key events — and to them, too, I am deeply grateful, because their perspectives helped me put matters in proper context. With few exceptions, “deep background” rules applied to all interviews, which meant I could use the information but could not quote interviewees or cite them as sources unless they granted me permission to do so.

  Journalists like me don’t usually write books like this, which chronicles at such length the workings of international institutions on issues of such technical complexity. At the same time, scholars don’t usually write books like this either. They tend to avoid anecdotes and the storytelling devices that are a journalist’s stock-in-trade, and scholars also go about gathering information and data in different ways than we journalists do (often at much higher levels of sophistication than we journalists are capable of). Persuading interviewees to furnish troves of confidential documents is a journalistic skill I have honed over the years; it is not high on the list of practices that think tank experts or university professors commonly employ. The ultimate result will, I hope, strike readers as an example of hybrid vigour, combining the strengths of journalism and scholarship, rather than a case of bastardization.

  A word of explanation is in order concerning how the book is organized. When I started my research in 2010, I thought I would write broadly about how global institutions and bodies performed in all the major international aspects of the crisis; instead, I have ended up devoting in-depth coverage to a couple of institutions and to pre-crisis events. That is attributable to circumstances that are at least partly fortuitous. Seeking support for the project, I approached The Centre for International Governance Innovation (CIGI) in Waterloo, Ontario, where Tom Bernes, who was then CIGI’s executive director, kindly offered to fund research papers on some of the proposed book’s key topics; we agreed that the papers would explore the FSF’s history and the IMF’s efforts to address the problems of global imbalances. I spent extensive time and energy obtaining confidential documents on those subjects, and succeeded way beyond my expectations. After CIGI published the papers in 2012, and I turned my attention to how the book would be structured, I concluded that making extensive use of the material from those papers would illuminate the main theme of the book far more cogently than a broad-brush approach. And in the meantime, some of the other episodes I had initially planned on chronicling — the IMF rescues of Eastern European countries, for example — had been eclipsed by events of much greater magnitude and importance, notably the crisis in the euro zone. The euro crisis proved far more prolonged than I h
ad imagined, and, as a result, I am obliged to reserve for a future book a detailed study of the role played by international institutions — in particular the IMF — in that crisis.

  In addition to Tom Bernes, who now holds the title of distinguished fellow at CIGI, Eric Helleiner provided enormous inspiration for this project. Eric, holder of the CIGI chair in international political economy at the Balsillie School of International Affairs, also in Waterloo, gave helpful guidance and encouragement throughout my research process, without which the book never would have reached fruition. Jim Haley, former director of CIGI’s Global Economy Program, contributed greatly to the final product as well, by offering his critique of the two research papers. Once a draft of the book was finished, Tom — together with Domenico Lombardi, the new director of CIGI’s Global Economy Program — conferred even more extensive assistance in the form of insightful feedback and suggestions for improvement. Tom, Domenico, Eric and Jim bear no responsibility for any errors or shortcomings in the book, of course, and they should be held totally blameless for my policy recommendations, from which they demurred to varying degrees. But their support and encouragement was invaluable, and I am especially grateful for the friendly spirit in which they gave it.

  In addition to funding from CIGI, this research was assisted by a grant from the Abe Fellowship Program, administered by the Social Science Research Council and the American Council of Learned Societies in cooperation with and with funds provided by the Japan Foundation Center for Global Partnership. During four months of the time I spent working in Washington, the Woodrow Wilson International Center for Scholars provided a Public Policy Scholarship and a stimulating environment from which to conduct research; I am particularly indebted to the Wilson Center’s Kent Hughes and Lucy Jilka for making that possible. The Smith Richardson Foundation, which has generously supported all of my books to date, provided support for this project as well. The Brookings Institution, where I am a nonresident fellow, provided substantial logistical support and was a wonderful, welcoming “home away from home” during my visits to Washington. My thanks go to Kemal Dervis and Homi Kharas, director and deputy director respectively of the Global Economy and Development Program, as well as Kristina Server, Jackie Sharkey, Barrett Mihm and Yamillett Fuentes.

  This book, though, became primarily a CIGI project, especially after Rohinton Medhora, CIGI’s president, agreed to publish it. In addition to the CIGI folks mentioned above, I owe a particular debt of gratitude to Neve Peric, CIGI’s former vice president of operations, who handled some crucial administrative tasks with adroitness and good humour. Carol Bonnett, managing editor, publications, and Jennifer Goyder, publications editor, expertly edited countless passages and got the book ready for prime time; additional editorial advice and support came from Fred Kuntz, vice president of public affairs, and Declan Kelly, communications specialist. For their warm welcome and the honour of their association, I thank all of my CIGI colleagues.

  Finally, regarding my family: I naturally expressed appreciation to my wife, Yoshie, and my children in my previous books for their forbearance and support, but since I am now on book number four they are no longer impressed (if they ever were) by my fulsome words. And Yoshie informs me that in Japan, where we now live, authors do not customarily mention their spouses in their acknowledgements. So to avoid committing any cultural transgressions, I will limit myself to saying that my previous statements of thankfulness and love apply equally, indeed more than ever, to my current state of mind as I bring this latest undertaking to a close.

  Paul Blustein

  Kamakura, Japan

  July 2013

  1

  Ungovernable?

  The Crisis in “Country A”

  The morning of February 5, 2007 dawned the same as any other workday for the 2,800 employees of the International Monetary Fund (IMF). Arriving at the Fund’s downtown Washington, DC headquarters, staffers swiped their ID badges to pass through electronic security gates at the entrance, then strode across the marble floors of the sunlit atrium-style lobby to board elevators that whisked them up to their offices. Only a handful of people — perhaps a dozen — knew that an unusual twist was in store that day. Most of the IMF’s Ph.D. economists went about their work assuming it would follow the same uneventful pattern that had prevailed for many months. This was an exceptionally boring period at the IMF, with no signs of the one thing that would quicken the heartbeat of any Fund staffer — a financial crisis.

  Although IMF economists were loath to admit it, many of them looked back almost nostalgically at the late 1990s, when bouts of financial turmoil had beset three of Asia’s dynamos — Thailand, Indonesia and South Korea — followed by similar disasters in Russia and Brazil. For Fund staffers, who tend to fancy themselves the world’s most sophisticated firefighters, those crises in emerging economies had abounded in professional fulfillment. Jetting off on missions to stricken countries, marshalling multi-billion-dollar emergency loans and hammering out the terms of country reform packages under tight deadlines as currencies crashed and markets swooned — that was the kind of pressure-filled activity that set IMF economists apart from their graduate school classmates. There had been some unpleasant aspects of serving at the Fund during that time — the institution came under intense criticism for failing to foresee the crises and mishandling some crucial aspects of the rescues — but at least the misfortunes plaguing the emerging markets had challenged IMF staffers to do what they had been trained to do, and had added a frisson of glamour to their lives.

  Not so in the middle years of the first decade of the twenty-first century. Financial markets were relentlessly buoyant, not only on Wall Street, the City of London and other major financial centres, but also in emerging Asia, Latin America, Eastern Europe and the Middle East — the places where the IMF traditionally stood ready to offer rescue packages. Furthermore, most of the emerging powers were going to great lengths to ensure that they would never again need to come “cap in hand” to the Fund. They had learned their lessons the hard way during the 1990s, when the IMF had insisted that the countries adopt wrenching austerity measures and politically painful reforms in exchange for loans they desperately needed to continue paying their foreign obligations. Their central banks were, therefore, hoarding vast stockpiles of US dollars and other “hard” currencies required for international commerce.

  These developments presented the IMF with disturbing questions about its raison d’être. The last major crisis the Fund had handled was in 2002; countries that had once been the Fund’s biggest borrowers — Brazil, Argentina and Indonesia — had even paid back loans ahead of schedule. This spelled trouble for the financial viability of the IMF, which depended on interest income from loans to cover its annual operating costs of about US$1 billion. Even worse were the increasingly vocal — and often mocking — musings about whether the world needed the Fund at all. “Not Even a Cat to Rescue,” was the headline of an April 2006 story about the IMF in The Economist. “A Rudderless Ship Adrift on a Sea of Liquidity,” was the phrase coined by Barry Eichengreen of the University of California, Berkeley, while Mervyn King, governor of the Bank of England, delivered a speech warning that the IMF could “slip into obscurity.”1

  1 See “Not Even a Cat to Rescue” (2006), The Economist, April 20; Barry Eichengreen (2006), “The IMF Adrift on a Sea of Liquidity,” in Reforming the IMF for the 21st Century, edited by Edwin M. Truman, Special Report 19, April, Washington, DC: Peterson Institute for International Economics; and Mervyn King (2006), “Reform of the International Monetary Fund,” speech given at the Indian Council for Research on International Economic Relations (ICRIER), New Delhi, February 20.

  The Fund’s relevance was under attack for another reason — its poor governance. The newly wealthy member countries from the emerging world were not accorded the voice, vote or control that their growing size and importance should have entitled them to. The apportionment of seats on the IMF executive board, and the voting power of
individual executive directors, did not reflect the big emerging powers’ vastly heightened status in the world’s GDP league tables; for example, although China’s economy was twice the size of Belgium and the Netherlands combined, Beijing had fewer votes than those controlled by board members representing those two small European nations. More important, top management of the IMF and its sister institution, the World Bank, was in the hands of the United States and the European Union, under the terms of a long-standing “gentlemen’s agreement” assuring that the managing directorship of the IMF would go to the Europeans, while the presidency of the World Bank and the number two position at the Fund would go to the Americans. These patently unfair arrangements undermined the Fund’s legitimacy and authority, as Martin Wolf, the chief economic commentator of the Financial Times, warned in a column: “Countries that have a choice will refuse to be bound by the diktats of an organization subservient to those they view as either present or past imperialists.”2

  2 Martin Wolf (2006), “The Fund’s Ancien Régime Will Have to Give up Its Privileges,” Financial Times, September 20.

  Unsurprisingly, the dearth of stimulating activity and the institution’s existential crisis had a deleterious effect on the morale of the staff, whose members hailed from over 140 countries (about one-quarter were from the United States and Canada) and often boasted doctorates from the world’s premier universities. Resignations rose by 45 percent in 2005 over the average of the previous three years, and departures increased again in 2006. (To be sure, the lavish compensation that Wall Street firms were offering ex-IMF economists played no small part in that exodus.) The managing director, Rodrigo de Rato, was doing little to infuse his underlings with enthusiasm; though his intelligence and even temper won him some admirers, his frequent trips to his native Spain and workouts in the IMF gym struck many on the staff as evidence of a lack of passion for the job.