How Does Global Economic Crisis Affect Imf Finance Essay - Free Essay Example

The seeds of the current global financial crisis that we are in had been sown a long time before 2008 but the effects started showing from 2007. The crisis that made banks worldwide write down about $550 billion started from the major lending institutions in the United States. The problem was simple but it wasnt checked on time. Banks needed to be warned about the credit default swaps and make loans of larger quantity available to only borrowers who could afford to pay. (IMF Surveillance, 2010) The reason why that happened was simple too, no regulations and restrictions on the banks and the inability of the government to enforce rules that would be beneficial for the long term health of the country. The loans created a high for the country. Once these loans were available to borrowers with bad credit history, the prices of assets began to increase, the real estate market rose and the stock market advanced. The annual growth rate of the United States of America grew by leaps and bounds. If the United States government had not thought about the short term benefit that these loans would create and thought about the long term impact the impact wouldnt be too deep. In a sentence issued by the government, they state that In fact, we have seen a remarkable expansion of credit, especially in the United States, in parallel with a dramatic rise in securitized mortgages, especially after 2004. (IMF Surveillance, 2010) It was this securitization of assets that led to the downfall and the subprime mortgages. Loaning institutions did not understand the repercussions of the loans they made available in the market furthermore due to the complexity of these loans even the borrowers did not understand what they were entering into. (How Did the Global Financial Crisis Start? 2008) The first impact of the crisis began to show in 2007 April when the IMF warns financial institutions of weakening the global financial markets. Then the New Century financial corporation stops giving new loans. In June, two hedge funds of Bear Sterns collapse and warning bells start to ring. Then in February 2008, Fannie Mae reports a loss of $3.55 billion. Many other banks got into this huge problem and ran out of reserves and eventually were forced to take a bailout plan from the government in order to survive. (Chro nology, n.d.) German banks too, fell into this problem and needed bailout. Then in April, the IMF projected a $945 billion loss due to the global crisis. Throughout 2008, the crisis deepened and the true picture of the cause of the subprime loans came into view with Lehman brothers coming out with a $600 billion bankruptcy and many other leading financial institutions posting losses. AIG was given $85 billion as bailout and Washington mutual and Fannie and Freddie collapse. Banks were either planning a merger like Wachovia and Wells Fargo or getting a bailout or going bankrupt. (Shah, 2009) The total amount that the government gave in bailouts came up to $9.7 trillion and 33% of the value of the worlds companies were wiped out due to this crisis. Along with the global financial crisis came the food crisis hence the government not only needed to look out for that but other aspects as well. On a macro level all the countries in the world were affected due to the financial crisis and all the financial institutions needed help from the international financial institutions like the IMF to stabilize the economy. Role of the IMF in the current global financial crisis The international monetary fund (IMF) was created with the sole aim of balancing macro financial issues faced by countries worldwide. It works on the basis of loans provided to other countries in time of need. They have many types of loans for countries who need monetary help but since the last financial crisis a decade ago countries have built up foreign exchange reserve in order to avoid taking a loan from the IMF. This has reduced the role the IMF played and restricted its function to only giving advice on macroeconomic aspects. However as the developed countries faced liquidity problems they turned to the international financial institutions for help and the IMF to rescue them. (Shin Heath, 2009) The importance of the IMF increase and the role played by the institution became crucial for the world economies. IT was now the responsibility of the IMF to help member states to come out of the recession and possible depression. If the IMF would not have been there, countries wor ldwide would have to suffer enormous debts and depression. Swift action from all aspects needed to be taken by the IMF in terms of asking member countries to provide resources and foreign exchange for loans and providing these loans to countries that need them. Then, the IMF needs to supply information to countries on the verge of bankruptcy, way in which they can try and come out of the situation. The IMF also needs to handle the fiscal and monetary policy implementation by member states and as a control check if the member states are benefitting from them or they need other reforms. The IMF needs to develop a kind of early whistle blowing warming system so that these manmade calamities can be avoided. IMF and G20. (IMF Surveillance, 2010) The IMF needs to act like a global federal reserve and help countries in the process of recovery. The G 20 summit was held to discuss the effects of the financial crisis and how the member countries can fasten the recovery process. Since th e IMF was short of funds and SDR (Special Drawing Rights), member countries agreed to raise $250 billion to help other countries. The IMF was also asked to sell its gold deposits so that it could get more funds to provide loans. Agreements on how IMF could borrow from other member countries were set at the summit. Since it was the IMF responsibility to provide information on macroeconomic aspects, the member countries agreed to increase the research wing of the IMF. (IMF Surveillance, 2010) The G 20 came to the conclusion that the IMF needed to change the basic quotas and voting power from the traditional industrial countries to other countries as well since it is often treated as an underdog of the same. Hence as a result the IMF reduced the voting power of the previous members by 5% and gave the same to emerging nations. The IMF needed to work in collaboration with other international financial institutions like the World Bank and United Nations so that it could come up with be tter plans and policies. (IMF Surveillance, 2010) In 2009 the IMF decided that the NAB (New Arrangements to Borrowing) needed to be extended by $500 billion in order to help triple the funds available to the IMF in fighting the crisis. Since the IMF also needed to work on its pending reforms, it was agreed that changes in IMF procedures and investment standards would be changed with all possible haste so that the member countries would benefit from those changes in this time of crisis. (IMF Surveillance, 2010) Surveillance and Management One of the challenges faced by the IMF was its role as a surveillance officer. IMF has been criticized by member countries including China on the way it manages its surveillance. If the IMF had performed this role before, the financial crisis could have been evaded since it would be able to tell America to ensure strict credit rules however the IMF lacked in that aspects and therefore in the future in order to avoid such disasters, one of the first things the IMF needs to do is change its surveillance standards and technical knowhow. At the G 30 summit, the surveillance of the IMF came under the radar and ways to manage and monitor the countries were sought after. (IMF Surveillance, 2010; Kaufman et.al., 2000) Since all the countries that are members of the IMF needed to provide it with data regarding its financial, economic and other policies and situation, the IMF needed to review them thoroughly. Individual countries needed to be analyzed based not only by the report sent by these countries but also on the basis of analysis done by the IMF intelligence. Before the crisis, IMF did not evaluate individual countries hence problems started to show. It was concluded that once this evaluation would be done member countries could rely on the reports of the IMF to manage their country better hence surveillance would become the primary role of the IMF. (GuitiaÃÆ'ŒÂ n, 1992; Johnson Turner, 2003; Soederberg, 2004) According to the IEO report (Independent evaluation officer) the IMF was not as effective as it needed to be in both its analysis and advice, and its dialogues with member countries (Climate Investment Funds, 2010). The IMF needed to create more focus on multilateral issues and have better control over the exchange rate policies faced by the countries. The IEO asked IMF to study the relations of each member countries with the others and what effect would their foreign exchange policies changes would have on the others. This would help th em in predicting the future of the countries exchange reserves which is one of the vital signs of financial disasters. The IMF failed in its role to be a savior to the poor nations as they were the ones that got exploited the most due to its lack of surveillance. Unemployment increased and more and more countries came on the verge of bankruptcy. Hence multilateral surveillance especially exchange rate needed to be focused on. If these surveillances had been done correctly, the IMF would have known the extent of damage the crisis would cause and help take preventive and curative measures however the start of the analysis was faulty hence that needed work more than other aspects. The IMF knew in early 2008 that a crisis would be caused by the banks policies however even though it had all the data available, it was unable to correctly judge the extent of the loss. Hence as a gatekeeper it lacked focus. The IMF blames its lack of skilled staff as one of the reasons for failure. It ar gues that only 9 of the 24 staff members were effective in calling countries and asking them to manage their exchange rates better. Since the crisis had hit the United States, the IMF needed to call countries that had ties with it, and who would be impacted most due to the crisis and help them prepare. However, the IMF itself was unable to understand the situation which clearly showed missing standards for an international agency. (Yeung, 2002; Fratianni, Kirton Savona, 2003; Solomon, 2008) Now, the IMF needs to work on building up a good surveillance team and methods and models to understand the multilateral aspects. It needs to give monthly and annual reports to countries in a more precise manner and give information on how they would be affected by international developments and how they can safeguard themselves. This would be crucial in the future. For the current crisis, it still needs to help make the member countries find ways to escape the liquidity problem and rise from the catastrophe. (Climate Investment Funds, 2010; De International Center for Monetary and Banking Studies, 1999; Lynch, 2003) Lack of resources One of the reasons for the failure of the system and a challenge for the IMF is its lack of financial resources. If the IMF had more resources it would have better staffing and newer models to not only avert danger but also once the crisis occurred give better help. The lack of surveillance was the primary reason for inability to prevent crisis and the lack of resources the reason for untimely help. The IMF did not have money to lend to nations at the time of crisis. At the time of crisis the total funds that the IMF could lend amounted to $335 of which $228 were unusable. The total gold resources available were 3224 metric tons. There werent any reserves and only a little scope for gold sales in order to help nations pay loses of close to $1 trillion. The IMF would not be able to help America (the first one affected) if it had asked for help regarding loans. (Truman, 2010) This is shameful for the IMF since its sole purpose is to give loans to member countries at the time of ne ed. To overcome this challenge the member countries of G 20 and G 30 decided to increase resources. Main contributors remained Japan ($100 billion), China ($50 billion), America ($100 billion), Russia ($10 billion), Brazil ($10 billion) and UK ($15 billion). This money would help in the loan process and increase the chances of the IMF to resolve the disaster. The problem IMF was facing was the decrease in lending due to which it not gets interested payments to keep up operations would be resolved and IMF would be able to help other nations by providing loans and other options. More for developing countries The developing countries are the ones who were most incapable of handling the crisis and at the same time they were the ones who were affected the most due to close association with the United States. Their dependence on America caused them to lose millions of dollars. The IMF could not help the developing countries by providing loans and they had to beg their neighboring countries for help. Of the 185 member countries most are developing and there was greater need for developing their situation. More than help the developing countries did not have a say in the policies and procedures undertaken by the IMF. They did not have voting rights or majority of approval to pass agreements and this was a challenge for the IMF. America has most of the rights to vote(15%) and for any bill or agreement to be passed, America needs to have an affirmation on the same. (The Financial Crisis and Information Gaps, n.d.) Hence the IMF needs to increase communication with the developing nations, he lp them understand their situation in the crisis, give them loans at better rates that they are capable of paying and increasing their voting rights. The smaller economies need to be heard and paid attention to and at the same time they are the ones that need help the most. IMF needs to implement a change that suit the developing countries and help them revive their status again, after all that is the reason why the IMF was created to begin with. (Wood Carin, 2005; Rehman, 1998; Barry, 1999) Better models and policies The IMF needs to work on models that are most relevant to the crisis. They can compare the models used in the great depression and use the same thinking process and create new and better ways to come out of the liquidity shortage. It needs to do more research on the situation each country faces and give them more personal analysis on the macro as well as micro front. Certain developing countries do not have the resources to conduct these analysis hence it is not only a challenge but also a moral responsibility of the IMF to provide these analysis. (Siebert, Kiel Week Conference, Kiel Week Conference on the Worlds New Financial Landscape Kieler-Woche-Kongress, 2001) Change in core practices The fund needs to changes its practices from focusing on short term loans to long term ones since the long term loans provide more interest and help the fund finance itself. What IMF used to do was provide loans for balance of payment problems faced by countries hence the longest loans it would issue were for 3 years. The IMF has to change its function according to time and state of the world economies. If a country takes a short term loan in the current crisis it would have a negative impact not only for the country but also for the IMF. Hence the requirement now is to be able to provide long term loans to countries. If the IMF provides long term loans for more than 7 years then it would bring economic stability and attract investors towards IMF. The IMF also needs to regulate the loans and make periodic overviews of the short as well as long term macro economic conditions and loans issued. (Weiss, 2008; Knoop, 2010) Risk in financial sector The IMF needs to assess the risk in the financial sector and clearly communicate the information in to all member nations. All sectoral and other financial and economic datasets need to be shared with all nations so that they can be better prepared in any situation. (Hart Spero, 2010; Ronalds, 2010) Conclusion The IMF staff and the FSB secretariat coordinated closely throughout the crisis to make the economies more stable. With loans and other financial data the IMF played an important role in making the crisis last much shorter. This kind of financial crisis was similar to the time of the great depression and the economy took a decade to recover however it was with the help of the IMF that nations could count on a speedy recovery. The crisis is not over yet and the IMF still needs to do a lot of analysis and research to find better ways in which economies can protect themselves. The crisis was like a challenge since the IMF was not prepared for it to such a large extent. The fund had no idea it would grow that large in size and it become a problem to all nations. Even more challenging was the fact that IMF did not have the monetary resources to provide capital to these nations in need. Post the G20 and G 30 summit the IMF could handle the crisis better with the skill in management and c apital contributed by members. There are many challenges that the IMF is currently facing like the lack of monitoring practices, long term loan development, elevation of poverty and more representation of developing nations. IMF lacked surveillance and at the same time it did not communicate correctly the economic data with other nations. IMF needs to assess all these factors carefully as well as cautiously and takes steps to avoid them as fast as possible. If the IMF was better prepared for these challenges then it would not have affected nations worldwide however it did overcome most of its difficulties and to a large extent helped nations in coming out of depression and recession.