Typical street scene in Santa Ana, El Salvador. (Photo: iStock)
IMF Survey: Financial Markets: Getting the Incentives Right
May 30, 2008
Correcting the problems that led to the financial market crisis of 2007-8 will not be easy, given that the faulty incentives that created the crisis are entrenched in the marketplace and in regulatory and supervisory systems, according to the lead article in the IMF's Finance & Development magazine.
Checking market prices in China: correcting the problems that led to market instability in industrial countries will not be easy. (photo: Newscom)
Market turbulence
The June issue looks at the root causes of the current turmoil in financial markets in industrial countries and what can be done to ensure those problems don't happen again.
The lead story, "A Crisis of Confidence ... and a Lot More," argues that perverse incentives were the major source of the problem and changing those incentives will be the solution. But the incentives are numerous and will be hard to change—some are part of how unimpeded markets work and others have been imposed by rules and regulations.
These faulty incentives encouraged traders, investors, loan originators, and credit rating agencies to downplay risks in creating, buying, and selling the complex, asset-backed securities at the heart of the crisis.
The magazine includes several articles on the crisis, while the Straight Talk column looks at high commodity and fuel prices and possible policy remedies.
A Crisis of Confidence . . . and a Lot More
Laura Kodres
What can be done to prevent future crises like the one that began in the U.S. subprime mortgage market? This article argues that the source of the problem lies in incentives. But the remedies may be difficult to implement because faulty incentives are entrenched in the marketplace and in regulatory and supervisory systems.
Outbreak: U.S. Subprime Contagion
Randall Dodd and Paul Mills
The authors examine the origins of the subprime mortgage crisis and the reasons for its large spillover effects. They suggest policies to deal with such problems should aim to moderate leverage, improve liquidity management, foster market liquidity, promote due diligence, and increase transparency in the public availability of price and trading information.
Point of View:
Asia: A Perspective on the Subprime Crisis
Khor Hoe Ee and Kee Rui Xiong
The authors, from the Monetary Authority of Singapore, examine the current crisis through the lens of the financial crisis that hit Asia in 1997. They discuss lessons industrial countries can take from the Asian crisis and lessons Asian countries can learn from the subprime crisis. They also explore the reasons for Asia's resilience, so far, to the current crisis.
Jaime Caruana and Aditya Narain
One reason that banks succumbed to the subprime crisis is that they did not hold adequate amounts of capital. Against that background, the authors discuss the Basel II New Capital Adequacy Framework, suggesting that it does not address all the regulatory issues that arose from the crisis but that it does, nonetheless, have a key role to play.
Point of View:
Will Basel II Help Prevent Crises or Worsen Them?
Jesús Saurina and Avinash D. Persaud
The authors offer opposing views on whether the Basel II capital adequacy guidelines are too procyclical—that is, too lax on capital requirements during good times and too strict when conditions deteriorate.
Straight Talk
Simon Johnson
Normally, says the IMF's Economic Counsellor, when growth slows in a major economy, the demand for and prices of commodities decline. In the current turmoil, however, the prices of food and fuel have remained high and are having a destabilizing effect on the world economy. Watch Video.