IMF failed to anticipate dreadful eurozone crisis, watchdog says

Flickr © International Monetary Fund

The IMF’s watchdog – Independent Evaluation Office (IEO) - has recently published an assessment of the Fund’s engagement with the euro area during the period of financial assistance to Greece, Ireland and Portugal. The report blames the IMF for not foreseeing the magnitude of the risks that would dominate the eurozone’s concerns such as the oversized Irish banking system and the consequences of reckless lending.

Overall, existing literature regarding the IMF’s conduct was mainly critic, underlying causes for the crisis such as policy failures and external borrowing that was not productively invested. The Fund was also criticised for being overly realistic with projections for Greece and Portugal. More realistic forecasts would have made structural reforms and fiscal consolidation more progressive and therefore less devastating for the poor and middle class segment of society.

The IEO’s methods of research were however confronted with some difficulties, as “the IEO did not have full access to confidential IMF documents in a timely manner.” Nonetheless, after eight years since the onset of the financial crisis, a dominant factor seems to be on the root of the financial woes and public finances of the economies of the Member States: banks issued billions of euros in loans with relaxed lending standards during times of financial prosperity and economic stability.  

In terms of surveillance, it seems that the IMF should have been more attentive to reckless lending. After all, according to article IV, the IMF is responsible to conduct economic and financial surveillance in the member countries.

Faulty Euro's Architecture 

Daniel Dåianu, a Romanian Economist and Professor, identifies the roots of the strain in the European Union. To begin with, a flawed financial intermediation system is one of the root problems. More specifically, this refers to mistakes in macroeconomic policy, the same errors — lack of regulation, excessive securitisation, inadequate risk-assessments models — that contributed to the emergence of the American crisis.

Another issue is related to the premises of the European Monetary Union (EMU), which are those of a single market, but lacking a coherent risk management policy. The EMU has never solved several issues related to the distribution of responsibilities between home and host country. In addition, the EMU was not built on detailed burden-sharing arrangements in the event of a crisis.

The third problem is the failure of the Europe 2020 strategy to combine centralised decision making with national or regional initiatives in economic policy making. And, last but not least, EU has always suffered from a lack of integration and harmonisation among member states, this meaning that “conflicting views and interests among EU member states reduce its internal cohesion and harm its power projection externally.”

IMF and Interest Rates

In an article entitled "IMF Go Home", Daniel Gros, Director of the Centre of European Policy Studies, made a brief analysis on the interest rates applied by the IMF and the European counterparts. Hence, his main findings indict the IMF of setting up on higher interest rates compared to the interest set up by the European homologues.  According to Gros, the IMF’s assessments of debt sustainability in Greece are undermined by a deep conflict of interest and more important, IMF credits are too expensive.

"The IMF is charging a much higher interest rate (up to 3.9%) than the Europeans (slightly above 1%, on average), largely because it has surcharges of up to 300 basis points on its own funding costs, compared to less than 50 basis points for the European lenders. Moreover, IMF loans are to be repaid in just 5-7 years, on average, compared to up to 50 years for the European funding."

"There is a broader point as well. Greece is not the only country suffering from the high cost of IMF loans. The outstanding IMF loans held by Ireland and Portugal, which amount to another €23 billion, should also be re-financed. If IMF loans are replaced with European Stability Mechanism financing, eurozone taxpayers will save hundreds of millions of euros per year."

Memories of the Irish financial crisis

Ireland requested financial assistance in November 2010. © Dirty Stacks

On his recent published book “Recap: Inside Ireland’s Financial Crisis”, Kevin Cardiff, former second secretary general of the Irish Finance Ministry describes the fateful moments in the backstage scenes of the financial crisis in Ireland. The crisis came to the surface in late 2008 with subsequent serious concerns on the sustainability of the banking sector.  As a consequence, the once-called Celtic Tiger had to seek financial assistance from the EU and the IMF in late November 2010. By the end of the programme, in 2013, Irish banking system and public finances were stable.

 Default of the Irish banking system

What began as a banking crisis with the two biggest banks – AIB and Bank of Ireland - operating on the Irish markets, rapidly turned into a serious financial crisis. Six Irish banks were bailed out in Ireland. As a consequence, a series of extraordinary official meetings took place between the representatives of the Central Bank, the Financial Regulator, the Department of Finance and the National Treasury Management Agency, where the different actors were analysing the different possible aspects of crisis response applied to the country as well as developing legislation to be implemented according to the current needs. In the meantime, the National Asset Management Agency, the so called "bad bank", was created as a response to counter the financial crisis.

In parallel, meetings have also occurred with delegates of the Irish banking sector, who have shown a slight rejection in matters of cooperation regarding the takeover of the Irish Nationwide Building Society (INBS). “The regulators received a strong refusal: the banks were concerned that INBS’ s very high property exposure would be too difficult for them to digest.” The author questioned this refusal: “did their reluctance now in supporting INBS suggest we needed to get more and better data on the INBS property book for ourselves?” Perhaps the government should have had better control supervising the banking sector. Nevertheless, work on the potential rescue of the banks was in course and the nationalisation was likely to be the response. A nationalisation bill was sent to the Oireachtas, the legislative branch of the Irish government, and passed on 20th-21st January 2009.

Early in 2008, Sachsen Landesbank, a publicly owned German bank with subsidiary in Dublin’s International Financial Centre was bailed out.  The crisis was systemic and contagion needed to be tackled. The sleepless media was already announcing the collapse of the banking sector which left costumers terrified queuing in ATMs to withdraw cash. Brian Lenihan, the then Finance Minister asked the head of RTÉ News to avoid creating panic within the population. In order to calm down social speculation, an increase of the level of protection on banking deposits to €100.000 was established.

Trichet’s demand

The instability in Ireland raised concerns at the European level too. Jean-Claude Trichet, the then managing director of the European Central Bank (ECB) sent out the message that “it is essential for European and Irish financial stability that there are no bank failures in Europe.”

Both AIB and the Bank of Ireland were in difficulty to attract funds and soon “the Irish banks would not have the cash to honour them.” A guarantee framework granting broad guarantees to all significant Irish banks was then framed. It was generally accepted by the parts that the bondholders must be kept on board to encourage the flow of new funds and the question to how the State would charge the banks for its guarantee was being worked on.

Unsteadiness was growing and the faster legislation could be passed, the less likely the guarantee would be questioned in the market. In October 3th 2008 the bill became law. Alarmed with the risk of contagion, other banks approached the Ministry of Finance asking to be covered by the Guarantee, a request the Irish government couldn’t cope with. Later on December 14th, the government announced its proposal approach to recapitalisation.

Countless reunions with all the stakeholders involved in the rescue of the banking sector in Ireland marked the last months of the year 2008 until late 2010, when the official request of financial assistance was formalized to the EU and the IMF. During these problematic years of crisis and consequent demanding negotiation meetings, many prominent bankers resigned to their functions. 

In late September, ECB’s chief Trichet called the finance minister Brian Lenihan to assess the Irish situation. Lenihan explained he and his office were doing the possible to restructure the banking sector whilst preparing the budget for 2011, year of general elections in Ireland. Cardiff wrote that “Trichet demanded that the European Commission be allowed to come to Ireland to examine the situation – an immediate mission from the Commission was required, he said.”

Jean-Claude Trichet was the IMF's managing director during the Irish crisis. © Google

Preparing the bailout

The back and forth with Brussels had begun and the Irish Finance Ministry staff would soon be quite acquainted with meeting rooms in the Berlaymont and Beaulieu. The main focus of recurring negotiations lied on the financial assistance package and consequently on its guarantees for the creditors and obligations for the lenders. Despite recognising the willingness of the ECB in supporting the Irish crisis, Kevin Cardiff claimed “there was great pressure on Lenihan to agree immediately to request an EU/IMF programme.” After all, the Irish Central Bank governor Patrick Honohan, made the official announcement from Frankfurt, over a telephone interview to RTÉ News. The Irish government requested EU/IMF assistance on Sunday, November 21st 2010.

Senior Bondholders

Amidst the rough negotiations was the question of burden sharing by senior bondholders. However, according to Cardiff, the burden sharing stopped being negotiable after rejection of IMF officials and a warning from the Commission. “The pro-burden-sharing views of the IMF officials on the ground in Ireland were overruled, and the IMF stance on such burden-sharing became officially negative. The Commission reported to us that the EU position was now that if there was to be burden-sharing for senior bondholders, there would be no programme,” wrote Kevin Cardiff.

The prospects of a bailout and deteriorating political developments alarmed the markets leading to a decrease of credibility on the Irish financial system. Standard and Poor’s reduced the credit of rating on Irish government debt and bond yields rose.

Later on, in 2010, the iconic meeting in Deauville determined that sovereign bailouts from the European Stability Mechanism would require that losses would be imposed on private creditors. This was a decision defended by chancellor Angela Merkel and criticised by then French president Sarkozy. Although, the vast majority of the Irish citizens probably concurred with Merkel that foreign creditors who loaned billions to Ireland's bans without due diligence (by mispricing credit) should share the cost of the bailout, such talk only served to further unnerve the jittery investors, sending shockwaves in the bond markets and pushing up yields in several Eurozone countries. According to several media outlets, this agreement was blamed for the increase in sovereign spreads in late 2010 and early 2011.

In fact, the EU/IMF package exempted senior bondholders (although subordinated-debt holders were not spared), who lent money to Irish banks from suffering any losses – even though the EU agreed that private investors would be held accountable for losses in future crisis. However, this procedure only became effective once the permanent rescue mechanism came into force in 2013.

Former IMF officials speak out on the Irish crisis

Towards the end of the programme in July 2013, former IMF representative Ashoka Mody said austerity was a "potentially self-defeating policy". The IMF distanced itself from Mody's comments, declaring that "Mr Mody has retired from the IMF and his views do not represent the Fund's position."

In September 2015, former IMF mission chief Ajai Chopra appeared before the Banking Inquiry committee accusing the EC and the ECB of putting euro-wide concerns "above what is appropriate for the individual Member State even when this resulted in higher Irish public debt." With regards to the correspondence exchanged between Trichet and Lenihan in 2010, Chopra said that it showed that Ireland was being issued with an ultimatum. He stressed that the ECB had exceed its mandate by discussing Ireland's fiscal policy and the need for structural reforms.

Obesity, a European concern

Obesity is related to the intake o sugar-sweetened beverage, which is increasing in several EU countries. Google

The Parliament is expected to assemble at least 375 signatures from MEPs next Monday (July 11^th) in an attempt to increase the social awareness of obesity within the citizens of the Union.

Anticipating the celebration of the European Obesity Day (May 21^st), on April 26^th a written declaration was introduced in the European Parliament by MEP Alfred Sant (S&D) calling on the urgent recognition of obesity as a chronic disease. Next Monday (July 11^th) the Parliament is expected to assemble at least 375 signatures from MEPs, paving the way to formally call on the European Council and the European Commission.

“Obesity causes many other diseases, including Type 2 diabetes, cardiovascular disease and certain cancers,” said Sant following the Healthy Breakfast event at the Parliament. “Better prevention and treatment of obesity will provide tangible healthcare system savings, as well as reducing the suffering of the millions affected.”

This move marks an important step towards the combat of obesity, exposing its severe risks – including morbidity and mortality - and calling on immediate action to improve the EU response. Up until today, Portugal is the only European country recognising the illness.

Towards a Common Goal

Triggered by the socialist, the written declaration - a political tool to raise awareness on certain topics and proportionate debates and sustainable solutions - has counted with the support from most political families in the Parliament and several stakeholders, stressing the relevance of this serious public health concern.

The advent of sedentary lifestyles combined with poor eating habits has resulted in an increase of the world’s population affected with obesity. According to Eurostat, country estimates for 2008 recorded over 50% of both man and women as overweighed. A European health survey is currently being conducted with a scheduled update projected for December 2016.

The occurrence of this disease has tripled in many European countries since the 1980’s posing serious threats to our public health and to the sustainability of healthcare systems. Obesity-related costs currently represent more than €70 billion a year in expenditure and lost productivity for governments.

One of the main reasons for the prevalence of this disease is connected to the bad alimentary habits in our society and the easy and affordable access to tasteful processed foods and sugar-sweetened beverage (SSB). According to estimates the annual deaths attributed to SSBs reaches 184,000.

The term SSBs comprises caloric soft drinks, lemonade/lime carbonates, ginger ale, tonic water, orange carbonates, iced tea, juice drinks, sports drinks and energy drinks.

Sweetened-Sugar Beverage Sales in Europe

A recent study from the International Chair on Cardiometabolic Risk (ICCR) has delivered the latest trends of SSB’s sales around the world in 2015. The study is measured in liters per capita and the Netherlands, Belgium and Germany are the top seller countries with 93.0, 91.4 and 83.8, respectively.

Nations like Portugal (64.7), Greece (39.4), Croatia (61.4), Italy (52.6) and Spain (77.1) registered a decrease in the number of SSBs sold.  Overall, the highest cuts in SSBs sales were mostly seen in Western countries. Noteworthy though is the abrupt growth of sales in developing countries.

Nevertheless, when focusing separately on energy drink sales – a minor fraction of total SSBs sales - ICCR reported it to be on the rise throughout the world, except for Ireland, Portugal and Finland. Questions remain whether the cuts on Western sales are being offset by the rise on energy drink sales.

Regulatory Framework

Back in 2007, the European Commission released a paper proposing several measures at different levels for the promotion of healthier lifestyles for the citizens of the Union. One of the key goals of the initiative was to reach consumers directly through EU rules on information and agricultural policies.  In the area of information, food labeling came into effect on December 2014 and obligation to provide food nutrition will apply as of December 2016. The Commission also regulated advertising in order to endow consumers to make informed decisions. Guidelines for the promotion of physical activities were also endorsed, promoting healthier lifestyles.