November 17, 2008

And good luck to them!

Sir Ms Gail Easterbrook in his letter “Act locally to embed the right attitude to risk” November 17 when referring to giving new regulatory powers to IMF to provide “early warning” of risk to the global economy summarizes it adequately with an “And good luck to them.”

The case for more humility and lower expectations with respect “early warnings” is laid out with crude clarity by the United States General Accounting Office (GAO) in its study of the IMF’s capacity to predict crisis, published in June 2003 (SecM2003-03-734). In it, GAO states, among other things, that of 134 recessions occurring between 1991 and 2001, IMF was able to forecast correctly only 11 percent of them, and that it was similarly bad in forecasting current accounts results. Moreover, when using their Early Warning Systems Models (EWS), in 80 percent of the cases where a crisis over the next 24 months was predicted by IMF no crisis occurred. Furthermore, in about 9 percent of the cases where no crisis was predicted, there was a crisis.

Ms Gail Eastebrook also receives my warmest nod of approval when reminding us that we need to embrace risks and that “without risks there are no rewards”. This is something our financial regulators should have thought upon before they so arrogantly decided to drive risks out of banking, with their minimum capital requirements for banks based on a vague concept of risks of defaults, and that, because it also led the regulators to empower the credit rating agencies, created the current crisis when these lousy pipers led us into the swampland of badly awarded mortgages to the subprime sector.