The most salient issue of those concerned with the international financial architecture back in mid-2007 was "governance," in particular governance of the International Monetary Fund (IMF). This involved, among other things, the selection of future Managing Directors (by convention since 1946 always a European), representation on the Executive Board (which is responsible for the operating decisions of the IMF), and voting rights, which were based on out-dated formulae. The "legitimacy" of the IMF was said to be in doubt. This concern with governance was against a backdrop of excellent performance of the world economy since 2002, high and widespread growth, and low inflation but rising commodity prices, which helped exporters of primary products. The IMF had made no significant loans since 2003, many countries had repaid their outstanding debts to the IMF (down from US$107 billion in 2003 to US$15 billion in 2007), and with low interest income the IMF was anticipating difficulty in meeting its normal operating expenses.
Much has changed since mid-2007. The likelihood of worldwide recession has moved governance reform to the back burner--or, in the views of some, made it more urgent. There is much talk of the need to reform the international financial system substantively and calls for a second Bretton Woods, recalling the international meeting in 1944 that agreed on the main features of the post-1945 international monetary system and that led to the creation of the IMF and its sister institution the World Bank.
However, a key unasked question lies behind these calls: if international financial governance had been plausibly different, would it have markedly attenuated the magnitude of international ramifications of the evolving financial and economic crisis? My tentative answer is negative, as international organizations such as the IMF are constrained by the limitations on international action. But that is not to say that the IMF does not warrant an expanded role.
A New Governance Proposal
There were signs of difficulty in the US subprime mortgage market beginning in 2007, when defaults had begun to rise and construction of new residences had declined from their peak in 2005. This even had a modest international impact, as two French mutual funds suspended trading because they could not properly value some of their securities backed by US mortgages. But all this seemed to be mainly a US problem, no doubt manageable.
However, by mid-2007, events were changing, often rapidly and dramatically: the seizing up of asset-backed commercial paper markets in August 2007, requiring large injections of liquidity both by the European Central Bank and by the Federal Reserve; the failure and government takeover of Northern Rock, a major British mortgage firm; the takeover of Bear Stearns, America's fifth largest investment bank, by JPMorgan Chase with strong financial assistance from the Federal Reserve; government financial support to two large US mortgage institutions, Fannie Mae and Freddie Mac; unusual support to AIG, the world's largest insurance company; the failure of Lehman Brothers, the fourth largest US investment bank; and by September 2008 a general flight to safety and aversion to risk among most financial institutions.
By the fall of 2008 the IMF was back in the lending business, with loans to Iceland, Hungary, Ukraine, and Pakistan, and more in the works. Governance issues had receded in deference to more operational concerns--not only for the IMF, but also for other parts of the international financial structure, such as the several committees of the Bank for International Settlements charged with improving financial regulation, the Financial Stability Forum, and of course for governments and central banks as the world seemed to be sliding into recession, or worse.
Edwin Truman and I put forward a proposal in February 2007 to reform the governance of the IMF, addressed to the issue of legitimacy. …