IMF's Lipsky: Reeducating a Wall St. Cheerleader

♠ Posted by Emmanuel in , at 3/14/2008 02:07:00 AM
If you were to construct a stereotypical pro-market, pro-financial innovation individual circa early 2007, you would not have done any better than selecting John Lipsky. Formerly a vice-chairman at JP Morgan, he is currently the managing director at the IMF. By tradition, the Europeans usually get to pick the IMF head while the US gets to pick the second in command, the managing director. At Davos 2007, the ever-so-market-friendly Lipsky had this sort of "don't worry be happy" attitude prevalent before most Wall Street banks fell on hard times and the music stopped. Try not to laugh; this Financial Times article is dated 30 January 2007:

Lower energy prices and a more stable US housing market have diminished risks in the global economy to the point that the world now has the "luxury" of worrying about mispriced financial markets.

John Lipsky, the new first deputy managing director of the International Monetary Fund, told the Financial Times that financial market risks - including general high asset prices, an explosion of structured finance or unwise trading in the yen - were problems "less pressing than those we worried about a few months ago". "Now, we have the luxury of worrying about these other issues," he said.

Mr Lipsky, former vice- chairman of JP Morgan investment bank and a long-standing optimist on financial markets, is now the most senior US official at the IMF. He is radically reshaping the fund's thinking on financial market issues, something that has been quite a culture shock for the more cautious IMF staff. For example, he expressed far less concern about financial market risk than the consensus at the World Economic Forum at Davos last week...

As we all know this rose-tinted Wall Street view of things did not hold up, unfortunately. By 27 September 2007, Lipsky was a little more cautious about the benefits of all this financial "innovation" and the rest of it:

A few months ago, I would have said that one of most striking features of financial globalization has been the broadening reach of financial institutions and markets, creating an ability to disperse risk much more widely than previously. The process of globalized risk transfer is being facilitated by securitization and by the use of complex derivative transactions. As is well understood, the key benefit of modern risk transfer instruments is that they allow investors to bear only the financial risks they wish to.

While I still believe this to be one of the most relevant facets of financial globalization, the events of the past few months have demonstrated that the process of risk dispersion contains some inherent potential problems...

Whoa, you mean that there are problems with securitized assets and the like? At least for Lipsky, that was a breakthrough admission. Now, you all may be very surprised to know that Lipsky has turned into a Roubini wannabe of sizable proportions. He is now telling various IMF member countries to batten down the hatches and prepare for the worst:

"By now, there is little doubt that risks of further escalation of this crisis are rising and decisive policy action will be required to put the global financial system and global economy on a firmer footing," said John Lipsky, First Deputy Managing Director of International Monetary Fund (IMF).

"The first priority must be to reverse the spreading strains in global financial markets, and to restore the normal functioning of the financial system in advanced economies," he stated in an address at the Peterson Institute for International Economics in Washington, DC.

"The actions taken yesterday [March 11]," Lipsky added, "by several central banks are helpful, as they reflect a recognition of this critical need to assure market liquidity…"

Though advanced economies are taking steps in the right direction, integration of financial markets globally implies more rapid and potent spillovers to other economies, Lipsky warned. Policy actions worldwide, so far, "may not prove to be adequate" to deal with the "low probability but high impact events" that may materialize and undermine global financial stability. "Policymakers as a matter of course need to `think the unthinkable,' and to consider how they would plan to react if contingencies arise. The need to prepare systematically for potential risks has been demonstrated amply during the past few months."

Lipsky pointed to the potential for a "global financial decelerator" that could amplify the impact of financial turmoil on the real economy.

"A downward credit spiral, driven by rising defaults or margin calls that forces asset sales even as the value of collateral deteriorates could produce new rounds of deleveraging and asset price deflation," he explained.

Further crisis escalation? So there is a crisis now, eh? A global financial decelerator and a downward credit spiral too! Are you sure this is Lipsky? Pretty soon he'll be quoting from Bill Fleckenstein and Stephen Roach. Am I slow or is it just that Lipsky was behind the curve? While the change from "don't worry be happy" to predictor of doom is certainly drastic, it does seem gratifying to know that even these cocooned Wall Street types can default to reality sometimes, and it does bite--hard.