If it wants to remain relevant, the fund needs to come up with new ideas - By Heribert Dieter

Numerous institutions like the Bank for International Settlements warned some time ago that there were problems looming in the United States. By contrast, the International Monetary Fund (IMF) has always praised America's financial markets as exemplary. In the present crisis, the IMF has also been conspicuous by its absence. And that, says Heribert Dieter, is why it is appropriate to discuss its future now. A longer version of this essay is part of an upcoming book "Germany's Role in Globalization," which includes contributions by German Finance Minister Peer Steinbrück, Foreign Minister Frank-Walter Steinmeier, the leader of the SPD's parliamentary group Peter Struck and State Secretary Ditmar Staffelt.

For the IMF, the financial crisis that began in 2007 is a considerable problem. The fund had argued for some time that the American financial system - in contrast to that of developing countries and emerging markets - was exemplary.  Along with overestimating the strengths of the American financial sector, the IMF also failed to issue any warnings on the unfolding crisis. Instead, as it has done in other cases, it put its faith in the markets and their ability to survive crises. This was exemplified by how it assessed the American economy in 2005. Back then, the IMF looked at the financial sector and said it could weather any crisis. The fund's officials emphasized that the securitization of credit risks had led to a reduction of overall risk for the U.S. financial sector.

Unlike other observers, the IMF saw no risk in the combination of surging property prices and the securitization of credit liabilities, even though there were clear signs.

Between the first quarter of 2000 and the last quarter of 2005, the American S&P/Case-Shiller National Home Price Index, which measures the nominal value of the residential real estate market in the United States, had risen from 100 to 187 - it effectively doubled. The IMF did not see any particular danger in this property bubble, since it believed financial markets were immune to any kind of crisis.

In Europe, as elsewhere in the world, the structure of US financial markets was being called into question. In August 2007, a representative of the Association of German Mortgage Lenders told Germany's Frankfurter Allgemeine Zeitung: "Loose lending practices and 100 percent mortgages, which are also encouraged by government tax breaks, are nothing to be emulated."

The president of Germany's Association of Sparkasse savings banks, Heinrich Haasis, warned of the problem on the sidelines of the fall meeting of the IMF and World Bank that same year in Washington: "In the long term, the Americans will not be able to make banks around the world pay for their short-term perspectives and lax standards by means of lost investment opportunities and the risk of inflation."

Perhaps it is worth listening when Wall Street, formerly considered so efficient, is criticized for lax standards by the head of a German savings bank. But doubts were raised in other quarters as well. Loud complaints came from emerging economies. The Brazilian Finance Minister Guido Mantega directed fierce criticism at the U.S. at the fall meeting.

He said it was an irony of history that the country long considered a benchmark for a highly developed financial system, efficient market oversight and first-class risk management was endangering the stability of the world economy.

It is hard to overstate the significance of the U.S. financial crisis for the credibility of the Anglo-Saxon model of financial markets that has long been propagated by the IMF.

And then there was the securitization of loans, which bundled them into smaller packages that were then sold on. Along with the increased use of derivative financial products, it was intended to make it easier to evaluate credit risks and remove them from the banking system. The idea was to allow these risks to be taken on by the people in the financial sector best placed to bear them.

The expectation was that the financial markets would be stabilized as a result. But that never happened. Instead, those risks landed on the shoulders of creditors who had no inkling of the liabilities they had assumed.

Securitization of loans made the financial markets less transparent and thus more susceptible to crises. American academic and columnist Paul Krugman, winner of this year's Nobel Prize for Economics, argued that the financial innovation of recent years had not led to a broad dispersion of risk but rather widespread confusion.

Investors - from German state-backed regional banks, the Landesbanken, to investment funds working for state schools in Florida - allowed themselves to be seduced into making very risky investments. All they knew about those investments was that the potential returns were large. They had not understood the risks. The crisis in the U.S. has also shown that lenders were not very careful about what they lent because they did not have to come up with the cash in the event of non-payment.

For a long time, the IMF has been demanding that financial markets move away from the classical market model, where banks function as lenders, to a system of securitization. It further recommended that developing and emerging markets also adopt this model. The weaknesses of the Anglo-Saxon financial market model that have now become so obvious are a challenge for the IMF, which has so far failed to adopt a clear position.

If the IMF fails to come up with its own draft for the reordering of national financial markets or a new concept for the organization of international capital flows, it will probably be unable to build on the respect that it used to enjoy.

In East Asia, the trend toward emancipation from the IMF is becoming very clear. The region's economies have accumulated gigantic currency reserves over the past 10 years. In mid-2008, China alone had reserves worth more than $1.8 trillion.

Thanks to these currency reserves, most economies in East Asia will in future be able to fend off speculative attacks on their own currencies and prevent a dramatic outflow of foreign capital with a good chance of success. They no longer need the IMF to do it for them.

In many countries, the fund is no longer a very popular advisor. A key problem is that the IMF failed to draw any lessons from the experiences of the Asian financial crisis.

In Latin America, the IMF's influence has been diminished in quite a different way. From the 1980s, in the wake of the debt crisis, the organization held unusually large sway over economic policies of those countries that had become dependent on the IMF and its recommendations. It dictated economic solutions that equated macroeconomic stability with price stability, demanded the privatization of state companies and forced the liberalization of capital flows.

Argentina was the IMF's showpiece in that process. However, the serious crisis of 2001 and 2002 there can essentially be put down to the fund's recommendations. Even IMF managing director Dominique Strauss-Kahn, on a trip to Argentina in September 2007, acknowledged the mistakes the IMF had made in the country. He realized that many people in Argentina regard the IMF as the devil incarnate and they had good reasons to do so.

So how are the nations of Latin America now distancing themselves from the IMF? To start with, two big debtors, Argentina and Brazil, both paid down their loans ahead of time at the end of 2005. In so doing they have made themselves relatively immune to the conditions imposed by the IMF. The example of Argentina shows how much better it is for a national economy to grow outside the influence of the IMF. Since the crash of 2002, the country's economy has grown spectacularly, with growth rates of about nine percent a year.

The IMF was of central importance for the regulation of the world economy. Today, there are two problems to address. First of all, the IMF has no crisis management capability to speak of; more specifically, it is too slow to make liquidity available in the programs that are currently up and running. Secondly, the countries of the OECD dominate the IMF and that creates an imbalance that the ambitious economies of the developing world are no longer prepared to accept.

If the IMF is to remain an important institution in the future, it will need to be comprehensively reformed - both in terms of its lending policies as well as with regard to representing the interests of developing and emerging economies.

Cosmetic changes, say a slight increase in the voting rights of Asian countries, without a fundamental reform of its lending policies, will not stop the steady erosion of the IMF's influence.

- Heribert Dieter of the German Institute for International and Security Affairs (SWP) is a member of the Global Issues Research Group at the Foundation for Business and Politics in Berlin.