By Simon Johnson
Most Americans paid no attention this weekend when the International Monetary Fund announced it was well on its way to roughly doubling the money that it can lend to troubled countries – what the organization calls a $430 billion increase in the “global firewall.”
The United States declined to participate in this round of fund-raising, so the I.M.F. has instead sought commitments from Europe, Japan, India and other larger emerging markets.
At first glance, this might seem like a free pass for the United States. The additional I.M.F. lending capacity is available to euro-zone countries that now face pressure, such as Spain or Italy, so it might seem that global financial stability is increased without any cost to the American taxpayer.
But such an interpretation mistakes what is really happening – and actually represents a much broader problem with our budgetary thinking. The I.M.F. represents a contingent liability to taxpayer sin the United States – much as the Federal National Mortgage Association (known as Fannie Mae) and Freddie Mac (formerly the Federal Home Loan Mortgage Corporation) have in the past — and as too-big-to-fail mega-banks do now.
The budgetary consequences of all those government-supported enterprises are known as “contingent liabilities” – simply meaning that, when something goes wrong, the taxpayer is on the hook. (If you believe any of these guarantees are costless, please read the new book James Kwak and I wrote.)
The I.M.F. is not a corporation nor does it exactly resemble any other legal entity you are likely to encounter. To understand the way in which the American taxpayer is on the hook, focus on the fact that, like any corporation, the I.M.F. finances its activities with a combination of equity and debt.
Traditionally, the I.M.F. was funded mostly with “equity” – contributions paid in by member governments. In the 1940s, when the organization was created, the United States paid in dollars and gold (this was when gold was the mainstay of the international payments system). Other countries have also paid in gold, as well as in acceptable “strong” currencies.
According to the I.M.F. Web site: “The I.M.F.’s gold holdings amount to about 90.5 million troy ounces (2,814.1 metric tons), making the I.M.F. the third largest official holder of gold in the world.”
(On Tuesday, gold was trading around $1,640 a troy ounce, so the market value of the I.M.F.’s holdings was close to $148 billion. For more detail, including on how countries might get back “their” gold, see this fact sheet.)
More recently – and particularly since 2009 – the I.M.F. has increased its lending capacity not so much through additional equity (known as “quota” in I.M.F. jargon) but through debt. In effect, the I.M.F. is borrowing from some countries in order to lend to other countries.
There is a simple reason for this switch. The I.M.F. quota comes with voting rights – and these are currently skewed toward those countries that held the balance of power in the 1940s and 1950s (the I.M.F. was created in 1944). The United States has a veto, and the Europeans are overrepresented.
Now, the emerging markets, like China and the oil producers, have the cash reserves. Emerging markets would be happy to get more quota at the I.M.F., but there is no way that Europe or the United States and its allies would be comfortable with a big shift in who is calling the shots within the international monetary system.
But there’s the catch and to see it, think about the European Union’s recent decision to lend 200 billion euros (about $260 billion) to the I.M.F. If the E.U. lends to European countries under duress, it could lose this money, in the event of a complete default. But if the E.U. lends to the I.M.F. and the I.M.F. lends to stressed European countries, then the E.U. has some downside protection – from I.M.F. shareholders.
In the event of default or complete nonpayment on official borrowing, including loans from the I.M.F., the losses would be borne in the first instance by shareholders. In this sense the I.M.F. is like a bank, with loss-absorbing shareholder capital. If that capital were exhausted by losses, then the I.M.F. would be unable to pay back what it in turn had borrowed.
Some officials assert that none of this could happen, because the I.M.F. always gets paid back – one way or another. Certainly that has been the pattern in the past, but then again we have not seen this level of stress on the international system at least since the 1930s, when all the rules were torn up repeatedly.
A major euro-zone meltdown would cause severe damage around the world. Anyone who thinks otherwise has not been paying attention.
Over the weekend, the I.M.F. became a lot more leveraged – that is, its debt increased relative to its equity. The potential future liability to American taxpayers went up, because the risk of large credit losses increased, and those losses would need to be covered by shareholders (and our stake in the fund is 17.69 percent of quota, with 16.8 percent of the votes). There is also an implicit guarantee – arguably without limit – from the US to the IMF. We set up the world trading system after World War II, and we have a huge amount to lose if it fails. We also have deep pockets, compared to almost other countries.
Therefore, unlike with a typical corporation, we the shareholders in the IMF do not have limited liability – so we should care a great deal about the downside risks. The Europeans are currently increasing those risks – by lending to the I.M.F. and planning to use I.M.F. loans as part of future bailouts.
The Congressional Budget Office is getting better at scoring contingent liabilities, including United States obligations to the I.M.F., but there is still a lot more work to do. It’s time for Capitol Hill to pay more attention to the implications for the United States budget (and therefore the likely path for our national debt) of what is happening at the I.M.F. – points also made by Desmond Lachman in recent congressional testimony (see points 12-16 here.)
Do not take the statements of global leaders at face value. Congressional leaders on both sides of the aisle should begin by asking the C.B.O. to update its scoring of American commitments – explicit and implicit – to the fund.
An edited version of this material appeared this morning on the NYT.com’s Economix blog. It is used here with permission. If you would like to reproduce the entire post, please contact the New York Times.