By Simon Johnson
Just a few years ago, eurozone countries were at the forefront of those saying that the International Monetary Fund had lost its relevance and should be downsized. The organization was regarded by the French authorities as so marginal that President Nicolas Sarkozy was happy to put forward the name of a potential rival, Dominique Strauss-Kahn, to become managing director in fall 2007.
Today the French government is working overtime to make sure that a Sarkozy loyalist and the leader of his economic team – Finance Minister Christine Lagarde – becomes the next managing director. Why do they and other eurozone countries now care so much about who runs the IMF?
The euro currency union has a serious problem, to be sure, with the likes of Greece, Ireland, and Portugal, but it is beyond bizarre that these countries now find themselves borrowing from the IMF. The IMF typically lends hard currency to countries that have “balance of payments” crises – meaning that they have been importing more than they were exporting, and the previous private sector capital inflows (typically loans of some kind) that financed this current account deficit have now dried up.
Greece has a current account deficit but its money, the euro, is one of the world’s hardest currency – it is a “reserve currency” meaning that central banks and private business keep their rainy day funds in euros (as well as dollars, yen, Swiss francs, and perhaps still British pounds.) The eurozone as a whole does not have a current account deficit.
I recall vividly discussions with eurozone authorities in 2007 – when I was chief economist at the IMF – in which they argued that current account imbalances within the eurozone had no meaning and were definitely not the business of the IMF. Their argument was that the IMF was not concerned with payments imbalances between US states (all using the dollar), and we should likewise back away from discussing the fact that some eurozone countries, like Germany and the Netherlands, had large surpluses on their current account while others, like Greece and Spain, had big deficits.
Those eurozone treasury and central bank officials had a point. After all, if one of the deficit countries got into trouble, it could be helped out by other members of the currency union. As the euro is a reserve currency – and a highly regarded one, for example it remains strong relative to the dollar – the IMF is essentially now lending euros to the eurozone in its various bailout programs.
Why does this make sense?
It doesn’t – unless you understand that the goal of these various bailouts is to ensure that German and French taxpayers do not realize the full extent of their losses or the ways in which their banks have been completely mismanaged.
Take the most generous interpretation of IMF lending to Greece – it is like the U.S. Troubled Asset Relief Program, in the sense that there will be a great deal of outlay but all or most will be repaid in nominal terms.
Such lending could be made just as easily by other eurozone countries, either from current resources or by borrowing in the markets – for example, Germany has plenty of fiscal credibility and issues some of the lowest risk sovereign debt available. But even if the money lent to Greece in this fashion were all paid back, this would look bad – to German voters (and to French voters, as France would have to lend also).
Such loans are much more risky than commonly supposed. The IMF does eventually get its money back nominally, but not always in real terms (adjusted for inflation) and definitely not on a risk-adjusted basis (i.e., the interest rate charged does not include proper compensation for the risks being taken). There is a very real possibility that some or all of the monies lent will not be paid back in the foreseeable future.
The International Monetary Fund is, in this regard, essentially a credit union owned by 187 countries – with voting based on ownership shares that reflect relative economic size. The European Union “owns” about 30 percent of IMF, so 70 percent of any money at risk belongs to other countries: about 17 percent US, 7 percent Japan, 35 percent emerging markets, plus some more mixed sets of countries.
The managing director of the IMF is the impresario of any bailout. The big decisions must be negotiated with all significant stakeholders but this still leaves enormous scope for discretion.
If Ms. Lagarde becomes managing director she can directly influence the terms of IMF involvement – and based on her negotiating position to date within the eurozone, we can presume she will lean towards more money, easier terms, and above all no losses for the banks that made foolish loans.
Increasingly it looks like the eurozone leadership, under French guidance, will go for the Full Bailout option, in which all Greek debt is bought up by the IMF, by the European Central Bank, and by other eurozone entities. This debt will be held to maturity – and any creditor who did not yet sell will be made whole (those who already sold at a loss are out of luck).
This course of action will be expensive, in terms of nominal outlays and in real risk-adjusted terms, because whatever terms Greece gets must also be offered to Ireland and Portugal. The IMF may need to raise more capital or – more likely – tap its credit lines from member governments.
To be clear, the Full Bailout is still painful for the debtor countries – their fiscal adjustments will involve spending cuts, tax increases and asset sales. But the motivation is not generosity.
The Europeans greatly fear their own “Lehman moment” – in which any attempt to impose even moderate losses on creditors will cause chaos throughout the financial system. The French and Germans fought hard against increasing capital requirements under Basel III and the results of various European banking “stress tests” have been completely noncredible – particularly as they did not take into account serious sovereign debt default scenarios.
The French want to sway decision-making at the IMF in order to use US, Japanese, and poorer countries’ money to conceal from their own electorate that the eurozone structure has led all its members into serious fiscal jeopardy – some borrowed heavily, while others let their banks lend irresponsibly and thus created a large contingent liability.
The best way to hide the true cost is to have other people’s taxpayers foot the bill, preferably with the least possible transparency. There is a lot at stake for eurozone politicians. Ms. Lagarde will run the IMF.
An edited version of this post appeared yesterday 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.