Too many risks, too few rewards
Capitalism and serfdom
The spectre of intervention
Throwing good money after bad
A breathing space for the IMF
If the IMF were a banker it would be unemployed. Battered and threadbare, 52 years old, it was created for and some would say still lives in a world that is long gone. Its coffers are empty. Several powerful department heads are preparing to retire. And turnover has been heavy among the few younger Fund staffers qualified to transfer to today's fast-moving capital markets.
Whether or not the IMF gets the $90 billion it needs in fresh capital from governments around the world, what the Fund does, when and how, are crucial questions for the global financial system. And plenty of heavyweights are pitching in with their views.
Henry Kaufman, president of the New York-based financial advisory firm which bears his name, is one who thinks that the time has come for a new Bretton Woods meeting to reform and modernize the IMF and the World Bank. Kaufman suspects that the hesitation on the part of the US is based on a fear that it may not have the same dominant role with the restructured institutions that it has today. He thinks that US influence has on the whole has been a positive thing, but asks: "What good is it to have a dominant influence on institutions that are not functioning as well as they should?"
On the right, George Shultz, Walter Wriston and Bill Simon together (perhaps best known as heads of the US state department, Citibank and the US treasury respectively) have said let's abolish the thing and merge it with the World Bank.
These are titans from the generation which preserved and nurtured the Fund after the collapse of Bretton Woods. Were it not for them and a few others, the IMF could have lost all reason for being.
The commotion has also stirred some of the giants from academe. At Harvard, Martin Feldstein believes the IMF reaches too far when it gets into the business of micro-managing sick economies. And Jeffrey Sachs, Feldstein's Harvard colleague, has become perhaps the Fund's most vocal critic, complaining that it suffocates countries with its austerity programmes just as they struggle to break out of depression.
Bail-outs draw fire
Fiercest criticism is reserved for the bail-out strategy that has effectively made the Fund the international lender of last resort. Anna Schwartz, a long-time monetarist and critic of the Fund at the National Bureau of Economic Research in New York, believes the 1994-95 Mexican bail-out first planted this idea in the minds of the financial community.
Until Mexico, the IMF had been providing its members primarily with economic "surveillance" - IMF-speak for playing the role of inside adviser to governments - and lending modest amounts to finance balance-of-payments problems.
Mexico was supposed to be a one-off. As recently as two years ago, the G10 group of industrialized countries produced the Rey report on international financial crises. This was led by Jean Jacques Rey, the governor of Belgium's central bank. The message was that the Mexican bail-out seemed to make sense, but alas the G10 didn't want to make a habit of being sensible in that particular way. The report tried to put investors on notice that Mexico just might be the last bail-out for a while.
Peter Kenen, professor of economics at Princeton, makes the point that the credibility of the Rey report and the whole notion that countries in trouble should not expect to be bailed out has been undermined, starting with Thailand and ending in Russia. Kenen concludes: "The Fund got itself into a very difficult position by saying each time that it's not going to happen again."
The Fund cannot afford another multi-billion dollar bail-out without changes in the way it funds itself. But it is the issue of moral hazard, not hard cash that worries many.
If governments and private lenders come to rely on official bail-outs to reduce their losses after bad lending decisions in emerging markets, a moral hazard will arise that is bad for countries and their creditors.
In Asia, moral hazard was an unintended consequence of attempts by the IMF and the G7 countries to preserve the interbank payments system, come what may.
But Salomon Smith Barney's Jeffrey Shafer notes that moral hazard has arisen even more disturbingly in the case of Russia, where the effect on investment flows has been intentional. Shafer observes: "There was clearly encouragement for private capital to go into Russia and when IMF and G7 money was not delivered in August the markets went into shock." Shafer believes that at least some private investors put funds into Russia expecting that there was an IMF/G7 support network in place. "The IMF was taking on some implicit obligations," he says.
Michael Gavin, an analyst at the IADB, points out: "Emergency lending facilities are reducing incentives for international creditors to lend as carefully as we expect international borrowers to borrow." Markets respond to the prospect of a bail-out by imposing little or no discipline until a crisis becomes imminent. Then, they overreact.
Morris Goldstein, the Fund's former deputy director of research who is now at Washington's Institute for International Economics (IIE), says: "Of all the criticisms, the moral hazard argument is the most serious and it needs to be dealt with seriously."
The issue is complicated because the simplest solution is not to bail anyone out at all and to allow imprudent institutions and - at the extreme, countries - to go down. Those who argue against this laissez-faire approach point out that in those cases the suffering is felt disproportionately by innocent bystanders: the taxpayers and depositors of the country in question. They argue that IMF bail-outs are cheaper and more equitable. But where should the line be drawn?
Helping the bad guys
Charles Calomiris, professor at Columbia University, worries that right now the wrong interests are being supported: "The IMF should not come in and put together these packages to try to make it possible for the countries to do things which really aren't in their best interest. Instead of repaying the domestic oligarchs and the foreign banks, we should penalize them and force a work-out of those debts based on the actual assets against which they lent that money."
Michael Bordo, a professor at Rutgers University and editor of a book by the National Bureau of Economic Research on the Bretton Woods system, is also against indiscriminate bail-outs. "I suspect that the Indonesian bail-out was a big mistake." Bordo says he believes that Indonesia would have done no worse or even better if it had not accepted all the international help and intervention which came its way.
"Why should we be throwing money at them if they can't use it wisely?" Bordo asks. "Left to their own devices, the Asians will eventually come up with policies to get out of the depression."
Against the critics, Michael Mussa, the IMF's director of research, defends large Fund-led programmes, saying that moral hazard could be eliminated but only with pointlessly severe penalties that would kill economic activity. "The people who want to abolish the safety net are like people who argue that we should replace those air bags in cars with sharp spikes. We could solve the moral hazard problem of driving if somebody got impaled on their steering wheel even at two miles per hour."
He compares those who would limit bail-outs in cases such as the Mexican and Asian disasters to people who would have let the survivors go down with the Titanic. "It was terrible news," he likes to say, "that 1,500 people died, but the really bad news for the free-market critics [of the bail-out] was that 700 people lived." Why spend money on any lifeboats? Why not punish the designers for their flawed design by letting everyone perish?
Allan Meltzer, a professor in economics at Carnegie-Mellon University in Pittsburg and one of the founders of America's shadow open market committee, fires back: "This analogy misses the point. What lesson would have been learned if more people drowned? [None.]"
What concerns Meltzer is rescuing the banks at the expense of all the other passengers - the country. "Had it not been for the Mexican bail-out," he complains, "banks would have been much more cautious in Asia. I'm saying that we should have let the banks drown instead. The IMF should tell them: 'You went in there and lent at 20% or 30%. Now, take your loss.'"
(The shadow open market committee, set up by Meltzer and a few others, monitors macroeconomic trends and provides independent commentary on government policies in order to inform the public. The committee consists of specialists from academe and the private sector.)
If some sort of bail-out is necessary, how big should it be and what should dictate its terms? As Kenen says: "Everyone knows there must be an upper limit, but no one knows how to impose it and what sorts of criteria would provide a clear basis for saying that the Fund should finance this case and should not finance another case."
The only thing that seems clear is that most people acknowledge the need to cut back. Says Goldstein at the IIE: "The scale of support was in some cases larger than it should have been. We cannot continue to do $53 billion packages à la South Korea." Goldstein thinks that the way to get smaller IMF programmes is to rely earlier, and more heavily, on private debt rescheduling.
"You could have had perhaps a $30 billion package for South Korea. When you look at the size of these Fund programmes, you need some money to cushion the recession, some money to rebuild reserves and some money to recapitalize banks but you don't want too much money to bail out large, uninsured private creditors. That's the key," he says.
Shades of crisis
And then there is the question of exactly what kinds of crisis should the IMF become involved in and which are beyond it. David Folkerts-Landau is the global head of emerging-markets research at Deutsche Bank and the Fund's former director of capital market surveillance. He draws the distinction between liquidity-driven crises, such as Korea and Mexico, and cases such as Indonesia and Russia which require major political, corporate and financial restructuring. "One should try to get the structural cases out of the Fund," he says, "and give them more money through the aid agencies, the export agencies, the World Bank, the European Bank for Reconstruction & Development and directly through the G7."
Politics too will inevitably play a part. Robert Litan, director of economic studies at the Brookings Institution, fears that, if the IMF doesn't do these big bail-outs "the [US] Fed will do them and I prefer the IMF".
Litan believes the IMF has been "trying its best and has done a pretty good job under the circumstances". But things have not turned out as they had probably hoped, he admits. "Currencies haven't recovered. Stock markets have fallen. Asian economies are still sinking." Litan believes that without IMF help the situation now would probably be worse.
It's not just academics and think-tanks that are wrestling with these issues. Early this year, the US treasury asked the G22, a group consisting of most of the G10 as well as a sizeable contingent of developing countries, to study the architecture of the international financial system in an attempt to face the same issue.
The idea was to engage many of the crisis-stricken countries in a dialogue about burden-sharing, transparency and strengthening financial systems. Concrete recommendations are expected soon. And for its part, the Institute of International Finance has organized four task forces, representing globally active financial institutions, to review a similar list of issues.
"We don't view this as reinventing the international financial institutions (IFIs)," says David Lipton, departing assistant secretary for international affairs at the US treasury. "This is not a new Bretton Woods. We think that the IMF has done a good job. The world is changing and we all need to keep up with those changes."
Lipton says the US "has a significant agenda for strengthening rather than reinventing the international financial system's architecture. We have been working on reforming and improving the IFIs for some time, especially since the Halifax summit three years ago. And we began a new and important round of work this year."
Whether or not the bail-outs continue, it seems likely that there will be pressure for the IMF to step up or change its surveillance role. Catherine Mann, a former Federal Reserve official now senior fellow at Washington's Institute for International Economics, thinks that given the current volume of cross-border transactions, any problem is simply too complicated for central banks to contain without a cop, like the IMF, to direct traffic at the intersection of global finance. For example, a national central bank might not have access to enough of the right foreign currency - through swap networks with other central banks - to head off a modern banking crisis at home.
Add to that the fact that national central banks have very different mandates and respond to crises in their domestic markets in very different ways. Mann contends: "National lenders of last resort aren't going to be able to coordinate their activities quickly and decisively enough to prevent the crisis from spreading abroad. We need an international respondent."
It is certainly true that the old joke about the IMF standing for "It's Mostly Fiscal" is now badly out of date. Today a more suitable reading would be "It's Mostly Financial". Mismanaged banking systems as much as budget deficits caused the crises in Mexico and Asia. That will force big changes at the Fund as well as in its relationships with 180-or-so member governments.
MIT professor Rudiger Dornbusch recently said the Fund should turn one entire floor into a financial-sector surveillance department - even if that means closing the cafeteria.
However, there are serious obstacles both to an expanded surveillance role and to a formal definition of the IMF as a lender of last resort. The Fund has no brief to supervise banks and if it got into that business it could face rough sledding. The Fund would depend on national regulators - a very mixed bag - to provide it with information about the banks in their jurisdictions.
Nor can the IMF print money like a true lender of last resort - at least not at will. And there is no global counterpart to a taxing authority which could pick up the tab for international lender-of-last-resort operations.
Just as seriously, it is not clear how the Fund could act as whistle-blower without compromising its access to privileged information and exacerbating market crises.
Traditionally, countries in crisis have been viewed as clients of the Fund. The original idea was for the Fund to be, as Folkerts-Landau puts it, "the trusted adviser who stands behind the throne and whispers into the monarch's ear".
The quid pro quo was that Fund staff had access to information about the country and to the thinking of the government. The Fund was supposed to be a partner in decision-making and through close relations was to influence the member country to stick to sound policies. And yet the Fund had no way of enforcing remedial action.
The old model no longer works. In recent years the IMF uncovered weaknesses in the financial systems of several countries during the course of its surveillance and it apparently made its concerns known to their governments. The overexposure and the under-regulation of their banking systems was serious. Their failure to recognize and deal with bad loans was also serious - lending decisions made on the golf course are no substitute for decent credit evaluation.
Such things were slowing down growth in countries across Asia and contributed to the acuteness of the crisis when it hit. But earlier, when these countries didn't need the money, they didn't pay attention. Korea was certainly one country where officials ignored initial IMF warnings and the Fund itself declined to take more decisive steps.
Why? Fund sources say there's open warfare between the Fund's country departments and its centralized functions, such as monetary and exchange affairs, research and capital-market surveillance. Apparently, country and area departments sometimes cover up adverse information discovered by these other sources because they're too beholden to the country. One Fund official calls this "clientitis". Key officials in the countries have called the tune. They can simply refuse to deal with Fund staff if the IMF says anything negative.
So, the Fund should shift to an entirely new approach according to Folkerts-Landau. It's what he calls "in-your-face surveillance". Inspired by the US Securities & Exchange Commission, the idea is to be tough, adversarial and uncompromising. IMF teams would simply go, inspect and come back. If the country failed to supply the numbers, the Fund would relay that to investors.
Ian Vásquez of the Cato Institute, a free-market think tank, goes further: "The best that the IMF can do is to stop lending and simply provide surveillance." Vásquez thinks that would be a valuable service but the Fund would then just be replicating functions already performed by the market. So, in his opinion it would not be necessary.
Conflict of interest
Kaufman suggests that the Fund put a credit rating next to its member countries and give quick warnings to countries whose rating is deteriorating. One upshot would be that the Fund's multilateral departments, such as monetary and exchange affairs and capital markets, would have more influence.
Vásquez points out that the Fund, like any rating agency, will precipitate a crisis if it discovers something wrong and tells the world about it. Yet, it has a mission to help prevent crises and it also has, in many cases, billions of dollars of its loans at stake in any given economy. Vásquez says: "There's no way to get around this huge conflict."
Lex Rieffel, senior adviser at the Institute of International Finance, agrees that there is scope for in-your-face surveillance. But "the world needs evolution, not revolution", he says. Rieffel believes, for example, that the Fund should be selective about confronting countries as it experiments with the new approach.
As for tensions inside the Fund, Rieffel thinks they are part of a creative process of checks and balances. He plays down reports of open warfare, preferring to describe it as "the normal kind of carping that goes on".
But can the Fund eventually deliver effective surveillance? Kaufman thinks the IMF hasn't the capacity for the task. He believes the world today needs "a system that has improved supervision and regulation over major markets and major financial institutions". Kaufman wants to give that job to "a board of overseers: you're talking about an organization with several thousand people who have the capacity to monitor institutions in various financial markets".
Right now the Fund isn't even qualified for most of what its critics want. The IMF so far has been a macroeconomic institution and the majority of its staff is trained in that field. Few have much background in financial instruments and markets. The key challenge for the Fund, says Folkerts-Landau, will be to acquire the expertise and manpower to look at the international financial system, and the key players in it, to see whether things are going in the right direction - that is, financial-sector surveillance.
Tough words, not much action
But let's assume that the Fund takes on the mantle of supercop. It, or some other body. then needs to act when faults are uncovered. Unless Vásquez's advice is heeded, the IMF is still going to disburse emergency funds. So it makes sense to tie that lending to the tough new policies, forcing errant governments to comply. Of course that is supposedly true now. But in general the Fund does not succeed in making its conditions stick now, and to be effective as a supercop it would need to be a lot tougher.
Calomiris cites the Mexican example: "None of the reforms that the World Bank, the IMF and the US treasury had said were going happen have happened." The only progress in Mexico has been to allow foreign bank entry: that added a little new capital to the system. Otherwise, the situation is essentially the same as it was in 1994. "And the same is true now with what we're seeing in Indonesia and Korea," he warns.
So how will the Fund fare when it addresses more difficult issues, such as the role of government in banking and emerging markets' love affair with currency pegs?
Monetarist Schwartz at the National Bureau of Economic Research points out that: "It's clear that until you get the governments of these countries out of the banking business, there won't be sound banking. They're going to get into trouble because they'll issue loans that cannot be serviced. I'm not sure whether this is something that the IMF can achieve."
Calomiris doubts that the IMF can exert much influence even when a government is desperate: "This is not a serious formula for banking-sector reform: coming in for a brief period during a crisis, lending money and hoping for progress down the road."
So what chance is there that the Fund would be able to impose floating exchange rates, one of the best ways to limit damage to banking systems?
Fixed exchange rates, says Princeton University professor Kenneth Rogoff, are a lightning-rod for problems". There have been many instances - Mexico, Korea and Thailand, for example - where banks would borrow in foreign currency and lend in local currency. "The regulators couldn't tell them not to do that," Rogoff observes, "because it was awkward to say the fixed exchange rate - that they promised would never change - might change tomorrow. They kept building up these huge unhedged liabilities and that created a lot of problems."
This expanded role would politicize the IMF at a time when many poorer countries already see it as an arm of the US state department. Political forces within the G7 countries are already pressing the Fund to attach new, and some would say extraneous, side conditions to its programmes: protect the environment; take care of the poor; adopt labour practices more to the liking of trade unions in the industrialized world. These are already irritating IMF clients.
The more detailed the conditions that the IMF pins to its loans, the more people it will antagonize inside financially stricken countries. And the harder it will be for the government to take ownership of the programme. Former US secretary of state Henry Kissinger has publicly raised doubts that the IMF is qualified to make the tricky political judgements. But if the IMF doesn't get into details, says Litan, "critics would say that it's just handing out money to a bunch of crony capitalists. I'm not sure how viable the IMF would be under those circumstances - politically."
Retrench not expand
The alternative to this expanded role is a reduced one. Perhaps the IMF should leave longer-term help and the very poorest nations to other agencies.
Deutsche Bank's Folkerts-Landau, who helped put together the IMF programme for Thailand last year, thinks the IMF is spreading itself too thin: "There is clearly a drift towards widening the area of engagement when it comes to putting conditionality into lending programmes." The Fund wants to get as much control as possible over the stricken economy in order to ensure the success of the stabilization programme.
"You really want to button it down," he says. "So, there's always the temptation to go farther and farther afield, to worry about clove monopolies and things like that. I have a natural disposition to want the Fund to remain focused and not to do the World Bank's work."
Do we need a World Bank and an IMF? At Brookings, Litan notes: "There are inconsistent policies being advocated by their [the World Bank and IMF] country teams and that is nuts. Either there ought to be single country teams or there ought to be serious thought about how to merge these two institutions, because frankly they are now both very much in the micro-development business. One wonders why we need two of them."
Manuel Guitián, director of the IMF's monetary and exchange affairs department, believes that Bank-Fund cooperation has been successful in a majority of cases. "The coordination of our work is relatively easy to address conceptually," he points out. "We deal with macro. They deal with micro. We deal with demand. They deal with supply. We deal with short term. They deal with long term. But the boundary between all these concepts is not precise. This is an area in which there is always scope for improvement."
Rogoff, a supporter of the IMF, thinks some of its activities should be shunted over to the World Bank or another institution. "I would sharply pull back the Fund's presence in the world's poorest countries," he says. "Right now, IMF missions travel to many African countries and the poorest countries in the former Soviet bloc on virtually a monthly basis. The Fund is taking on so much that it could start to become ineffective." Some would limit the Fund to working with the world's top 40 economies.
Folkerts-Landau is a strong believer that the Fund in the financial sector should stick to surveillance of macroeconomic aspects of the - the size of credit expansion and the broad quality of credit. "The job of the Fund should be to form a judgement about the ability of the supervisory agencies to detect problems systemic in nature," he says. The World Bank, says Folkerts-Landau, "should deal with commercial bank restructuring and with restructuring the supervisory agencies through financial-sector adjustment loans and things of that kind."
Renowned speculator George Soros has suggested an International Credit Insurance Corporation as a sister institution to the IMF. Soros wants the new agency to keep funds flowing by offering a guarantee for prime-rate loans up to a fixed amount which would vary by country.
Private lenders, of course, would happily accept this type of credit enhancement from the official sector and the resulting flow of funds might, to some extent, reduce the demand for IMF loans. But taxpayers would not be off the hook. Future losses would just follow an indirect path to their doorstep.
Whatever the IMF becomes, no-one should be under any illusions as to its limitations - or those of any other multilateral agency. Ernest Stern of JP Morgan, formerly the second-in-command at the World Bank and one of the elder statesmen of international finance, points out that the IMF has no leverage over countries until they call it to come and help. "It can't stop borrowers from borrowing excessively and it can't stop investors from becoming overly enthusiastic," he says. "It would be a good thing if people stopped thinking that the Fund can make the world safe for capital flows because that ain't so."