Hoover Daily Report

Obama and the IMF Are Unhappy With Congress? Good

via Wall Street Journal
Thursday, February 13, 2014

The $1.1 trillion spending bill signed into law by President Obama last month did not include a crucial change in the U.S. financial contribution to the International Monetary Fund. By refusing to accommodate the White House's strenuous pleas to increase the IMF's discretionary loan budget, Congress effectively rejected an international agreement brokered at the 2010 G-20 meeting—and set off cries in some Washington quarters of a new isolationism.

Critics were right that this was a big deal, but wrong in the way they and the administration have portrayed it. At a meeting of the Council on Foreign Relations, Treasury Secretary Jacob Lew said changing the IMF funding was "critical" but that the administration "didn't get it done." He was obviously embarrassed by what the White House considered a broken promise to the other G-20 countries, all of which approved the agreement. But the real broken promise was by the IMF, thanks to an abrupt decision it made that increases risks to the world financial system.

The 2010 agreement sensibly shifts IMF voting power toward those emerging market countries such as Brazil, China and India whose economies have grown rapidly in recent years and away from the slow-growing European economies. But the agreement also doubled the funds that the IMF is free to loan to any country it wishes, from Greece to Grenada. That's where the trouble lies.

While the G-20 was reaching agreement on the funding boost, the IMF was quietly breaking an earlier, far-reaching agreement on how such funds were to be used. That agreement, called the "exceptional access framework," set criteria for countries seeking access to huge IMF loans. The framework was put in place in 2003 as a response to the recurrent emerging-market financial crises raging since the 1990s. It barred the IMF from making new loans to countries with unsustainable debts. Such loans effectively bailed out creditors, raised the debt burden on a country's citizens, encouraged irresponsible fiscal policy, increased risk-taking, and thereby created a crisis atmosphere.

Since 2003, countries and their creditors had to restructure and write down debt to a sustainable level before the IMF would grant them any new loans. The point was to reduce the bailout mentality, and it helped improve the policies and economic performance of emerging markets. While this exceptional access framework was in force, few large crises originated in emerging-market countries, and these countries weathered the 2008 financial crisis far better than most expected.

Then the Greek sovereign-debt crisis emerged in 2010. Rather than sticking to its rule—no loans to a country with unsustainable debt—the IMF simply changed the rule, perhaps under pressure from euro-zone countries and their banks, which held a large fraction of Greek debt. The IMF declared that it could make new loans if there was also a "high risk of international systemic spillover," then claimed, with very little evidence, that such a spillover risk was high and approved a €30 billion loan to Greece without any debt restructuring.

The change in policy came at the same time the Greek loan was approved, which was strong evidence that the rule was broken solely to allow for the loan. Some argue that the change was made surreptitiously: According to minutes of the May 9, 2010, Executive Board meeting on the Greek bailout decision, the Swiss representative to the IMF noted that the IMF staff had "silently changed . . . i.e. without a prior approval by the board . . . the exceptional access policy."

The Greek economy deteriorated sharply under its heavy debt burden after the loan, and by February 2012 all parties admitted that a restructuring was essential. Greek debt was written down by about 60%, with some arguing more may be required. An earlier and larger restructuring could have prevented much of this pain.

Because of the disappointing results of this "too little too late" approach, there are now new proposals by IMF staff and others to fix and clarify the exceptional access framework and insist on earlier restructurings. One of the proposals is to create a new "sovereign debt restructuring mechanism"—essentially a centralized global bankruptcy institution for countries—which could further politicize and thereby destabilize the world financial system.

This unwieldy proposal was rejected a decade ago when the framework agreement was first adopted in favor of decentralized "collective action clauses." Such clauses—incorporated in each sovereign bond contract—allow a supermajority of creditors to agree to a restructuring of debt that is binding on all creditors. By providing for a more orderly workout process than sudden damaging defaults, such clauses lower the risk of international spillovers.

Instead of creating a new global mechanism for restructuring sovereign debt, the IMF should simply reinstate and recommit to its exceptional access rules. To make this commitment more credible, sovereign-debt collective action clauses could be strengthened-to allow, for example, the orderly adjustment of the terms of all outstanding bonds together, rather than one bond issue at a time.

Congress can insist that the IMF's rules and limits on lending be reinstated and adhered to before increasing the amount of U.S. funds available for such lending. While some will continue to complain about a new isolationism, the global financial system will benefit if Congress stands firm.

Mr. Taylor, a professor of economics at Stanford University and a senior fellow at the Hoover Institution, served as Treasury undersecretary for international affairs from 2001 to 2005.

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