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REVIEW & OUTLOOK EUROPE
NOVEMBER 18, 2011
The IMF and the European Crisis
Taxpayers are already on the hook for bailouts, and the tab is rising.
Well, that was quick. Italy's 10-year cost of funds rose above 7% on Tuesday, two days after new Prime Minister Mario Monti was sworn into office. Yields fell slightly after the European Central Bank stepped in Wednesday to purchase a raft of new Italian debt, but relief may be short-lived.
Markets are again eyeing the possibility that Italy will become the first G-8 country to accept lending from the International Monetary Fund since the U.K. needed a life preserver during the 1976 sterling crisis.
That would be bad news for Italy. But it could also be problematic for the IMF, as well as the rich-country taxpayers whose contributions fund it. The scale of IMF commitments during the euro-zone crisis has already been unprecedented, and adding Italy or Spain could strain even the Fund's resources.
Let's tally the damage so far. Greece received a €110 billion loan commitment in May 2010, of which €80 billion came from the EU and €30 billion from the IMF. Of Ireland's €85 billion loan in December 2010, the EU pledged €45 billion and the Fund €22.5 billion. (Dublin pitched in the rest.) Portugal's €78 billion loan was split €52 billion EU, €26 billion IMF.
Where has this total of €78.5 come from? The Fund has 187 member countries, all of which pay into its main pot. The U.S. contribution is 17%, by far the largest by any country, but as an active creditor its role is much larger. The U.S. share of disbursements for Europe amounts to over $9 billion so far, and many more billions have been committed.
These IMF contributions to Europe's bailouts are the largest the Fund has ever made, eclipsing Mexico's $47 billion precautionary agreement in 2009. But an even more telling measure of the IMF's bet on Europe is the size of a country's loan relative to its contribution to the Fund—its "quota," in IMF parlance.
By that standard, Greece's loan is the largest in Fund history, at 32 times its quota. Ireland's and Portugal's loans clocked in at 24 and 23 times their quotas, respectively, the second and third largest since the Fund was created. South Korea's bailout during the 1997 Asian financial crisis, at 19 times its quota, is a distant fourth.
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At least so far these commitments have been through conventional IMF procedures. Capital for Greece is currently provided under a "stand-by arrangement," the Fund's workhorse lending instrument. Ireland and Portugal have "extended fund facilities," which give them longer repayment periods than the standard arrangement.
Italy or Spain would need stronger stuff, however, and for that the Fund has recourse to so-called "new agreements to borrow," or NAB, which are credit agreements between the Fund and a group of rich countries and institutions. Fund rules state that NABs are to be used "to forestall or cope with an impairment of the international monetary system or to deal with an exceptional situation that poses a threat to the stability of that system." An Italian or Spanish collapse would likely be held up as this sort of threat.
An "expanded and more flexible" NAB was activated in March, increasing the financing available for emergency lending by $339 billion right away. The U.S. share of the NAB is about 20%, so fully drawing down these resources would set U.S. taxpayers back a cool $67.8 billion.
But the present NAB is merely a stopgap until the Fund doubles its quota resources under a proposal that it hopes to implement by October 2012. The measure first needs approval by countries representing 85% of the quota pot, which means that the U.S., with its 17% share, has veto power. If the proposal goes through, the Fund's quota resources would grow to $767 billion, with the U.S. contribution increasing to $134 billion from $68 billion.
For our money, it remains far from clear whether lending of this form and magnitude does enough good to justify the costs—or even the Fund's existence. The IMF was created in 1945 to defend the Bretton Woods system of fixed exchange rates. That function became obsolete when Nixon closed the gold window in 1971, but the Fund's ambit has since gradually expanded. Today the Fund operates as something like a global economic micro-manager, imposing prescriptions of questionable value in exchange for cheap lending nearly without bounds.
Until the euro crisis, the Fund had in recent times focused its lending on developing countries. This often did little to help its borrowers, but it gave the Fund the moral mantle of shielding upstart economies from instability and hardship.
The euro case is different. With its European lending, the Fund is now engaged in the grandiose task of propping up an entire currency zone and rescuing spendthrift entitlement states, a mission whose end is not easily defined and whose progress is not easily evaluated. The troubles of Europe's economies run deeper than the IMF's recommendations can reach, and lending that reduces losses for large investors who made bad bets cannot be good for deterring future government profligacy.
This mission creep deserves more debate, especially in the U.S. Congress, since the IMF is making commitments that Western taxpayers barely understand but will still have to finance.
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