But is the world truly prepared to stand by while countries go bust—especially important ones? For Byeon Yang Ho and Lee Kyung Shik, the Korean officials who explained that default was an unacceptable option because of the long-lasting damage it would inflict on their country’s ability to obtain credit for essential imports, a no-IMF world would have no charms at all. Without the IMF, a country in Korea’s position in late 1997 would be out of luck.
And is the world truly prepared to stand by while the dogs of financial contagion run wild? After Russia went under, turmoil spread quickly in part because of the conclusions of investors like David Tepper that the world’s safety net had been shredded. If Russia could be allowed to default, so might Mexico, Brazil, and other countries. The mere existence of a strong, active IMF can limit the transmission of crisis conditions from one country to another—maybe not wholly effectively but at least to some extent.
The events of autumn 1998, moreover, showed that the entire global economy may be at risk when contagion flares. That the world survived does not mean that the systemic risk some policymakers perceived was merely a figment of their imaginations. Even if they overestimated it—and they may well have done so—the episode suggests that we ignore such risks at our peril.
In response to those who would terminate the IMF for all its mistakes and helplessness in the face of crises, Alan Greenspan has an illuminating way of looking at this issue: He has likened the IMF to a Model T—a “Tin Lizzie”—and observed that given the choice between a Tin Lizzie and no vehicular conveyance at all, the Tin Lizzie is worth keeping. A sleek new sports car would obviously be preferable, but if we’re stuck with the Tin Lizzie, a garage with some good auto mechanics might be a better place to take her than the Junkyard.
2. Since abolition is impractical, truncate the IMF severely. This option was proposed by the majority on a congressionally appointed panel headed by conservative economist Allan Meltzer. The panel’s plan, advanced in March 2000, has gained many adherents among Republicans on Capitol Hill and holds appeal for some Bush administration officials as well. The Meltzer Commission would drastically change the nature of IMF programs in two ways. First, loans would go only to countries that prequalified for an IMF seal of approval—those that had met various criteria of sound economic policy, including adherence to prudential banking standards that ensure that banks are maintaining sufficient capital. Second, the Fund wouldn’t impose policy conditions when it made loans, since it would have determined in advance whether a country qualified. One advantage of such an approach is that the IMF would generate less overall moral hazard; the Electronic Herd would presumably think long and hard before lending or investing in a country that didn’t have the seal of approval. Countries would also have a strong incentive to improve their policies so that they could qualify for the Fund’s endorsement. Furthermore, the IMF could stop worrying about scrambling to determine the best economic policies for crisis-stricken countries to follow.
But here’s the downside. Suppose the IMF had to drop a country from the list of prequalifiers; imagine how fast a crisis would erupt in that country in response to the Fund’s signal that the country’s authorities were adopting irresponsible policies. In addition, there are good reasons to doubt that the international community could restrain itself from lending to countries that had failed to prequalify. South Korea and Brazil presumably wouldn’t have prequalified, yet the pressure to lend to them was overwhelming, and it would be a sure bet that if such important countries suffered crises, the international community would find a way to mobilize rescues and circumvent the Meltzer rules, undermining their credibility.
3. Return to Bretton Woods. Still other reformers favor moving toward a system in which currencies are fixed the way they used to be, or are stabilized much more than they are now, or are reduced in number. Indeed, the world is awash in proposals for steadying currencies, linking them, or merging them. Some Asian officials, for example, have suggested the creation of an Asian currency unit that would rival the euro. Many Latin American economic policymakers have seriously weighed adopting the U.S. dollar as an official currency of their countries. (Ecuador, El Salvador, and Guatemala recently went through with it.) French and Japanese officials, meanwhile, have touted plans for a pact among the G-7 that would eliminate “excessive volatility” among the dollar, the euro, and the yen. The impulse behind these proposals is a perfectly understandable unease about the impact of currency swings on the world’s economic health and the crises that sometimes ensue.
Carefully calibrated exchange rates aren’t worth the cost for most countries, however, because they often require governments to take actions that make no sense domestically. A classic illustration is the case of a country (like the United States in 1995 or Japan in 1998) where the currency is weakening at the same time as the economy is softening; to attract investors and keep the currency within bounds, the central bank would have to raise interest rates—precisely the opposite of what should be done to fight recessionary forces. This helps explain why Bob Rubin, for one, sees no viable alternative to the world’s present currency regime. “To paraphrase Winston Churchill’s famous statement about democracy,” Rubin said in a speech in 1999, “the floating exchange-rate system is the worst possible system, except for all others.”
As for currency unions such as Europe’s, there are ample grounds for skepticism that they would work in Asia or the Western Hemisphere. Creating a currency union means that a supernational central bank decides when to print money, when to lower interest rates to combat recessions, and when to raise them to curb inflation. The Euroland countries have agreed to such an arrangement as the crowning step in their effort to bind themselves together and avert the strife that has afflicted their continent for centuries. But to reach that point, they have spent the better part of fifty years making their economic structures and policies as similar as possible; the deal won’t hold together if, say, recession-bound Spaniards are screaming for easy money while inflation-wary Germans want to keep money tight. The economies of Asia and the Western Hemisphere are far more disparate and less integrated.
The bull—or rather, the Electronic Herd—must be taken by the horns if the global financial system is to undergo change that is meaningful, effective, and sensible. That is, the High Command must have the means to involve the private sector in a more systematic way when crises arise. Top economic policymakers and the IMF’s official governing bodies have issued much rhetoric about their determination to bail in private creditors; as long ago as 1996, the finance ministers of wealthy countries, including Rubin, warned in a Joint report that neither bankers nor bondholders should expect official money to save them from incurring losses on their overseas loans. To give force to those words, something more daring is in order.
Anne Krueger is not the sort of person who would seem likely to spearhead a plan calling for greater government intervention in markets. At sixty-seven, Krueger, a short-haired woman quite capable of stating her views bluntly, was the Bush administration’s choice to succeed Stan Fischer as the IMF’s first deputy managing director in September 2001. Her conservative credentials were impeccable: As a professor at Stanford, she was a senior fellow at the Hoover Institution, a think tank teeming with former Reagan administration officials and leading intellects of free-market economics. During a stint as chief economist of the World Bank from 1982 to 1986, Krueger had played a key role in shifting the institution’s ideology sharply to the right, toward a much greater emphasis than before on open trade, privatization, and deregulation.
Thus, many of her fellow economists were dumbstruck when Krueger in a late November 2001 speech proposed that the IMF should move toward adopting a new approach to financial crises by creating a sort of international bankruptcy procedure. The plan would fill what Krueger called a “gaping hole” in the international financial system by giving crisis-stricken, overly indebted countries a means to block panicky investors and lenders from withdrawing their money and
to provide an orderly process for working out debts. For the Fund, which had historically frowned on measures restricting the flow of capital across international borders, the proposal was a radical departure.
“Our model is one of a domestic bankruptcy court,” Krueger said in her speech, although “it could not operate exactly like that.” This was music to the ears of many experts—most notably Jeff Sachs, who had been arguing for years that nations sometimes need protection from their creditors Just as companies and people do. After all, a bankruptcy court can grant multiple protective measures to a financially troubled company whose bankers and bondholders are snatching every dollar available and refusing new credit. Filing for protection with the court brings the “grab race” to a halt, thereby giving the firm breathing space while it negotiates new and more realistic terms for repaying its debts; and a court decree can enable the firm to obtain the cash it needs to continue operating, by guaranteeing that new loans will be repaid ahead of old loans. However, no such court exists at the international level to aid countries on the brink of default. Countries that unilaterally default risk becoming embroiled in destructive wrangles with the Herd, whose members may refuse to extend new credit for a long time and seek legal redress by seizing the country’s overseas assets.
Under Krueger’s plan, called the Sovereign Debt Restructuring Mechanism (SDRM), the IMF could call a halt to a run on a country whose government had become so burdened with debt as to cause the markets to stampede. In effect, the Fund would be sanctioning the country’s decision to suspend payments to foreigners and impose controls on outflows of capital. The country would have to ask the Fund first, of course, and show that it was prepared to correct problems with its economic fundamentals and negotiate in good faith with its creditors.
Just as in Korea’s second rescue, the creditors would be roped into a standstill temporarily abrogating their right to collect interest and principal. This cooling-off period would allow creditors to gather their wits, the country’s authorities to devise a sensible plan of action, and all parties to begin an orderly process for deciding how claims will be repaid. The procedure could also induce new financing for the country by providing assurance that any loans made after the commencement of the standstill would be treated as senior to all preexisting private claims. Once an agreement was struck for debt repayment—which might well involve reduction of principal and lower interest than the creditors were initially entitled to—all creditors would be bound to honor the terms negotiated, provided they agreed by supermajority vote representing, say, three-quarters of the principal amount of the debt.
Krueger’s SDRM had a number of other complex wrinkles, which needn’t be spelled out here, but one point is essential to understand: To make the whole scheme work, the world’s nations would have to agree collectively to make legal changes that would run roughshod over the claims of some creditors. That is because many bondholders have the right to insist on full repayment of their individual claims, especially when their bonds are issued under U.S. law. Typically, such bonds require the unanimous consent of all bondholders to changes in payment terms, which means that “rogue creditors” can hold out for full repayment regardless of what the others are willing to accept.
The rogue-creditor scenario is not merely hypothetical. As Krueger pointed out in her speech, when the Peruvian government was negotiating a debt restructuring plan with its creditors during the late 1990s, a New York “vulture fund” named Elliott Associates that had bought Peruvian bonds at distressed prices filed suit demanding full payment and won a court Judgment in 2000 giving it the right to attach certain Peruvian assets deposited abroad. Krueger’s proposal was designed to overcome that loophole while still preserving basic creditor rights; a supermajority vote would bind all creditors to a restructuring of the debt. (Likewise, in corporate bankruptcy law, Judges typically have the power to force all creditors to comply with the new terms accepted by the majority.)
Though loaded with technical Jargon, Krueger’s speech ended on what passes for a rousing note by an IMF official:Some approach along these lines would serve the causes of better crisis prevention and better crisis management simultaneously, to the benefit of debtors, creditors and the international community. The political imponderable is whether our members are prepared to constrain the ability of their citizens to pursue foreign governments through their national courts as an investment in a more stable—and therefore more prosperous—world economy.
With few exceptions, the Herd’s reaction to the proposed SDRM ranged from strongly negative to highly outraged. That was unsurprising: Bankers, fund managers, and other financial executives recoil at the threat of having their rights impaired. In speeches, seminars, and letters to the IMF and G-7, members of the financial community denounced Krueger’s plan as certain to increase the chances that countries would renege on their obligations—and thus certain to cause a serious reduction in the amount of capital flowing to emerging markets. Upon hearing that borrowing from the Herd would likely become more difficult and costly, many government officials in emerging markets also declared their opposition to the plan, even though it was supposed to benefit their people.
These objections were based on legitimate concerns. Abrogating contracts—the covenants that govern borrowers’ obligations to pay interest and principal on loans and bonds—is no trifling matter, and if creditors’ rights are weakened too much, credit will cease to flow or become prohibitively expensive. To cite a simple example, homebuyers would not benefit if the law were changed to prevent banks from foreclosing on people defaulting on their mortgages; banks merely would stop lending on homes.
But SDRM proponents offered compelling answers to these objections. Under the plan, countries could not cavalierly renounce their debts; as Krueger put it in her speech: “It would be ridiculous to argue that our approach would make restructuring an easy option. I would not support it if it did—countries, like anyone else, should pay their debts as long as they are able to do so.” Signing on to the SDRM would be unpleasant and thus presumably rare. A country using it would incur damage to its creditworthiness (though in theory not as much as if it unilaterally defaulted), and it would have to submit to the rigors of an IMF program.
As for the concern about a drying-up of money flowing to emerging markets, consider what happened to Malaysia after it shocked the global establishment by imposing capital controls in September 1998. Despite the dire predictions of officials in the U.S. Treasury and the IMF, who thought Malaysia would pay grievously for its transgression, the country subsequently performed well economically; indeed, less than a year after instituting controls, the Malaysian government was able to tap international markets for a major bond issue. Global financiers, in other words, often would be willing to overlook infringements on the sanctity of property and provide funds when they spotted profitable opportunities. And even if the SDRM put a damper on their eagerness to invest in emerging markets, it would be no tragedy if they provided less capital, or charged more for it, than they did during the mid-1990s.
The Herd wields formidable political clout, probably enough to kill legislation in Congress that would effectuate the legal changes envisioned under Krueger’s proposal. Partly to soften the bankers’ opposition, Krueger agreed to dilute her plan somewhat, with some of the main concessions coming in the standstill provision, which was a particularly contentious element. First she proposed that standstills could be extended past three months only if approved by a supermajority of creditors. Later an IMF staff paper spelled out plans for an SDRM that entirely abandoned the idea of a formal stay on creditor litigation. Dropping that element, Krueger and her colleagues concluded, wouldn’t substantially weaken the plan, thanks to other protections from creditors that the SDRM affords. Rogue creditors would be unlikely to pursue costly and time-consuming litigation for full repayment of their claims, Fund officials reasoned, because the reward for filing a lawsuit might well be zero if a debt restructuring plan won supermajorit
y approval, binding rogue creditors to the same terms as everybody else.
The Herd has remained implacable, notwithstanding these concessions and counterarguments. In a Joint statement issued in December 2002, major associations representing international banks, securities firms, and fund managers declared: “No changes in any specific aspects of the SDRM would alter [our] serious concerns about the proposal.”
John Taylor is not the sort of person who would seem likely to cross swords with Anne Krueger. The mild-mannered Taylor was a colleague of Krueger’s at Stanford and the Hoover Institution, and as Treasury undersecretary for international affairs, he played a role in her selection as the IMF’s second in command. But in a speech delivered at the Institute for International Economics in April 2002, Taylor gave the strong impression that he was bringing the full weight of the U.S. government to bear against Krueger’s plan, when he advanced a different, less potent bankruptcy proposal that has won support, albeit grudging, from the Herd. The episode sparked ill will between the Treasury and the IMF, which was quickly papered over with public statements that both ideas could move forward on “separate tracks.”
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