IMF bailouts & after

["Ulhas Joglekar" <joglekarulhas@xxxxxxxxxxx>]

The Economic Times

Saturday, April 13, 2002

IMF bailouts & after

JOSEPH STIGLITZ

I AM a frequent IMF critic, so when the IMF gets something right, I should
acknowledge it. The IMF has, at last, recognised the failure of its big
bailout policies - failures all too evident in Thailand, Indonesia, Korea,
Russia, Brazil, and most recently, in Argentina. Three cheers for the IMF.

Big bailouts allowed countries to briefly maintain over-valued exchange
rates, which in turn allowed the rich in these countries to get their money
out at more favourable terms than they might have done otherwise. These
bailouts also allowed western banks that engaged in imprudent lending to get
repaid. Meanwhile, as overvalued exchange rates - even if maintained for
only a short period - further depressed the economy, the country was left
with the burden of repaying billions of dollars in IMF loans.

Nowhere was the problem more evident than in the 1998 Russian bailout, where
only after the "failure" - after the ruble's devaluation - did growth
resume. The billions lent to Russia quickly wound up in the Swiss and Cyprus
bank accounts of Russia's oligarchs.

All of this was evident at the time the money was lent in July 1998, but it
is Russia's people that today must pay for the IMF's mistakes.

Argentina provided the coup de grace to the IMF's big bailout strategy. I,
and others, had argued for years for a greater reliance on standstill
agreements, restructurings, and bankruptcy. Finally, the IMF has come
around. But it should have been clear all along that the IMF, as a major
creditor, could not itself be the bankruptcy judge. The conflicts of
interest were glaring.

The IMF has now listened. Whether one agrees with the recent proposals made
by Ann Krueger, the IMF's deputy managing director, is not the issue: the
fact is that the IMF now recognises the potential conflict of interest, and
has proposed alternative procedures that might deal with the problem.

Regrettably, the US treasury immediately threw cold water on the proposals.
John Taylor, under-secretary of treasury for international affairs, and a
former colleague of mine at Stanford University (as was Ann Krueger),
suggested that matters ought to be left to the market.

All that is needed, he suggests, are "collective action" clauses that allow
the majority (or a supermajority) of a group of bondholders to impose their
will on a minority, so as to prevent scavengers who, in the past, bought up
small stakes in a bond issue and used their position to extract large
concessions for themselves.

Taylor is a distinguished macro-economist, but he has paid little attention
either to recent developments in economic theory or experiences in economic
policy in the arena of bankruptcy. Collective action clauses are important,
but they are not enough.

The IMF long advocated the "hands-off, market-oriented" approach to
bankruptcy resolution, and it has mostly been a disaster.

Korea and Malaysia ignored IMF advice and, instead, their governments took
an active role. There followed extensive restructuring, and those economies
recovered fast. Countries that relied on IMF advice fared far less well.

Economic theory holds that there are incentives for some market participants
to delay a resolution, and these are particularly costly in situations such
as those in East Asia and Argentina, where corporate distress is prevalent
and where the economy faces a major economic downturn.

The existence of such negative incentives is why bankruptcy law in America
allows bankruptcy judges discretion to force recalcitrant creditors to
accept a resolution that is in the broader interest. Why should principles
that make sense within countries - like the US - not be applied in the
international arena?

As the IMF now recognises, there needs to be some form of an international
arbiter. The question is, what guidance should be given to this
international bankruptcy referee? The issue is far from academic. The US has
experienced a fierce debate over bankruptcy reform, demonstrating that there
is no simple answer to the appropriate design of bankruptcy law or
regulation.

Bankruptcy is not a matter than can simply be delegated to technocrats as
much as the IMF would like to give the impression that such is the case.
There are efficiency issues; but there are also distributional concerns. The
IMF, linked as it is to financial markets, is likely to push for a set of
rules that favour those interests.

More balance is needed. The principles of America's Chapter 11 bankruptcy
law - the provision which allows rapid reorganisation of firms in ways that
maintain its economic activity, should underlay whatever rules are adopted.

The fact that America can veto even these modest IMF proposals illustrates a
fundamental weakness of current international economic arrangements. In the
UN, five countries hold a veto - largely a historical anachronism. India -
once a British colony, does not; France does. Whatever one's attitude to
these arrangements, the notion that a single country can exercise effective
veto power seems inconsonant with basic democratic principles.

Were America less bent on pursuing unilateralist policies, in pushing
against an international rule of law, this might not make much of a
difference. But the Bush administration not only ignores basic principles of
economics, but also the basic principles underlying international
co-operation.

There needs to be a new way of dealing with crises. The big bailout
strategies, associated with the Clinton-era IMF of Michel Camdessus, Stanley
Fischer, Larry Summers, and Robert Rubin, failed abysmally. An alternative
is demanded. America's proposal to rely on minor modifications in current
arrangements, while relying on the market, though it is a position long
advocated by financial markets, will not suffice. The IMF has been trying to
create an alternative. The world cannot allow America to veto its efforts.

(The author is Professor of Economics at Columbia University)

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