<!doctype html public "-//W3C//DTD W3 HTML//EN"> <html><head><style type="text/css"></style><title>Re: A More Sensible View than Allan Meltzer's</title></head><body> <div><font face="Arial" size="+2" color="#000000"><b>Personal View: A shortsighted vision for IMF reform</b></font></div> <div><font face="Arial" size="+2" color="#000000"><b><br> </b></font><font face="Arial" size="-3" color="#000000">There can be less crisis lending only if there is more crisis prevention, argue Barry Eichengreen and Richard Portes - 9 Mar 2000 11:24GMT<br> </font><font face="Arial" color="#000000"><br> The commission established by the US Congress on reform of the international financial institutions is infused with wishful thinking. Its report longs for simpler times, when investors and countries were left to their own devices.<br> The proposed contraction of the International Monetary Fund has radical implications. The Fund would be compelled to follow Walter Bagehot's rule for lending in the last resort: lend only to solvent countries against good collateral and at penalty rates. With fewer IMF rescue loans to create moral hazard, the report argues, investors would lend more responsibly.</font></div> <div><font face="Arial" color="#000000"><br> This is unrealistic. The proposals assume the IMF can differentiate between solvent and insolvent countries. But what is an insolvent country? One whose government refuses to balance its budget and service its debt? Or is this a solvent country whose government is simply short of political will and public support? The lack of clarity threatens to paralyse IMF programmes.</font></div> <div><font face="Arial" color="#000000"><br> The report says IMF loans should be secured by a clear priority claim on borrowers' assets. If it can identify "good collateral", the IMF will know a solvent country when it sees one, and it need not assess macroeconomic policies. Treasury bonds and other assets may be good collateral at the current exchange rate, but much less good in the event of a devaluation. To pretend that the IMF can disregard such contingencies when lending seems naive.<br> The report also suggests the IMF should be allowed to lend without limit but mainly to countries that do not actually need the funds. This idea is manifestly dangerous as it would starve funds from the countries most in need. Also, there would be irresistible pressures to violate the rules. The framework would not be credible and would thus fail to eliminate moral hazard.</font></div> <div><font face="Arial" color="#000000"><br> The report invokes history to support its analysis. But its idea that there was once a simpler era - in which investors and governments were left to sort out their problems - is historically incorrect. Before the establishment of the IMF, creditor governments aided investors with diplomatic assistance, if not gunboats. When systemic stability was threatened, governments organised a response, as in the Baring Crisis of 1890.</font></div> <div><font face="Arial" color="#000000"><br> It is not just because innocent bystanders and systemic stability may be jeopardised that we cannot leave international debt problems to the markets. Without supporting institutions, debt restructuring negotiations become too protracted and painful. Between 1871 and 1925, debt restructuring took an average of six years to complete - during which time investors received no income, and borrowing countries faced a continued decline in development.</font></div> <div><font face="Arial" color="#000000"><br> The same was true during the Latin American debt crisis of the 1980s. Very little restructuring took place between the outbreak of the crisis in 1982 and the end of the decade, when IMF lending into arrears and the Brady Plan brought creditors back to the negotiating table.</font></div> <div><font face="Arial" color="#000000"><br> Leaving the global financial system at the mercy of the markets will be even more hazardous in the future. Electronic trading will allow investors to react, and overreact, even faster than before. Investors' leverage is likely to increase still further, magnifying threats to systemic stability and encouraging the spread of crises. Bond holdings will be even more dispersed, making it harder to get investors to act collectively. Saying the markets should be left to clean up after crises ignores these dangers.</font></div> <div><font face="Arial" color="#000000"><br> Limiting IMF bail-outs and the resulting moral hazard would require better modes of crisis resolution. Several options are being discussed. For a start, bond contracts should contain collective-action clauses, allowing a qualified majority of bondholders to accept restructuring terms. Another viable option is to create standing committees of bondholders, to allow creditors to speak with a single voice.</font></div> <div><font face="Arial" color="#000000"><br> Finally, if the IMF is to be less of a fireman, it must become more of a policeman. If we want to avoid throwing money at floundering debtor countries, we need to do a better job of preventing crises in the first place. The IMF must play a continued role in the surveillance of its member countries, focusing on their financial policies.<br> On these issues, the Meltzer report is self-contradictory. Not only is there resistance to expanded IMF oversight but there are also loud complaints about the intrusiveness of its existing surveillance scheme. This poses a serious problem. There can be less crisis lending only if there is more crisis prevention.</font></div> <div><font face="Arial" color="#000000"><br> The report does not propose any meaningful institutional changes such as collective-action clauses. It relies on blind faith that the changes will somehow come about if left to the participants. Because it ignores the need for fundamental reform beyond the IMF and World Bank themselves, the report fails to provide a new vision of an international financial architecture.</font></div> </body> </html>