By Sebastian Mallaby Monday, August 13, 2001; Page A15
After bailing out emerging markets in the 1990s, the world's leaders thought they could come up with a better answer to crises. Bill Clinton wanted to "adapt the international financial architecture to the 21st century." Alan Greenspan wanted to change the "patchwork of arrangements" that applied to global finance. Three years on, Argentina's crisis shows why an unreformed system continues to pose problems -- and why talking about change without delivering it may be the worst of both worlds.
Over the weekend the International Monetary Fund held talks with Argentina about a possible bailout. The fact that the IMF even conducted these discussions is remarkable, because many IMF officials doubt a bailout will work. The IMF already has awarded Argentina a $40 billion rescue package in January, and some suspect that a second one will fare no better. Argentina, say the doubters, can't resume growth until it reduces its huge debt -- a polite way of saying that Argentina should default.
If Argentina were a U.S. company, this is precisely what it would do. It would file for bankruptcy and use the court's protection to force its lenders to take a haircut. But being a country, Argentina does not have this option. There is no international bankruptcy court to protect it: If Argentina tried to make its lenders take a haircut, the lenders might take it to court. Judges might order the seizure of Argentine assets to compensate international creditors. At the least, the legal uncertainty involved in default without the benefit of bankruptcy creates a powerful reason not to go down that route.
If the debate on international financial architecture had lived up to its grand rhetoric, we might by now have some kind of global bankruptcy court. But, because no such court has been created, Argentina has a strong incentive to go for the next best option -- an IMF bailout. Instead of reducing Argentina's debt burden, a bailout merely would change the country's debt structure. Argentina would pay off private loans with longer-term official loans, on the theory that buying extra time may allow the economy to start growing again -- and make eventual debt repayment possible.
This might work, which is why the IMF is even considering a bailout despite misgivings among its staff. But although a bailout may be the best policy available, it is not the best policy imaginable. Unlike bankruptcy proceedings, bailouts allow banks and investors who lent recklessly to get all their money out, which creates a morally hazardous incentive for them to lend recklessly again. Unlike bankruptcy proceedings, bailouts place the cost of the crisis on borrowing countries, which are forced to take on new debt that their struggling workers will be expected to repay.
So the first lesson from the Argentina crisis is that the international system is imperfect. Does this mean Clinton and Greenspan were right to wish for a better one, and that the Bush administration is right to worry about moral hazard now? Well, get ready for a paradox. The second lesson from Argentina is that the best thing world leaders can do about the system's imperfections is to stop discussing them out loud.
If the discussion led to changes in the international system, that would be fine. But countries are too jealous of their sovereignty to accept changes. An international bankruptcy court, for example, would run up against different countries' conceptions of the proper balance between lenders and borrowers. Moreover, bankruptcy courts have the authority to remove a company's managers, and it is hard to imagine a panel of international judges being empowered to fire Argentina's elected government. So an international bankruptcy court is not on the horizon. For lack of a better alternative, bailouts and the attendant moral hazard will remain for years to come.
If public fretting about moral hazard does not change the financial system, what does it achieve? Well, in the case of Argentina, Treasury Secretary Paul O'Neill's anti-bailout rhetoric persuaded investors until recently that no bailout was likely -- and therefore that default was in the cards. To offset this perceived default risk, investors demanded ever higher interest rates on Argentine securities. But now suppose that the Treasury backs an Argentina bailout after all. Anyone who bought Argentine bonds over the past six months will end up having enjoyed high interest rates, offset by a risk of default that turned out to be illusory. By inveighing against moral hazard and then backing a bailout anyway, O'Neill would have enriched recent investors, compounding the moral hazard that he deplores.
Of course, O'Neill may end up opposing an Argentina bailout, though the recent signals from the Treasury suggest otherwise. It is possible, too, that Argentina may default eventually and yet contain the legal chaos; the country has retained Lee Buchheit, one of the best Wall Street lawyers in this field. But the lessons from Argentina's troubles already are apparent. The financial system is imperfect, but there is a risk in rhetoric about reforming it. Empty reform talk confuses the signals that policy makers send to markets, making the problems that reformers care about paradoxically worse.
The writer is a member of the editorial page staff.