Wall Street Journal September 7, 2001 The IMF in Argentina: Bailouts for Investors
By Mary Anastasia O'Grady. Ms. O'Grady edits the Americas.
Stanley Fischer's parting message to the markets last week as he stepped down as managing director of the International Monetary Fund could not have been more emblematic of his tenure. Argentina, he said in an interview with the Financial Times, is likely to need more aid. More, that is, on top of the $40 billion package laid out in December 2000 and the $8 billion announced two weeks ago.
How much more, Mr. Fischer couldn't say. "There is no answer to how much is enough," he admitted.
Mr. Fischer's relentless diversion of other people's money to Argentina's creditors is of a piece with the series of IMF mega-bailouts he masterminded over more than six years, starting with Mexico in 1994. He can hardly be expected to disavow his own legacy now. Yet his recognition of the uncertain costs ahead is instructive.
For if his signature practices -- the bailout of creditors, and fiscal austerity forced on debtors -- remain intact after his departure, it is quite right to say that there is no way to know how much more money Argentina will need. There is also no telling how much more money other large emerging markets might require to ensure that they too avoid default.
As emerging markets tapped into international financing in the 1990s, we were told Mr. Fischer's bailouts would help stabilize markets. But treating developing countries as bottomless pits, while making losing investors who bet on them whole again, has hardly been good for stability; in fact, quite the opposite has occurred.
With $128 billion in public-sector debt, Argentina's high-tax economy is likely to remain hobbled. The much-lauded "zero deficit" appears a shell game, entailing a shift in accounting from an accrual basis to a cash basis to make the numbers work. And there is still the question of how to come up with the money needed to meet maturing obligations. The government might have to keep stuffing its unmarketable debt into domestic banks, weakening one of Argentina's few good institutions. Meanwhile, politicians still resist dollarization, despite its obvious advantages. The economy could languish for some time, while creditors capture high premiums backed by the full faith and credit of the G-7. The IMF is supposed be interested in "poverty alleviation" but a clinical evaluation of Argentina leaves one wondering whose burden it seeks to lighten.
IMF bailouts to Argentina carry the misnomer "aid," but those billions go to the creditors, who otherwise would have to sit down with the Argentine government, hammer out the restructuring of bad loans, and take losses. Economy Minister Domingo Cavallo's attempt to force his country to make good on its obligations is, at first glance, admirable. Argentina borrowed the money and it should pay it back. Yet it is hardly more moral to avoid default by passing the bill to a third party like the IMF while the odds for authentic repayment remain impossibly long.
Investors no longer worry about those odds though. Instead they assess Argentine investments by evaluating the G-7's level of fear of contagion -- panic selling and a reverberation that destabilizes the international financial system -- and political instability associated with an Argentine default. The winners of the latest round were those who wagered that the Bush administration would cave when it looked like Argentina was sinking fast last month. Analysts still recommending Argentine bonds seem to be doing so largely on the grounds that, with 25% of total emerging-market debt, the country remains "too big to fail."
Yet Argentina's best chances for a recovery might come from an admission that bailouts and austerity are not working. If the IMF were to signal an end to rescues, investors would immediately begin assessing Argentine returns net of IMF intervention and markets would clear. In the very short run, investors would probably sell Argentina. But that would create an incentive -- one that presently does not exist -- for the country to restructure the economy with sound banking and monetary commitments and low taxes. Getting out from under crushing debt is not a policy on its own, but together with serious reform the country could woo back investors. The U.S. could help legitimately by expanding free trade.
Reducing moral hazard -- lending irrespective of risk because there is a perception that the IMF will rescue creditors -- is an urgent task if the world is to ward off future financial crises. To do this, investors must face their losses when a country cannot pay. So far policy makers have been afraid to let this happen in Argentina because of contagion fears. But a few months ago economists Alan Meltzer and Adam Lerrick proposed a plan for the IMF to let Argentina default while still controlling for a free-fall. The idea is for the IMF to create a floor for bondholders, below the minimum price that the government expects to pay in a workout. While this would prevent panic, investors would still lose to the extent of the write-down. Free of IMF conditionality and stripped of IMF backup, Argentina would then have the latitude and incentive to undertake reform.
This looks like a moderate solution to the problem of contagion but it does not seem to have changed Mr. Fischer's views of bailouts. This may be because he is not concerned about the underlying problem of moral hazard, which he says is a "feature of every insurance arrangement." He defends this insurance on the grounds that without it, emerging markets would receive less international lending and pay higher borrowing rates.
This then, is the heart of the ideological conflict between those who want to reform the IMF and the dinosaurs. Interventionist stalwarts believe that abundant low-cost capital for emerging markets is a public good that rich countries must provide. For proponents of the market though, investor unwillingness to put money into countries with bad policies is the transmission of valuable information necessary to make markets work and governments behave. IMF "insurance" only distorts that process. What we have here is Mr. Fischer's worldview of international finance, with its flare toward socialist redistribution, clashing with the view that the market, with all its risk, is the best vehicle for economic development.
If the Bush administration is to reverse rampant moral hazard caused by six years of bailouts, it must start by letting the market and Argentina sort out the risk. The best policy option may well be taking advantage of the depressed Argentine bond market by letting investors undergo their long overdue haircuts and freeing Argentina from both unmanageable debt and IMF austerity.