Commentary:
Caroline Baum is a columnist for Bloomberg News.
The opinions expressed are her own.
08/28 15:08
Constructive Default -- a Chronic Bailout Cure:
By Caroline Baum
West Tisbury, Massachusetts, Aug. 28 (Bloomberg) -- Let's face it: There's never a good time to let a country default.
Systemic risk, contagion effect, a weak global economy, the need to support a fledgling democracy or U.S. ally -- all these reasons/excuses stand in the way of letting private borrowers bear the burden of their bad investments. Instead, the cost is defrayed, with the International Monetary Fund forcing taxpayers to foot the bill. (This is the same IMF former Treasury Secretary Bob Rubin said didn't cost the taxpayer a dime.)
Argentina was on the brink of default last week -- three years of recession and prohibitive borrowing costs made debt repayment impossible -- when the IMF rewarded the country with another $8 billion loan. In December, Argentina got a $14 billion credit line from the Fund, part of a $40 billion package from international lending agencies.
Some of the new loan is contingent on restructuring its $130 billion in debt. In June Argentina swapped almost $30 billion of bonds maturing in the next five years for longer-term ones to extend debt payments. The swap increased the country's net interest cost and total debt, but Wall Street, which earned hefty underwriting fees, gave the swap rave reviews.
They weren't the only ones.
Famous Last Words
``We have beaten those who were betting against Argentina,'' said Economy Minister Domingo Cavallo at the time of the swap, which was oversubscribed. ``Now we are going for what is really important for the people: economic growth.''
Treasury Secretary Paul O'Neill, who came into office as an opponent of international bailouts, had a sudden change of heart -- when it became clear Argentina could not avoid default. Just 11 days ago, O'Neill said the U.S. was ``working to find a way to create a sustainable Argentina, not just one that continues to consume the money of the plumbers and carpenters in the United States who make $50,000 a year and wonder what in the world we're doing with their money.''
What we're doing with it is shaping it into an expensive Band- Aid. After Mexico and Thailand, Indonesia and Korea, Russia and Turkey, and Brazil and Argentina, isn't it about time the broken bailout system was fixed?
Allan Meltzer, professor of economics at Carnegie Mellon University and president of the university's Gailliot Center for Public Policy, and Adam Lerrick, the Center's director, have a proposal. They think there's an alternative to total bailout or total market chaos: default without disruption.
Setting a Floor
Here's how it would work. The IMF ``would stand ready to buy any and all debt of a crisis government to the private sector at a support price significantly below its expected restructured value,'' Lerrick and Meltzer wrote in a May report.
The floor would prevent a panic and collapse in the market, the authors claim. The element of uncertainty -- over whether the country would default -- would be removed. The financial system would be insulated from any contagion effects. The country's debt burden would be reduced to sustainable levels. Private lenders would bear the loss, which would have ``predictable limits.''
With the IMF backstop in place, the borrower ceases all debt payments. The debt is restructured within a short time frame (three to six months in the Meltzer/Lerrick plan).
In short, ``the official sector would step back from its current role of guarantor of speculative capital to emerging economies and become a true lender of last resort that responds to market failure yet preserves market discipline,'' Lerrick and Meltzer wrote.
Taxpayers' Burden
Meltzer, who served as chairman of the IMF reform committee, says he developed this proposal after watching banks on the brink of failure bailed out, with the taxpayer footing the bill.
``Even Treasury secretaries like (George) Shultz and (William) Simon, who would normally be opposed to things like this, ended up endorsing bailouts,'' Meltzer says. ``All the reasons to prevent a failure are really hokum. But no one wants to take the chance.''
The chance may come sooner rather than later, says Ian Vasquez, director of the Cato Institute's Project on Global Economic Liberty.
``Default is a necessary market outcome,'' Vasquez says. ``I wouldn't rule out the possibility. Argentina can cover its obligations for the rest of this year, but not next year. The bond market will figure it out before then.''
The main problem is Argentina's IMF program does not solve the debt problem or put in place a pro-growth agenda.
``The only thing Argentina has done is bought itself some time,'' Vasquez says. ``The program does not address currency stability: people fear that they will devalue (the peso). The tax and regulatory issues are substantial.''
Conflict of Interest
For example, labor regulations include a prohibitive 43 percent payroll tax, divided between employer and employee, Vasquez says. And the VAT is 21 percent.
The prospect of yet another juicy underwriting fee has Wall Street clammed up on the subject. A spokesman for J.P. Morgan Chase, which has large exposure to Argentina, says the bank would not feel comfortable commenting on the Meltzer/Lerrick proposal, or anything with ``Argentina'' and ``default'' in the same sentence, because of the ``extreme sensitivity'' of the issue.
``Wall Street salivates over the money to be made from the debt swaps and learns to shut up'' on the fundamentals, Vasquez says.
As far as the IMF is concerned, I'm still waiting for a spokesperson to get back to me with an official comment.
No need to hold the presses, however. I'll be sure and include it in tomorrow's column if it is anything more than the expected ``no comment.''
quote.bloomberg.com |
