International Monetary Fund: Into the fire
By Alan Beattie
The new boss must find answers as an organisation crucial to managing Europe’s debt crisis finds its own money and credibility on the line
When Christine Lagarde, former French finance minister, left eurozone policymaking to head the International Monetary Fund in July, she went from the heart of Europe’s sovereign debt conflagration to an institution at risk of getting scorched by the heat.
Ms Lagarde is the latest heir to the managing directorship appropriated by Europe when the IMF started operations in 1946 and bequeathed to favoured offspring ever since. She has joined an institution still shaken by the spectacular departure of Dominique Strauss-Kahn, its former head, after he faced charges (later dropped) of sexual assault in New York City.
The IMF, whose annual meetings are held in Washington this week, is one of the main characters in a drama that, despite moments of high farce, threatens to end in tragedy. The sovereign debt crisis in western Europe, and particularly in Greece, is shaking financial markets worldwide and raising the prospect of a second global recession in three years.
The organisation said this week that the global economy had entered a “ new and dangerous phase” and urged the eurozone to get a grip on the Greek problem. With the fund itself involved in the rescue – and painfully aware, from experience of lending to dangerously indebted countries such as Argentina, of the costs of continuing to throw money at an unsustainable situation – it also finds its own money and credibility on the line.
The IMF has succeeded in restoring itself to a central position in global crisis resolution – it must now prove whether it has earned that place.
Conversations with representatives of shareholder countries and IMF staff suggest Ms Lagarde has made a confident start at leading the institution, and shown signs of a management style distinct from that of her predecessor. But bringing calm to crisis-racked western Europe while under suspicion of bias towards her home continent will be rather more difficult.
The intellectually confident, politically astute Mr Strauss-Kahn was a harder act to follow than the cause of his departure might suggest. Even after the New York episode he was popular with IMF employees, having seized the opportunity of the global financial crisis to retrieve the fund from irrelevance. He recently drew a good crowd of staff when he returned to the fund’s Washington headquarters for an emotional farewell.
“DSK was a politician and an economist who would push his own ideas,” says one hedge fund manager who monitors the IMF. “Christine Lagarde is more like a chairman of the board.” Whereas Mr Strauss-Kahn would lead and expect the fund to follow, people who have attended board meetings say his successor’s approach is more consensual. One official says that, while he tended to operate with a trusted small cadre, her style includes canvassing a range of opinions and allowing a view to coalesce.
Domenico Lombardi, who formerly represented Italy on the IMF board, says: “So far she has kept a low profile and been very much in a listening mode. She chairs the board meetings in an interactive style, asking a lot of questions – which is unusual in an MD.”
This could be in part a reflection of Ms Lagarde’s professional background in law – a fact that caused much rending of garments among economists when she was appointed. She tried to deflect criticism about her qualifications early on, promising at her first press conference to compensate for her lack of grounding in economics by consulting expert opinion widely. Another official says that, perhaps because of her time managing the law firm Baker & McKenzie in Chicago, her style resembles the flatter, more open structures of American companies. The fund, by contrast, which was heavily shaped by European civil servants, features more hierarchical traditions.
In policy, too, Ms Lagarde has put clear water between herself and Europe. Unusually, she attended the annual August gathering of central bankers at Jackson Hole, Wyoming – normally the IMF second-in-command goes – and stole the show with a speech calling for more fiscal stimulus and recapitalisation of European banks, which infuriated some eurozone policymakers. Fund staff say her forthright opinions on the subject – from which, despite pressure, she has declined to back down – won her respect inside the institution.
“Sticking fingers in a few European finance ministers’ eyes on stimulus and financial stability meant paying a price for going public, but it is a price she has to pay,” says Ted Truman, a former US Treasury official now at the Peterson Institute for International Economics in Washington. “On those issues, she is on the same page as the US authorities.” David Lipton, a veteran US policymaker who has moved from the White House to become Ms Lagarde’s deputy, has been a strong advocate of more stimulus.
Still, it is one thing to comment from the sidelines on issues such as fiscal policy and bank regulation. The critical decision is what the IMF does with its own money now that it is entangled in western Europe’s sovereign debt imbroglio. As Mr Lombardi says: “Pretty soon the honeymoon will be over and she will have to take decisions.”
That time could be now. The fund, at Mr Strauss-Kahn’s urging, provided a third of the money for huge rescue loan packages in Ireland and Portugal, with the European Union providing the rest, and the European Central Bank joining in the supervision of the bail-outs as the third member of the so-called “troika”. In May last year, the IMF agreed to provide €30bn ($41bn) of a €110bn package for Greece in return for a breathtakingly tough programme of tightening fiscal policy, deregulating swathes of the economy and hunting down tax evaders.
At the time, many economists said Greece would struggle to generate enough economic growth to escape a sovereign debt burden equal to about 150 per cent of gross domestic product, while savaging government spending. They were right. Last weekend, even eurozone ministers – generally eager to shovel more money at Athens, given how much Greek sovereign debt some of their commercial banks hold – put the latest tranche of the rescue money on hold, worried about weak growth and failure to meet fiscal deficit reduction targets.
One IMF policymaker says the eurozone authorities had, in the familiar phrase, “kicked the can down the road so much” that by the time Ms Lagarde took over, “she had an awful lot of cans to deal with and not much road left”.
A supposed pivot point came on July 21, when the eurozone promised a mark II rescue with official finance for Athens estimated at €109bn, and a modest writedown in global banks’ Greek bondholdings. But the announcement of the package, which is still painfully winding its way through multiple eurozone parliaments, manifestly failed to turn around investor confidence.
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Ms Lagarde and the fund’s shareholder countries now face a dilemma. Leading the organisation deeper into an unsustainable situation that ends in default – a rerun of the Argentine economic crisis in 2001 – will damage the institution’s credibility and vindicate internal and external sceptics who accuse it of indulging western Europe. One vocal critic on the IMF’s own board, Paulo Nogueira Batista, the Brazilian representative, has long questioned the sustainability of the Greek rescue. In July he told the Financial Times the episode offered Ms Lagarde a chance to show her independence from Europe, a view she rapidly dismissed as “rubbish”.
Yet halting loans to Greece and precipitating a default is also unpalatable. Few think the fund will pull the plug if its eurozone partners want to keep disbursing. Unusually, the fund is a minority partner in this rescue, which may give it less influence than when it is in sole charge; often it has meant watching with intense frustration the public bickering between its fellow troika members.
Anne Krueger took over as second-in-command at the IMF in 2001 just months before the Argentine default. Now an academic at Johns Hopkins graduate school in Washington, she says: “[The IMF] had major difficulties the minute they joined up with the EU and the ECB. It is a mess.”
The IMF has long struggled with a so-called “time inconsistency” problem – an impulse to give in to short-term pressure and keep lending in near-hopeless situations rather than face blame for precipitating chaotic debt default. That perverse incentive is only exacerbated when other lenders are involved – particularly when, as with eurozone governments, they have direct vested interests in the borrower paying creditors. For the IMF to pull the plug would risk the wrath of the entire eurozone and its banks.
“Europe says it won’t give Greece money until the IMF says OK,” Professor Krueger says. “But all that means is that the pressure on the IMF to say OK is immense.”
Moreover, Ms Lagarde personally may find it hard to disown the Greek rescue programme. As French finance minister since the sovereign crisis began, her fingerprints are all over the European end of the package. She warmly praised eurozone authorities for the July 21 deal, telling the FT shortly afterwards: “The euro countries have been on the verge of the cliff and have actually understood that they have to come together and join forces.”
Given the continued dithering and disagreement since, that judgment now looks extremely optimistic. In the past week, a string of policymakers – Wen Jiabao, the Chinese premier; Tim Geithner, US Treasury secretary; and on Tuesday Olivier Blanchard, the IMF’s own chief economist – has warned the eurozone that failure to prevent the Greek crisis spreading risks catastrophe.
People familiar with negotiations with Athens in the past few months say Ms Lagarde and the rest of her team have tried to balance these competing imperatives. The IMF has, they say, at least managed to withdraw from its informal commitment to provide one-third of any new financing, and its share may drop considerably. Some also credit the managing director and her staff for insisting on an open-ended financing commitment from eurozone governments; and for achieving a writedown, albeit limited, in private sector bondholdings. “The fund forced the decisions taken on July 21,” Mr Truman says. “They could perhaps have gone further.”
The IMF’s success in western Europe could help determine whether a body still dominated by European nations, despite recent reforms, retains a central position in rescuing governments worldwide from financial crisis.
If the Greek economy and financial system implode to such a degree that even eurozone authorities accept the game is up and agree a radical restructuring of its debt, the decision about the country’s future could be taken out of Ms Lagarde’s hands. Otherwise, she will face a difficult balancing act between defending the integrity of an institution she now runs and staving off immediate disaster in a continent she has just left.
Strauss-Kahn’s legacy:
A frustrated peacemaker in the currency wars And for the International Monetary Fund’s next trick: making peace in the currency wars. Besides getting the organisation back into the thick of crisis lending, another of Dominique Strauss-Kahn’s legacies is the latest in a string of IMF attempts to broker a grand deal on rebalancing the world economy.
The case for the Fund to co-ordinate economic co-operation would seem strong. Current account imbalances – the balance of trade in goods, services, investment income and transfer payments – are threatening to widen again, with China’s trade surplus, for example, swelling again after shrinking during the global recession. The Group of 20 leading economies is once more split by accusations of competitive currency devaluation.
But the processes put in place by the IMF and the G20 to create consensus have had conspicuously few successes. In theory, the gains from economic co-operation could be huge: China could float its exchange rate and rebalance its economy, shifting demand from exports to domestic consumption. In return, the US would reduce its fiscal and external deficits. In practice, disagreement and mutual suspicion have prevented serious moves in that direction.
Seeking a more comprehensive view of the world economy than the IMF’s traditional country-by-country analysis, Mr Strauss-Kahn initiated so-called “spillover reports”. The plan was that these would detail the impact of policies in the biggest, systemically most important economies – the US, Japan, China, the eurozone and the UK – on the rest of the world. In the event, the first set of reports, published in summer, reflected what appeared to be a rather mechanistic exercise, with small estimates of the likely impact of, for example, a hypothetical Chinese revaluation on the global economy.
The other initiative in this area is the G20’s “mutual assessment process” (Map), for which the IMF provides research and analysis support – and which similarly is intended to set benchmarks for returning economies to balance. In reality, the Map created a huge fight more or less as soon as it started, with the US trying and failing to convince the G20 to set numerical targets for current account deficits at last year’s heads of government meeting in Seoul.
This year, systemic international economic co-operation of the type sought by the IMF has been very largely absent. Only relatively small ad hoc initiatives got off the ground, such as the US Federal Reserve reactivating the dollar swap lines to other central banks that it extended at the height of the global financial crisis.
Beyond that, the grand scheme advanced by French president Nicolas Sarkozy to re-engineer the international monetary system during the country’s leadership of the G20 more or less expired in a cloud of vagueness. The structure of the global economy remains much as it was. |
