The International Monetary Fund has announced a new lending facility designed to combat global financial crises. This should worry us because it suggests further international economic crises are on the horizon, and their new facility is probably not the best way to combat them. At least, though, the institution tasked with attacking these problems is doing its best to get ahead of the curve.
So what exactly are we talking about? When countries face problems with currency reserves or sovereign debt, as Greece did earlier this year, other countries, the IMF, or both provide emergency loans to see the suffering state through the crisis. Generally, these loans require the country in question to meet a series of conditions for future fiscal probity, making IMF packages -- austerity in exchange for bailouts -- very controversial.
Sometimes, though, you see countries that have few fundamental problems with their economic policy (Spain is a good current example) that become victims of a financial panic, not mismanagement -- like a global bank run, but with countries. In order to protect these countries, officials in the late 1990s came up with an idea for Flexible Credit Lines (FCLs) so that states whose policies were preapproved by the IMF were also preapproved for loans in the case of a crisis. The IMF finally implemented this program after the 2008 crash, giving aid to Mexico, Poland, and Hungary. For a broader explanation of these issues, I suggest you read my story on Lael Brainard, the top U.S. official who manages these issues and who helped propose FCLs in the first place.
Today's news is that the IMF has decided that FCLs don't go far enough. Now, they're willing to commit IMF funds to countries that are just so-so in the economic policy department. This puts more of the global emergency reserve at risk, but it is the kind of proactive step that could halt a run. Here's the problem: While throwing enough money at these problems may work, sometimes it doesn't, as we saw throughout the Asian financial crisis in the late 1990s; lenders eventually get paid off but the economic damage in victim countries tends to last. Instead of bailing out creditors, some scholars and practitioners think a better idea is creating a process to restructure a country's debts, with a haircut for lenders, so that the country has a reasonable chance of paying them off. Imagine a bankruptcy process for a country.
This is called a "Sovereign Debt Restructuring Mechanism" or, more euphemistically, a "bail-in." It doesn't currently exist except informally; the U.S. and the IMF helped restructure Brazil's debt to end the 1990s financial crisis. At one time that was easy -- when most sovereign creditors were major banks and it was possible to more or less get everyone in a room. Now, with lenders coming from the less-supervised capital markets and with the rise of securitization, figuring out who can actually take that haircut is very hard. That, however, ought to be the impetus for reforming our international financial institutions to do a better job of handling global crises. Did I mention you should read my story about the U.S. role in the current international turbulence? If the IMF foresees trouble ahead, you're going to want to know what's going on.
-- Tim Fernholz
