Please, No More ‘New’ IMFs

March 21, 2000 • Commentary
Reprinted from the Wall Street Journal © 2000 Dow Jones & Company, Inc. All rights reserved.

After presenting a scathing indictment of the IMF, Charles W. Calomiris concludes that the IMF should reinvent itself, yet again (“The IMF Needs More Than a New Boss,” editorial page, March 2). Mr. Calomiris then presents his vision of what the IMF’s new mission should be: “An IMF that focuses on crisis management — with rapid, effective liquidity assistance at a penalty rate rather than subsidized long‐​term conditional loans — would be more effective, less corrupt and self‐​financing.”

Ironically, Mr. Calomiris echoes the Clinton administration and the IMF. The idea that the IMF should be an international lender of last resort was planted in 1995, when the Clinton administration cobbled together a multibillion dollar bailout for those who had invested in tesobonos, cetes and dollar‐​denominated loans to nonfinancial enterprises in Mexico. It wasn’t until Jan. 3, 1999, when the IMF’s acting managing director, Stanley Fischer, addressed a gathering of the American Economic Association, that the idea got legs, however.

The classical lender of last resort idea was first proposed in the 19th century by Henry Thornton and Walter Bagehot. The classical theory was that banking panics could be averted if central banks stood ready to supply liquidity (high‐​powered money) at rates above those prevailing in the market to solvent, but illiquid, banks that put up good collateral. In practice, central banks don’t adhere to the classical prescription. Indeed, central banks in emerging market countries, where the IMF plies its wares, egregiously flaunt the classical lender of last resort rules. The Bank of Indonesia, for example, is insolvent because it broke every classical rule in the book. In late 1997 and early 1998, the BI allowed commercial banks to overdraft the payments system to the tune of $37 billion. Insolvent banks automatically received high‐​powered liquidity from the BI at below market rates and without putting up any collateral.

In the real world, the lender of last resort causes more banking panics than it stops. In the past two decades, 150 major financial breakdowns have affected 130 countries in which central banks have actively used their lender of last resort facilities. These breakdowns have imposed enormous bank bailout costs on taxpayers. Indeed, in some cases, these costs have exceeded 50% of GDP. Never mind. By endless repetition and obeisance, the lender of last resort idea has congealed into a crust of economic dogma.

Where does all this leave the IMF as a potential international lender of last resort? Since the IMF cannot create high‐​powered money, it would act as a pseudo‐​lender of last resort, one that had to rely on its own resources, its ability to borrow or its capacity to create more Special Drawing Rights. This liquidity would be funneled through the IMF’s Supplementary Reserve Facility and be made available at penalty rates to borrowers that put up good collateral.

Time out. International capital markets are ready, willing and able to provide liquidity on these terms. Indeed, in December 1996, Argentina adopted a formal “liquidity policy.” Its linchpin is a contingent repurchase facility in which the Argentine central bank has the option to sell certain domestic assets valued at about $7 billion in exchange for greenbacks to a group of international banks subject to a repurchase clause. The cost of this liquidity protection is modest. The option premium is 32 basis points and the cost of funds implicit in the repo agreement is roughly LIBOR plus 205 basis points. Mexico has also tapped international capital markets for liquidity protection by establishing a $2.1 billion credit line with international banks.

Who needs the IMF as an international lender of last resort? At best, it would be a half‐​baked, redundant affair. And if history is a guide, it would amount to something analogous to giving an arsonist matches and gasoline.

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