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. Theidea that the IMF should be an international lender of last resort wasplanted in 1995, when the Clinton administration cobbled together amultibillion dollar bailout for those who had invested in tesobonos, cetesand dollar-denominated loans to nonfinancial enterprises in Mexico. Itwasn't until Jan. 3, 1999, when the IMF's acting managing director, StanleyFischer, addressed a gathering of the American Economic Association, thatthe idea got legs, however.
The classical lender of last resort idea was first proposed in the 19thcentury by Henry Thornton and Walter Bagehot. The classical theory was thatbanking panics could be averted if central banks stood ready to supplyliquidity (high-powered money) at rates above those prevailing in the marketto 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 itswares, egregiously flaunt the classical lender of last resort rules. TheBank of Indonesia, for example, is insolvent because it broke everyclassical rule in the book. In late 1997 and early 1998, the BI allowedcommercial banks to overdraft the payments system to the tune of $37billion. Insolvent banks automatically received high-powered liquidity fromthe BI at below market rates and without putting up any collateral.
In the real world, the lender of last resort causes more banking panics thanit stops. In the past two decades, 150 major financial breakdowns haveaffected 130 countries in which central banks have actively used theirlender of last resort facilities. These breakdowns have imposed enormousbank bailout costs on taxpayers. Indeed, in some cases, these costs haveexceeded 50% of GDP. Never mind. By endless repetition and obeisance, thelender of last resort idea has congealed into a crust of economic dogma.
Where does all this leave the IMF as a potential international lender oflast resort? Since the IMF cannot create high-powered money, it would act asa 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 ReserveFacility and be made available at penalty rates to borrowers that put upgood collateral.
Time out. International capital markets are ready, willing and able toprovide liquidity on these terms. Indeed, in December 1996, Argentinaadopted a formal "liquidity policy." Its linchpin is a contingent repurchasefacility in which the Argentine central bank has the option to sell certaindomestic assets valued at about $7 billion in exchange for greenbacks to agroup of international banks subject to a repurchase clause. The cost ofthis liquidity protection is modest. The option premium is 32 basis pointsand the cost of funds implicit in the repo agreement is roughly LIBOR plus205 basis points. Mexico has also tapped international capital markets forliquidity protection by establishing a $2.1 billion credit line withinternational banks.
Who needs the IMF as an international lender of last resort? At best, itwould be a half-baked, redundant affair. And if history is a guide, it wouldamount to something analogous to giving an arsonist matches and gasoline.