The Asian Bailout

Dear Fred Bergsten,

       The International Monetary Fund has just asked the American people for another $18 billion so that it can continue to “save” Asia and the world. It’s an arrogant and untimely request. Typically, it’s fair to say, an organization might have to justify itself a bit before putting its hand out for a cool $18 billion. But this, after all, is the IMF. The organization is so used to secrecy and to its monopoly of power in the developing world that it believes a request is justification enough. Strangely, the U.S. Treasury seems to believe the same thing. Though the IMF has repeatedly demonstrated deep weaknesses in its operations and strategy, the U.S. Treasury hasn’t told us a word about how it might try to fix these problems.
       Almost every prediction that the IMF has made about the Asian crisis and its own bailout programs has proved wrong. The IMF praised the East Asian economies for years–just up to the time of the crisis. Then the crisis hit. The IMF quickly put together $17 billion in bailouts for Thailand, $43 billion for Indonesia, and $57 billion for Korea–with the money in each case coming from the IMF itself, together with the World Bank, the Asian Development Bank, and leading governments. In fact, the IMF pledged such vast sums so quickly that it has now come back for more. But what happened to the first $117 billion? Contrary to the IMF’s declarations and formal programs, the currency and stock markets in Asia continued to plummet. Sure, the IMF money has been used by the crumbling Asian economies to pay off Western banks, thereby keeping Wall Street happy, but the IMF’s brave talk about restoring confidence and stability in Asia has so far come to nought.
       At the start of the IMF’s intervention in Indonesia, I suggested that IMF policies were on the wrong track (New York Times, Nov. 3). My fears were that the IMF’s crude strategy of sudden bank closures, sharp hikes in interest rates, and deep budget cuts would stoke the Asian panic rather than moderate it. Not only the markets but also the IMF’s own internal documents (still hidden from public view but now widely reported in the press) confirm those early fears. The IMF staff now admits that the decision to close 16 Indonesian banks at the start of November 1997 led to a bank panic that in the end dragged down almost the entire Indonesian banking sector. In renegotiating the Indonesia program, the IMF now acknowledges that it was wrong to insist on budget surpluses.
       In all three bailout countries, the IMF now recognizes that it wildly miscalculated the consequences of the crisis and its own targets for growth, inflation, and exchange rates throughout the region. It has had to remake its forecasts for 1998 just weeks after its first (and failed) forecasts. The sovereign debts of all three bailout countries–Indonesia, Korea, and Thailand–have by now been reduced to junk-bond status. The banking sectors in all three countries have frozen up, especially following the IMF-led bank closures. All three countries are on the path to outright recession.
       We are now entering Stage 2 of the Asian crisis. The IMF’s approach in Stage 1 has failed. If there is a glimmer of hope, it is that the private-sector creditors of Asia (mainly international banks) have begun to renegotiate their claims with Asian counterparts. An orderly restructuring of debts, now imminent in Korea, offers the best chance forward. The key for Korea is to avoid the mistake of agreeing to excessively onerous terms of debt restructuring. The Koreans simply need to remember that the banks have no effective alternative but to roll over the existing claims. Debt workouts for the other countries are likely to follow. Indonesia has just announced an effective moratorium on debt repayments by corporate borrowers, with the expectation that this will be followed by creditor-debtor negotiations.
       The IMF needs fundamental reforms before it is given any additional funding. The institution must be rid of its pervasive secrecy. All loan documents should automatically be made public, with slight delays in the case of extremely market-sensitive information. All archived materials should be released. The executive board should routinely screen a wide range of professional opinion instead of simply receiving reports from the IMF’s own staff, as is now the practice. It should implement a formal external-review process to encourage professional peer review and independent evaluation of IMF programs.
       The IMF’s substantive strategy should change dramatically. Too many IMF failures over the years have gone unheeded, so that failed approaches have not been corrected. Most importantly, the IMF is not sensitive to problems of financial panic, liquidity, credit-grab races, and orderly workouts. To put this in general terms, the IMF has failed to recognize–and address–the collective action problems that bedevil financial panics and debt overhangs. IMF bailout operations often stifle appropriate market responses, or even add to panic. The time has come to search for more market-sensitive solutions to international financial crises. One part is better prevention, by limiting rather than enhancing the flows of short-term credits to banking systems in emerging markets.
       For the crises that will inevitably occur even with increased efforts at prevention, we can learn from the structure and strategy of bankruptcy law. Instead of the bankruptcy courts sending advisers and money to insolvent corporations, à la IMF, the bankruptcy law creates a legal venue for orderly workouts between creditors and debtors. The law is designed to nudge both sides to overcome problems of panic and free riding. Creative thinking along these lines could put the IMF out of the bailout business, and into the much more constructive role of market facilitator.

Jeff Sachs