The Asian Bailout

Dear Jeff:

       We still differ on several important issues concerning the International Monetary Fund, to which I turn below, but I very much liked your latest piece. As you said in your very first paragraph, we agree on the basic point that the IMF is a very valuable institution that should not only be saved but also strongly supported and that the legislation pending before Congress should be passed with dispatch.
       This agreement between us is more important than might meet the eye. I have now testified on the pending legislation on four different occasions, and it is clear that the fund is under intense assault from a sizable group that blames it for many of the world’s problems. Their main argument is that the very existence of the fund, by raising the possibility of financial rescue programs, creates a moral hazard of sufficient dimension to outweigh all its benefits in countering crises and limiting the need for problem countries to adopt even more draconian policy responses. Some go so far as to argue that the fund’s (and U.S. Treasury’s) support program for Mexico in 1995 caused the Asian crisis by inducing the world’s creditors to lend recklessly to companies and banks in the region.
       There is of course something, albeit much less than these critics assert, to the moral hazard argument. It can be readily addressed, however, through IMF insistence that private (including foreign) lenders share the losses inherent in any adjustment program. The fund has tended to do so in most cases, but it needs to set a clear policy in this direction. The risks of private lending will then be abundantly clear, and such lending will rigorously follow market signals. I applaud the insistence of Congress on this reform and believe it is even more important, both systemically and politically, than the other reforms that you emphasize.
       There is no need to debate the transparency issue. As I said in my initial piece in this series and have said since the late 1970s when I wrote the speeches of the secretary of the Treasury on the subject, the fund should indeed be much more transparent. I congratulate you personally for your impressive success in pushing the fund in the correct direction on that front.
       My only demurral relates to timing. The fund is an international organization composed of 181 members to which the United States cannot dictate unilaterally. Hence, the required changes will take a while. I agree that Congress should instruct the administration to make every effort to negotiate those reforms and have every reason to believe they will succeed. But the legislation should not be held hostage to implementation of the needed reforms.
       I stress timing because the situation is extremely urgent. The IMF is now short of the resources needed to handle even one more major crisis, say in Brazil or Malaysia. It has only $10 billion to $15 billion in available funds, compared with its contribution of $21 billion to the Korea package alone. With the impasse on reform in Indonesia and the coming recessions in Korea and Thailand (and probably elsewhere in Asia), with their deep political implications, it takes little imagination to envisage a renewed outbreak of crisis that could engulf other countries in the region and spread well beyond it. Replenishing the coffers of the fund is urgent indeed if one believes in its basic purposes, as you and I do.
       The final question is then the effectiveness of fund programs. I have read your excellent paper with Steve Radelet, from which I believe you draw two conclusions: that the fund’s basic strategy is correct but that its execution often contains dreadful errors.
       A certain amount of your country criticisms smack of Monday morning quarterbacking. Some Indonesian banks did have to be closed. Korea’s private creditors were integrated into the reform package–and surely you would not argue that the debt restructuring alone, without the rest of the IMF program, would have been sufficient to quell that crisis? The initial macroeconomic targets in the Asian packages had to be modified because of the extent and duration of the contagion, which no one had envisaged, not because (as you assert) of the contractionary effect of the fund’s own recommendations–and the targets have indeed been altered with commendable flexibility. Your recognition that “the IMF eventually gets around to correcting many of its errors” is a bit grudging, and your follow-up that it adjusts “only after tremendous damage has been done” is hyperbolic second-guessing, but the judgment is essentially correct and, to me, dispositive.
       In closing, however, I return to the key point from the outset: that you (and Radelet) endorse the basic strategies adopted by the IMF and thus its fundamental orientation. That is the central point in the current debate. To be sure, reforms are needed and should be promoted by the pending legislation. But I am pleased that we agree on the fundamentals and look forward to working together to support early congressional action.