Global Policy Forum

By Joseph Stiglitz

I am a frequent IMF critic, so when the IMF gets something right, I should acknowledge it. The IMF has, at last, recognized the failure of its big bailout policies - failures all too evident in Thailand, Indonesia, Korea, Russia, Brazil, and most recently, in Argentina. Three cheers for the IMF.

Big bailouts allowed countries to briefly maintain over-valued exchange rates, which in turn allowed the rich in these countries to get their money out at more favorable terms than they might have done otherwise. These bailouts also allowed Western banks that engaged in imprudent lending to get repaid. Meanwhile, as overvalued exchange rates - even if maintained for only a short period - further depressed the economy, the country was left with the burden of repaying billions of dollars in IMF loans.

Nowhere was the problem more evident than in the 1998 Russian bailout, where only after the "failure" - after the ruble's devaluation - did growth resume. The billions lent to Russia quickly wound up in the Swiss and Cyprus bank accounts of Russia's oligarchs. All of this was evident at the time the money was lent in July 1998, but it is Russia's people that today must pay for the IMF's mistakes.

Argentina provided the coup de grace to the IMF's big bailout strategy. I, and others, had argued for years for a greater reliance on standstill agreements, restructurings, and bankruptcy. Finally, the IMF has come around. But it should have been clear all along that the IMF, as a major creditor, could not itself be the bankruptcy judge. The conflicts of interest were glaring.

The IMF has now listened. Whether one agrees with the recent proposals made by Ann Krueger, the IMF's deputy managing director, is not the issue: the fact is that the IMF now recognizes the potential conflict of interest, and has proposed alternative procedures that might deal with the problem.

Regrettably, the US Treasury immediately threw cold water on the proposals. John Taylor, undersecretary of Treasury for International Affairs, and a former colleague of mine at Stanford University (as was Ann Krueger), suggested that matters ought to be left to the market. All that is needed, he suggests, are "collective action" clauses that allow the majority (or a supermajority) of a group of bondholders to impose their will on a minority, so as to prevent scavengers who, in the past, bought up small stakes in a bond issue and used their position to extract large concessions for themselves.

Taylor is a distinguished macro-economist, but he has paid little attention either to recent developments in economic theory or experiences in economic policy in the arena of bankruptcy. Collective action clauses are important, but they are not enough. The IMF long advocated the "hands-off, market-oriented" approach to bankruptcy resolution, and it has mostly been a disaster.

Korea and Malaysia ignored IMF advice and, instead, their governments took an active role. There followed extensive restructuring, and those economies recovered fast. Countries that relied on IMF advice fared far less well.

Economic theory holds that there are incentives for some market participants to delay a resolution, and these are particularly costly in situations such as those in East Asia and Argentina, where corporate distress is prevalent and where the economy faces a major economic downturn. The existence of such negative incentives is why bankruptcy law in America allows bankruptcy judges discretion to force recalcitrant creditors to accept a resolution that is in the broader interest. Why should principles that make sense within countries - like the US - not be applied in the international arena?

As the IMF now recognizes, there needs to be some form of an international arbiter. The question is, what guidance should be given to this international bankruptcy referee? The issue is far from academic. The US has experienced a fierce debate over bankruptcy reform, demonstrating that there is no simple answer to the appropriate design of bankruptcy law or regulation.

Bankruptcy is not a matter than can simply be delegated to technocrats as much as the IMF would like to give the impression that such is the case. There are efficiency issues; but there are also distributional concerns. The IMF, linked as it is to financial markets, is likely to push for a set of rules that favor those interests. More balance is needed. The principles of America's Chapter 11 bankruptcy law - the provision which allows rapid reorganization of firms in ways that maintain its economic activity, should underlay whatever rules are adopted.

The fact that America can veto even these modest IMF proposals illustrates a fundamental weakness of current international economic arrangements. In the UN, five countries hold a veto - largely a historical anachronism. India - once a British colony, does not; France does. Whatever one's attitude to these arrangements, the notion that a single country can exercise effective veto power seems inconsonant with basic democratic principles.

Were America less bent on pursuing unilateralist policies, in pushing against an international rule of law, this might not make much of a difference. But the Bush Administration not only ignores basic principles of economics, but also the basic principles underlying international cooperation.

There needs to be a new way of dealing with crises. The big bailout strategies, associated with the Clinton-era IMF of Michel Camdessus, Stanley Fischer, Larry Summers, and Robert Rubin, failed abysmally. An alternative is demanded. America's proposal to rely on minor modifications in current arrangements, while relying on the market, though it is a position long advocated by financial markets, will not suffice. The IMF has been trying to create an alternative. The world cannot allow America to veto its efforts.

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