Adam Lerrick

This selection first appeared in the Financial Post—Canada on Feb 27, 2001.

When the International Monetary Fund's US$40–billion rescue package for Argentina was announced in January, officials boasted that private sector lenders would contribute half the money. The idea was simple. Creditors with the most at stake in a default should pay a serious share of the funding to forestall loss. Argentina was to be the prototype of the "new intervention."

But when the package details were laid out, it was just another bailout of failed policies with a bonus to international speculators for their bad lending behaviour. Public pressure on the IMF to ensure that those who garner high returns bear the cost of the high risk implied has produced nothing but subterfuge. Here is what is really happening to produce the illusion of the much-touted US$20–billion of private sector participation. First, Argentina is holding Internet auctions to exchange US$7–billion in debt; US$4.2–billion were completed this week. But the new bonds are more attractive than the old, with a pick-up in value of 1%–1.5%. This is hardly a sacrifice for investors who exercise the option to exchange, but it could cost the Argentine people up to US$100–million. Second, some US$3–billion of new bonds will be stuffed into local pension funds, where Argentine workers will be shortchanged by below-market returns. Third, US$2.5–billion of standard bonds will be issued on terms dictated by the market. A final manoeuvre rolls over US$2.5–billion of short-term notes three times in one year to count as US$7.5–billion of funding. It all adds up to the magic number of US$20–billion, but not to the bona fide participation for which bailout critics are clamouring.

Once again, the IMF has socialized the risk and privatized the return for international lenders. In this rescue, there is no cost to investors since they have not been forced to write down a single loss or provide new funding that includes concessions. Instead, there is high cost to the global system in a spiral of speculation, as markets absorb the lesson that lending will be underwritten by a G7 guarantee. And there is serious cost to the "New IMF" in loss of credibility.

Argentina is number eight in the rising flood of IMF bailouts for troubled economies that began with Mexico in 1995. The list is lengthening fast: in 1997, Thailand, Indonesia, and Korea; in 1998, Russia and Brazil; and now Turkey and Argentina. At an average of US$30–billion per country, a quarter-trillion dollars in debt and risk has been shifted from the balance sheets of private creditors to official ledgers.

There is real debate as to whether Argentina is experiencing illiquidity, which is the province of the IMF, or insolvency, which is clearly beyond its mandate. So, as Argentine finance officials tour the global capital markets to talk up the new debt offerings, they walk this fine line by terming the current crisis a "temporary liquidity problem" that will be relieved once the economy starts to grow. Yet Argentina is an egregious but familiar example of a government that continues to live beyond its means, investors who continue to fund that extravagance, and public institutions that continue to underwrite the process.

A nation of just 38 million people now accounts for an astounding 25% of emerging-market bonds worldwide. The crushing US$120–billion owed is 350% of the largely agricultural, and hence limited, export base. Almost two-thirds of foreign exchange receipts are being devoured by debt service. Leading economists, among them Charles Calomiris of Columbia University, believe the burden to be unsustainable and that, unless debts are substantially written down and genuine economic reform is implemented, this will not be the last bailout tango in Buenos Aires.

The IMF maintains that a write-down of Argentina's debt is not required. But that's because it knows that a heavy subsidy on new loans from official lenders—which are 7%–10% below true market rates—will provide US$1.5–$2.0–billion in cash each year. And as investors perceive that bailouts will continue, the costs of private financing will decline. These windfalls could circumvent the once inevitable outcome of loss by an undeclared transfer from G7 taxpayers to private sector hands.

"Crisis," with its overtones of global disaster, has become cheap currency to compel approval of extravagant funding solutions. But when there are eight "crises" within six years, both semantics and policies should be altered.

As developing countries, with their economic and political volatility, enter the global community, they carry a natural potential for disturbance. An undisciplined flow of capital magnifies the risk. We are not faced with unforeseen seismic eruptions but with the expected and recurring pattern of a financial flood plain. Here, emerging nations build and rebuild too close to the water's edge and their lenders are emboldened by what they correctly perceive to be unlimited indemnification against loss. Multilateral agencies have become insurers on a monumental scale and, as the exposure escalates, the day will come when there will not be enough capital to satisfy all the claims.

The IMF has constructed a new policy, without legislative endorsement, whereby development in emerging economies is a global public good. It holds that a high flow of affordable funding to these markets, beyond official capability, must be encouraged. As a result, the shadow of contagion, real or imagined, has been stretched with each bailout, moving from a close neighbour to trading regions and now, with Turkey, to the view that default in any major emerging nation will shake investor confidence in all. Fear of global disruption is the bugaboo, but it is no longer the prime motive for intervention.

There is no doubt that growth and prosperity in developing countries are in the interest of every member of the system, but less reckless means must be explored. Just two forces motivate the marketplace: reducing the risk or raising the return. The IMF has opted for an implicit guarantee backed by the G7 governments that appears to eliminate virtually all investor risk and cries crisis to justify emergency aid. But this strategy has consequences. Flows are bound to become excessive as speculation escalates, governments become profligate, domestic entrepreneurs overextend, and foreign investment is ill-considered. Without the stabilizing discipline of natural market forces, incentives to fulfill politicians' promises of structural reform are destroyed, economic growth is subverted, and the population at large is shortchanged. The totality of this new Ponzi scheme could cause a world-wide crisis that engulfs the donors along with the recipients.

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