On June 18, 2012, Peter Doyle, a senior International Monetary Fund (IMF) economist, resigned and wrote a damning letter to the IMF Executive Board. He accuses the IMF leadership of suppressing staff warnings about the 2008 global financial crisis and for alleged pro-European bias that has exacerbated the euro-zone turmoil:
The consequences include suffering (and risk of worse to come) for many, including Greece, that the second global reserve currency is on the brink, and that the Fund for the past two years has been playing catch-up and reactive roles in the last-ditch efforts to save it.
Doyle is a 20-year IMF veteran and a former division chief in the IMF’s European Department. Today, he is “ashamed to have had any association with the Fund at all.” On the one hand, his resignation reflects the ongoing turmoil at the IMF. On the other hand, it reflects a reassessment of the IMF crisis management approach in the euro-zone.
Moral hazard, with European characteristics
What is new in the Doyle debacle is not so much the substance, but the harsh tone. Some of the criticism has been documented in the reports by the IMF Independent Evaluation Office (IEO). In the years leading up to the global crisis, the IMF routinely failed to detect the vulnerabilities that brought the global economy to its knees; even once the turmoil had begun. Moreover, IMF staff often felt pressure to align conclusions with the views of IMF management.
Unfortunately, when ideology triumphs over facts, the outcome tends to be sub-optimal.
Theoretically, the IMF is owned by its 188 member nations. In practice, it is guided by a small club of advanced economies, which dominated the world economy in the post-World War II era. In contrast, the large emerging economies, which today account for the bulk of global growth, continue to have a junior position in terms of voting and bargaining power.
During the rivalry for the next IMF chief last summer, several European countries argued that, as the euro-zone is currently facing great debt pressures, the leaders of such economic powerhouses as Germany and France need to feel trust in the management of the IMF. Read: only Europeans understand European problems.
The argument was (severely) flawed. After all, few Europeans saw the need for a Latin-American to cope with the crises of the 1980s and 1990s; or for an Asian to overcome the Asian financial crisis of the late 1990s.
As I argued in the EconoMonitor in May 2011:
The argument on European exceptionalism introduces an element of moral hazard; that is, a situation in which one person makes the decision about how much risk to take, while someone else bears the cost if things go badly.
If the idea of moral hazard in this context is hard to digest, it should not be forgotten that currently some 80 percent of IMF credit outstanding is to European countries.
Europe enjoys credit that is highly disproportionate to its share in the world economy. In the coming years, it is likely to need much more credit. As a result, it is hardly surprising that the large emerging economies may feel somewhat uneasy with the implications.
For all practical purposes, it is the poor of the world – at least measured by GDP per capita – who are expected to bail out the wealthy of the world.
The Doyle debacle reflects the unease that many economists feel over the adverse consequences of moral hazard.
Acknowledging the facts
When the Euro-zone crisis erupted in spring 2010, I argued that a central element of a comprehensive solution is likely to comprise a series of debt restructurings, starting with Greece. Nonetheless, the troika – the IMF, the European Union (EU), and the European Central Bank (ECB), which has played a vital role in the crisis – opted for a very different approach.
As long as Jean-Claude Trichet was the head of the European Central Bank (ECB), the very subject matter of debt restructuring was rejected out of hand. The IMF, in particular, has faced increasing criticism for extending a big bailout package to Greece despite the country’s persistent failures to meet the terms of its rescue agreements.
In summer 2011, the need for restructuring was finally acknowledged, but its extent remained grossly underestimated. As the IMF and European leaders began to accept the idea of a 21% debt restructuring, Greece actually needed a 50% restructuring. And in the fall 2011, when the idea of a 50% debt restructuring became more acceptable, what was really needed was a 75-85% restructuring. If time is money, delays of time are costly. In the eurozone-crisis, they may soon prove prohibitive.
If the IMF had really been loyal to its mandate, it should have urged a restructuring of Greek debt much earlier, instead of acquiescing in the face of strong opposition with some European political leaders. Instead of efforts to insulate the crisis, the current approach permitted the unnecessary spread of debt contagion; first from a few small crisis economies to the entire periphery, then – through trade and financial channels – into the fiscally conservative Europe.
In the process, austerity fatigue in Southern Europe became augmented by the bailout fatigue in Northern Europe. Economically, it has pushed the crisis economies into a Depression mode, while weakening the few, remaining triple-A nations in Europe. Politically, it has squeezed the middle class in the crisis economies, and supported the rise of extremist movements and anti-immigration sentiment – unlike anything that has been seen in Europe since the 1920s and 1930s.
If Greek debt had been restructured at the early stage, not only would Europe have been able to stem the crisis, but it would now be more united politically, stronger economically, and healthier socially.
The IMF is only one actor – though a pivotal one – in this debacle. If it had been appropriately stringent on European aid recipients in both policy prescriptions in the bailout agreements and in its willingness to withhold funds when the terms were not met, it could have contributed to the solution instead of adding to the problem.
The tacit message of the current approach is that there are two kinds of debt crises: those that occur in the advanced world, and those that take place in the emerging world. In the former case, crises require understanding and cooperation. In the latter case, tough love must prevail. Since the Asian financial crisis of the late 1990s, the emerging world has regarded such dual conduct as a pretext for hypocrisy.
In rhetoric, certainly, the IMF executives and staff economists have ramped up warnings about the deteriorating euro-zone. But these notices have not been followed by enforcement or decisive efforts to drive European policymakers into appropriate action.
Turmoil at the IMF European Department
At the IMF, the Doyle debacle also reflects turmoil at the European Department. Reportedly, he shifted earlier this year to a position as an adviser to the IMF. While his resignation is expected to take effect in the fall, his job change occurred around the same time a new Department chief was appointed. The latter restructured the department, replacing many of its staff. That was only the latest phase in the ongoing rollercoaster.
In November 2010, Dominique Strauss-Kahn (DSK), then-chief of the IMF, appointed Antonio Borges to lead the unit. Between 2000 and 2008, the Portuguese Borges had been managing director of Goldman Sachs international in London, followed by a brief stint at the head of the Hedge Fund Standards Board in London. As he stepped in, the European Department took on the growing burden with the euro-zone bailouts.
As DSK was forced to resign, he was replaced with Christine Lagarde as the new IMF managing director. Soon thereafter, Borges suggested during a Washington brief on the euro-zone crisis that Britain’s austerity program was not working in terms of growth and that a “Plan B” should be put together to avoid a deep recession. In early October, only a few weeks later, he told reporters in Brussels that the Fund could potentially intervene in secondary markets to support stressed member states. In effect, the Fund has not indulged in direct bond buying and has been at pains to be junior partner in the European rescues. Borges was forced to issue a quick correction.
A month later – amid the greatest economic crisis in Europe since World War II – Borges resigned “for personal reasons.” He was replaced by Reza Moghadam, a British-Iranian 20-year IMF veteran, who is more comfortable with the traditional low-profile IMF approach to crisis management.
If the IMF European Department is to sustain its credibility and relevance, it cannot apply different norms in Europe and Asia. Until recently, the emerging world has followed the ongoing debacle with great understanding. But as growth prospects in the West now contribute to diminished horizons in the East, nothing is forever.