Lagarde, Juncker, and Greece’s solvency

By Felix Salmon
May 26, 2011
international campaign to become the next head of the IMF is an attempt to maximize her credentials as the choice not only of Europe but of the rest of the world as well.

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Christine Lagarde’s international campaign to become the next head of the IMF is an attempt to maximize her credentials as the choice not only of Europe but of the rest of the world as well. The job is hers, at this point: once the US falls in behind Lagarde there’s no question that Lagarde will get the job, and with Hillary Clinton now waxing enthusiastic about how “we welcome women who are well qualified and experienced to head major organizations such as the IMF”, it’s going to be hard for the US to support anybody else. So Lagarde’s latest world tour should be seen as maneuvering to make her life as easy as possible when it comes to dealing with increasingly-powerful shareholders such as China and Brazil, after she starts in her new role.

Meanwhile, Jean-Claude Juncker, who chairs meetings of euro zone finance ministers, took it upon himself to come out in public and say just how bad the Greece situation has become. The key date we’re counting down to is June 29 — that’s the day on which the IMF is due to disburse its next tranche of aid to Greece. But before that can happen, the “troika” — the IMF, the ECB, and the EU — have to agree that all of Greece’s funding needs for the next 12 months have been covered or guaranteed by someone. Which they haven’t. “I don’t think that the troika will come to this result,” said Juncker.

If the IMF doesn’t come up with the money, Greece is in real trouble:

“If the Europeans have to acknowledge that the disbursement from the IMF on 29 June cannot be operationally implemented, then the expectation of the IMF is that the Europeans would step in for the IMF and take upon themselves the IMF’s portion of the financing,” Juncker said.

“That won’t work, because in certain parliaments — Germany, Finland and the Netherlands and others too — there is no preparedness to do so,” he said.

Why is Juncker saying this? Neil Hume quotes David Mackie of JP Morgan, who reckons that Juncker is twisting the arms of various Eurocrats to ensure that Greece gets access to the European Financial Stability Fund sooner rather than later. If EFSF terms get agreed before June 29, then that’s exactly the guarantee that the IMF is looking for, and the IMF’s funds can get disbursed.

But there’s another possibility: maybe Juncker is pressuring the euro zone to install Lagarde as IMF managing director before June 29. Lagarde has “earned a reputation as the most uncompromising opponent of a Greek debt restructuring among euro zone ministers,” according to Daniel Flynn, and it’s pretty much impossible to imagine that her very first act as managing director would be to throw the euro zone into crisis by denying Greece its scheduled tranche of IMF aid. After all, the tougher that the IMF becomes on conditionality, the more likely a Greek restructuring becomes.

The deadline for installing a new managing director at the IMF is June 30; I’m sure that a lot of Europe would like to see Lagarde get the job a few days earlier than that. And so maybe that’s what Lagarde’s jet-setting is all about: shoring up enough global support that she can sail through the nomination process very quickly. The G20 countries will be asking her about a possible double standard: why should the IMF be generous to Greece, when it’s been so tough on many other countries in the past? Lagarde, I imagine, will give an answer along the lines of Daniel Davies’s comment here:

The purpose of defaulting on the debt would be to improve Greece’s access to credit? And by putting its deficit funding at the caprice of international capital markets rather than other EU governments, Greece gains political independence? I suppose it is the land of the Pyrrhic victory, but even so; I am unconvinced that gaining the sort of freedom to set its own fiscal policy enjoyed by, say, Ecuador is really worth all that much.

btw, I don’t really know what the difference is between a liquidity problem and a solvency problem in this context, and I don’t believe anyone else does either.

What Davies misses here is the distinction that the markets make between ability to pay and willingness to pay. Once a country has defaulted on its debt, its ability to pay on new debts naturally goes up — it becomes more creditworthy, not less. But just as your credit score goes down rather than up after you declare bankruptcy, so do the markets tend to punish countries which have recently defaulted, on the grounds that if a country is prone to default, it’s not a good idea to lend to that country.

In the case of Greece, the markets would be utterly unconvinced by a “soft restructuring” which left the country’s debt-to-GDP ratios looking unsustainably large for the foreseeable future, and which kept alive the risk of a second restructuring — or even devaluation — down the road. And there’s no realistic chance of a coercive “hard restructuring” which would involve outright default on existing debt — not in the next year or so, anyway.

But still, I do think that there’s a difference between a liquidity problem and a solvency problem in Greece. The solvency problem has been apparent ever since this Greek government came into power and came clean on the country’s finances; the liquidity problem is the kind of thing which Juncker is talking about. Defaults are generally caused by liquidity issues rather than solvency issues, which is why Greek bond yields are so much higher now than they were at the beginning of 2010. But solvency is still important, and Lagarde faces a stark choice the minute that she becomes head of the IMF.

Either Lagarde will attempt to persuade both her shareholders and the markets that Greece’s debt burden is actually sustainable, or else she’ll have a Nixon-in-China moment and announce that in order to bring Greek debt down to a manageable level, there will need to be a broad restructuring of its liabilities. My guess is that by the time she’s finished her current tour, Lagarde will have a very clear idea of whether Plan A — the muddle-through-and-hope approach — has any chance of success at all. And if I were the Chinese, or the Brazilians, or the South Africans, I’d be trying to impress upon her in the starkest possible terms that it doesn’t. It’s not the job of the IMF to facilitate a state of denial in Europe and Greece. Indeed, that’s one reason why I’m uncomfortable with Lagarde getting the job in the first place. Despite the fact that she seems certain to get it.

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