Felix Salmon

Gordon Brown is very comfortable at the IMF. He chaired its most important committee, the IMFC, for many years, and he would love to take the top job of managing director. There might be a vacancy soon, if the incumbent, Dominique Strauss Kahn, steps down to run for president of France. But it won’t be filled by Brown, now that UK prime minister David Cameron has made his opinions crystal clear.

Mr. Cameron told BBC Radio 4′s Today program: “I haven’t spent a huge amount of time thinking about this. But it does seem to me that, if you have someone who didn’t think we had a debt problem in the UK, when we self-evidently do, they might not be the best person to work out whether other countries around the world have a debt and deficit problem”.

He added: “Above all what matters is the person running the IMF someone who understands the dangers of excessive debt, excessive deficit, and it really must be someone who gets that rather than someone who says that they don’t see a problem.”

Mr. Cameron also said: “I certainly don’t want a washed-up politician from another country. It’s important that the IMF is led by someone extraordinarily competent.”

He suggested that the next IMF head could come from “another part of the world”, such as China or India. By convention they are usually chosen from European countries.

All of this is exactly right. Brown comes with way too much baggage: he’ll never be able to admit that enormous chunks of what he did as Chancellor turned out, in hindsight, to be disastrous.

The head of the IMF has to deliver tough news about debt and deficits to heads of state around the world — and Brown simply has no credibility on that front. And his diplomatic skills leave something to be desired as well.

More generally, it would be crazy to appoint a European to head the IMF right now, just as the biggest sovereign crises in the world look set to take place in Europe. If the IMF itself wants credibility, it must appoint a non-European to provide independent leadership in an era when the IMF will surely be asked to help bail out troubled European sovereigns.

It long since time that the head of the IMF stopped being a European. If and when DSK leaves, let’s replace him with someone highly qualified — someone who wasn’t a partial cause of the last financial crisis — from elsewhere in the world. It doesn’t really matter where, just so long as it’s not Europe or the U.S. Gordon Brown should be disqualified on both counts.

Mohamed El-Erian delivered this year’s Per Jacobsson lecture at the IMF annual meetings, and was very clear that the international community has failed in its job over the past year or so:

The impressive degree of global coordination highlighted by the April 2009 G-20 meeting did not last long. It only took a few months for that moment of extraordinary collaboration to give way to solely domestic agendas.

The result of that, he says, is going to be ugly indeed:

Having won the war, industrial country societies are in the process of losing the peace. Indeed, absent some important mid-course corrections, industrial countries confront the prospects of low growth; high unemployment that is increasingly structural in nature; welfare losses, including a growing number of citizens falling through the large gaps created by overly stretched safety nets; and a rising risk of protectionism.

El-Erian is characteristically vague on exactly what those corrections should be, beyond saying, unhelpfully, that “structural reforms are key”. But the question’s probably moot in any case: countries are moving further apart, and tail risks are higher than ever.

El-Erian gave his speech on the same day that the ECB’s Lorenzo Bini Smaghi said that “if Greece restructures it would have a total collapse of the economy” — exactly the tail risk which is preventing Greece’s spreads from coming down to a sustainable level.

But if you want a clear visual of what the new world of higher tail risk looks like, you could do a lot worse than this chart, from the Bank of England’s latest inflation report, pointed to by El-Erian:

This is most emphatically not your typical bell curve, with the most likely outcome being represented by a peak in the middle. In fact, it’s inverted: the chances of inflation being outside the central 1.5% to 2.5% range are significantly higher than the chances of inflation falling within that sweet spot. And the UK’s central bank is, if anything, even more pessimistic:

The Committee judges that, given the scale of the risks in both directions, at both the two and three-year horizons there is only around a one-in-four chance that inflation will be within 0.5 percentage points of the 2% target.

This is a world which is out of the control of governments and central banks, where everybody is getting used to expecting the unexpected, and where uncertainty breeds a high degree of risk aversion even as monetary policy tries to push companies and investors to take ever-greater risks with their capital.

I’m inclined to agree with the message of El-Erian’s lecture: infighting between the world’s governments has failed the global economy, and we’re all going to be buffeted by unpleasant and unforeseeable consequences as a result. Fasten your seatbelts: the New Normal is going to be very bumpy.

The IMF held its first-ever blogger meet-up on Friday, with PR honcho Caroline Atkinson, first deputy managing director John Lipsky, and various other Fund types sitting rather formally around a big table at IMF headquarters in Washington. “The discussion here is on the record, because I’ve been told that bloggers don’t do on-background,” said Atkinson — which made for an interesting contrast with how they do things at Treasury.

Everybody was kind of feeling their way at this first meeting, so it’s too early to draw much in the way of conclusions; I did get the impression that Fund staffers would like to engage the blogosphere in theory, but don’t actually spend as much time reading blogs as their Treasury counterparts do. That makes sense: the blogosphere has lot more in the way of policy prescriptions aimed at Treasury, or even the World Bank, than it has wonky discussions about the Fund’s areas of expertise.

I went in to the meeting with the idea that the Fund is on something of a downward trajectory these days. Its high point was surely the 2009 G20 meetings in London, which ended with a much beefed-up role for the IMF, and a lot more money too. But since then, the occasional Germany-mandated foray into Greek fiscal policy notwithstanding, the IMF seems to have played less of a role, especially in terms of crisis resolution and prevention, than I and many others expected it would.

I left the meeting a bit more impressed at what the Fund has managed to achieve in the past 18 months: it’s not hogging the financial-press headlines, but it is doing quiet, necessary work, especially in non-G3 nations where its expertise and money can be put to best use.

Matt Yglesias said the most interesting thing along these lines — that maybe the IMF didn’t want to get caught up in the headlines, and could actually be more effective if the eyes of the world were pointed elsewhere, at institutions like the G20. Just like Basel, it’s often easier to get things done when what you’re doing isn’t particularly politicized.

It’s also asking some important questions. I spoke to Lipsky a bit about cross-border resolution, and the way in which neither Basel III nor any other international agreement seems to have made it any likelier that a failed international bank might get resolved in a non-messy manner. Much of the worst damage from the Lehman collapse came as a result of the forced liquidation of its London operations — something the panicked meeting at the New York Fed over the previous weekend had barely stopped to consider. And Lipsky pointed out in a speech in July that even European bank failures have run into significant problems associated with duelling national authorities.

In the case of Fortis, [resolution] was complicated by national interests coming to the fore even between jurisdictions whose financial regulators have a long tradition of co-operation and whose legal frameworks are considerably harmonized. As a result, the Fortis group was resolved along national lines in a protracted process.

“Basel III is microprudential”, said Lipsky, and there’s very much still a need for big-picture cooperation between countries when international financial institutions get into trouble. That said, he was at pains to say that he didn’t want the job: “we’re not supervisors, we’re not regulators, and we do not aspire to be either. We can provide perspective to the standard setters. This will be an agreement among sovereigns.”

I’m not going to hold my breath. Here’s what Lipsky said in his speech:

A basic problem with many national regimes is that the authorities often are effectively precluded from cooperating in an international resolution exercise. For example, in liquidating the local branch of a foreign bank, some countries require their authorities to ring-fence the local assets of the branch for the benefit of local creditors and, in this manner, effectively prevent participation in a broader international process. Under our approach, national legislation would be amended to remove these obstacles. Moreover, it would call for national authorities to cooperate with other countries in the framework, but only when they believed such cooperation to be consistent with the interests of creditors and supportive of financial stability. A jurisdiction will be willing to defer to another only if it is clear that local creditors will be treated equitably and will receive at least what they would have received had the entity been liquidated on a strictly national basis.

In order for Lipsky’s proposed framework to work, then, two highly improbable things need to happen. First, the U.S., along with lots of other countries, would need to change its national legislation so that it can cede control of bank-resolution processes to other countries’ regulators. I wouldn’t like to be the legislator proposing that.

And secondly, if an international institution failed, the regulators of the good bits would have to decide that they’d be better off throwing those good bits into the international pot, rather than holding onto them themselves. Think of AIG, for instance: it had one huge black hole in London, and another big black hole in its U.S. securities-lending operation. It was highly profitable in Asia. Why would Asian regulators, if they had the power to keep the Asian operations for themselves in a resolution, give up that power and accept whatever fate befell the counterparties of the parent company more generally?

As Lipsky says, these questions are tough — so tough, indeed, that I doubt anybody’s going to seriously address them. Financial institutions will always spill across borders, and when cross-border institutions fail, it’s always going be messy. Lipsky’s warnings might make policymakers think about such issues, but I doubt that they’ll prompt them to actually do anything substantive about them.

John Hempton of Bronte Capital sent me a pushback note in response to my post on Greece this morning:

I do not understand. If you are going to default (and Greece is) you get all the credit rating stuff up etc – all the pain of default.

Why not try to maximize the benefits by defaulting REALLY PROPERLY. That is actually doing an Argentina. You stuff your credit rating anyway. Nobody will lend to you.

Promise not to pay ANYTHING back – maybe 10c in the dollar and then keep that promise to rebuild your rating.

Its like when you lose the house you might as well live in it for six months free before they kick you out. No point defaulting by halves.

Flatly I think you are wrong. Argentina is the right word as far as capital markets are concerned.

He’s in good company: Peter Boone and Simon Johnson actually think that Greece is in worse shape than Argentina was pre-default.

Greece is far more indebted, is much less competitive in global markets, and needs a commensurately greater fiscal and wage adjustment…

The odds, for Greece, are slim. It is impossible to say exactly what the odds are, but suffice it to say, Greece’s external debt and current fiscal difficulties, while tied into a fixed exchange rate regime, mean that nation needs far harsher adjustments than any of the sovereign major defaulters of the last 50 years. We cannot think of one comparable example of success. The social and political divisions in Greece, along with the penchant for debilitating strikes, also reduce the odds for success.

Boone and Johnson reckon that if Greece opted to default on its debt while staying in the euro, it would “call a stop to all interest and principal for, say, two years”, and then drive a hard bargain:

Financial collapse would mean Greek debt would need to be written down substantially. We would guess that a 65% write down of face value, bringing total Greek debt to around 50-60% of a lower new GDP, would be reasonable. Such write downs roughly match the terms that Argentina received after its debt restructuring.

Still, I’m not convinced. There’s another option here, which I haven’t seen mentioned: rather than Argentina 2001, why not go Uruguay 2002? Or at least somewhere in the middle, like Ecuador 1999? Given the choice — and of course they have the choice — I think that pretty much all politicians in Europe, including the Greeks, would opt to avoid the Argentine precedent.

There are a few different points to bear in mind here, but the first is that holders of Greek debt are powerful voters. Remember Warren Buffett’s words of wisdom:

Let’s go back to 1975 when New York City was on the edge of bankruptcy. At the time its bonds – virtually all uninsured – were heavily held by the city’s wealthier residents as well as by New York banks and other institutions. These local bondholders deeply desired to solve the city’s fiscal problems. So before long, concessions and cooperation from a host of involved constituencies produced a solution. Without one, it was apparent to all that New York’s citizens and businesses would have experienced widespread and severe financial losses from their bond holdings.

Replace “New York” with “Greece” and I think you see a plan much along the lines of Argentina’s much-maligned “megaswap” — the failed attempt to restructure the country’s debt which preceded the outright default. No principal reduction, but lots of pushing out of maturities and interest-rate grace periods, all with the intention of giving the country a bit of time to get back onto its fiscal feet. And while Greek politics are certainly dysfunctional, they’re not as dysfunctional as Argentine politics were at the time of the megaswap, and Greece’s politicians — at least the present ones — are likely to be able to avoid the kind of self-sabotaging comments which turned the Argentine deal into a fiasco. And Buffett’s point is that substantially all of Greece’s elite — not to mention most of its foreign lenders — would be pulling in the same direction if such a thing were tried: they all would know that the alternative would be far worse.

Even then, however, the alternative is not an Argentina-style default. The Kirchners have been masters at demonizing foreign lenders for short-term domestic political gain, but it’s going to be very hard for Greek politicians to do likewise. No one’s blaming Greece’s bondholders for the country’s current fiscal woes.

Argentina, to this day, is essentially an outcast on the international capital markets, and not only because any attempt to issue new debt would immediately be pounced on by the holders of $20 billion in defaulted bonds. A second swap is expected some time this month, which will help, but we’re now almost a decade on from the default, which is an insanely long amount of time to get around to dealing with the bonds you defaulted on.

Argentina therefore spent pretty much all of the oughts in a state of financial isolation: it always had to be super-careful not to place any sovereign assets abroad, lest they be attached; it could borrow only under its own domestic law; and even its own exporters frequently ran into large taxes and other obstacles to growth. It was a set of policies which might work for a proud nation at the tip of South America, but which could never work for a member of the European Union. That kind of default wouldn’t just mean leaving the euro; it would also mean leaving the EU. Which is something all Greeks would oppose, if only on the grounds that the Turks would love it.

The alternative is to have a sensible conversation with the sensible end of your creditor base — the banks and large institutional investors who understand the mathematics of debt sustainability and who want to make sure that if you default, you’re only going to do it once. When Ecuador defaulted in 1999, its creditors weren’t happy. But they could see why the default was fiscally necessary, and they overwhelmingly accepted a 30% haircut, which in hindsight was more than enough to make the country’s debt burden sustainable over the long term. (The fact that Ecuador went on to default a second time was entirely a function of politics and willingness to pay: it certainly had the ability to pay.)

Hempton is I think wrong when he says that a country’s credit rating will be “stuffed anyway” in the event of a default. If done elegantly, that’s not true at all: indeed, a successful restructuring can visibly improve a country’s balance sheet and its ratings. And Greece cares very, very, very much about being a high-income EU country and not an emerging-market basketcase. Remember that it’s still investment-grade today, from all three ratings agencies, despite its 114% debt-to-GDP ratio and 13%-of-GDP 2009 deficit. If it can use a reasonably creditor-friendly debt restructuring to get those numbers moving in the right direction, there’s no reason its credit rating shouldn’t improve.

Uruguay is a case study in how a country can default in an elegant manner, use financing from multilaterals to get it over a short-term hump, and then refinance that debt in the public markets as liquidity and positive sentiment returns.

Essentially, Greece faces two options. It can go the Argentina route, and become an emerging-market country which can support a debt level of no more than 50% or 60% of GDP. Or it can attempt to structure a solution in which it retains its status as a fully-fledged member of the EU and the eurozone, with commensurately low borrowing rates and the ability to support debt much closer to 90% or 100% of GDP.

My base-case expectation for any Greek default, then, will be a restructuring proposal offered with the full support of the EU and the IMF — including lots of liquidity from those two sources. It’ll involve a relatively modest NPV haircut of about 25%, and will probably involve no principal reduction at all — that way banks which don’t mark to market and who have Greek debt on their books won’t need to take a write-down.

The restructuring, if it happens, will be painful and noisy, of course: all defaults are. And Simon Johnson will hate it, saying that it’s insufficient and that Greece will have to reprise the whole operation all over again sooner or later. (Simon is like most present and former IMF staffers in that he loves imposing as much pain as possible on private creditors, since that means that the Fund needs to cough up less cash.) But the point is that it won’t be Argentina, and there will at least be a sliver of a chance that the other PIGS dominoes might not fall as a result.

Back when Dominique Strauss-Kahn first put himself in the running for the managing director job of the IMF, I said this:

One point in his favor: he’s utterly failed to become president of France, so he’s not going to pull a Horst Köhler and quit to become president of his own country.

It seems I might have spoken too soon:

Dominique Strauss-Kahn, the French politician who heads the International Monetary Fund, said on Thursday he might cut short his mandate, stoking speculation that he wants to run in France’s 2012 presidential election.

His term as managing director of the IMF expires in October 2012, several months after the election, which means the Socialist veteran would have to quit ahead of time if he wanted to challenge President Nicolas Sarkozy at the ballot box.

Clearly DSK doesn’t feel much gratitude towards Sarkozy for getting him the job in the first place. But if this does happen, the Europeans really don’t seem to be doing a very good job with the position: both Köhler and Strauss-Kahn clearly consider it inferior to the national presidency, while Rodrigo Rato, who held the post briefly in between them, quit for mysterious “personal reasons”.

Is this a job which we really want to give to Gordon Brown, who certainly would love it? The answer I think is no. It’s long past time that a non-European held the position; maybe, after living in Paris for the past few years, Angel Gurría counts as being French enough to get the support of at least a few European countries.

Gurría is highly qualified for the job, but I think the main thing now is to set an important precedent and just appoint anybody who isn’t European. Strauss-Kahn himself has told the Brazilian president that he wants to change the selection process for his job. If it ends up going to another European, he’ll have failed.

First, there was the G20 communique:

The agreements we have reached today, to treble resources available to the IMF to $750 billion, to support a new SDR allocation of $250 billion, to support at least $100 billion of additional lending by the MDBs, to ensure $250 billion of support for trade finance, and to use the additional resources from agreed IMF gold sales for concessional finance for the poorest countries, constitute an additional $1.1 trillion programme of support to restore credit, growth and jobs in the world economy.

That word “additional” is important. But what does it mean? Liam Halligan thinks it means much less than you think:

The much-vaunted “$250bn [£169bn] in new trade finance” is a mere $4bn of extra money if you look in the communiqué annex.

Doing the maths, even the “$1,100bn stimulus package” – the figure that drove a thousand headlines – turns out to be nonsense. There is less than $100bn of new money, most of that agreed before the G20 convened.

And now Mark Landler is trying to get to the bottom of all this:

About $500 billion of the $1 trillion represents increased direct financing for the International Monetary Fund. But, by Mr. Prasad’s count, less than half of that has so far been committed by Japan, the European Union, Canada and Norway. China is expected to kick in $40 billion, which it may do by buying bonds issued by the fund.

Treasury Secretary Timothy F. Geithner has committed the United States to $100 billion. But that must be authorized by Congress, which, administration officials acknowledge, is skeptical of foreign aid and may be doubly so this time, given its heavy spending on domestic stimulus.

Even counting the United States, Mr. Prasad said that left a shortfall of $145 billion of the $500 billion in donations…

The leaders agreed to commit $250 billion in trade credit over two years, on top of $100 billion in loans from multilateral development banks, which lend to poorer countries…

But of that $250 billion, experts said, only a quarter represents fresh cash: trade financing is rolled over every six months as exporters get paid for their goods and repay the agencies that lent them the money. The agencies then lend out the same money again. There is also some double-counting between the $250 billion and the $100 billion from the development banks.

In perhaps the most novel move, the Group of 20 authorized the monetary fund to issue $250 billion in Special Drawing Rights… The I.M.F. will issue the S.D.R.’s to all 185 of its members, and they in turn can lend them out to poor countries.

Special Drawing Rights are not cash but a form of credit, against which a country can borrow. The Obama administration, which conceived the idea and sold it to the Group of 20, figures it would create between $15 billion and $20 billion in additional credit for the poorest countries.

Where does this all leave us? It’s all rather murky, but some things are more obvious than others: it seems a bit rich to take $62.5 billion in six-month trade finance, for instance, and declare that it represents $250 billion of trade credit.

On the other hand, if the IMF issues $250 billion in SDRs, how can that create only $15 billion to $20 billion in new credit for poor countries? What happens to the rest of the SDRs?

And the biggest question marks of all surround the $500 billion in extra money for the IMF. Where will that money come from? When will it arrive? And did the G20 heads of state actually commit to providing the cash or not? Does Congress have a veto over the US portion? Will it use it?

Net-net I’m inclined to believe that any hard-and-fast statement about how much new money there really is in the G20 package is almost certain to be false: the fact is that no one knows for sure, and won’t for some time yet. But I think that Halligan is overshooting on the pessimistic side, while I’m inclined to optimism here. Maybe I’m being naive, but if the G20 says that there’s $1.1 trillion of additionality, then going by Landler’s article, I’d assume that will work out to at least $400 billion in reality, and possibly more.

Dani Rodrik spots a particularly bright bit of the G20 communiqué:

We agree that the heads and senior leadership of the international financial institutions should be appointed through an open, transparent, and merit-based selection process.

This is spectacularly good news: as Dani says, it “may mean that the era of the World Bank and the IMF being run by Americans and Europeans, respectively, is over. And good riddance too”.

Might Ngozi Okonjo-Iweala become the next World Bank president? Might Mohamed El-Erian be the next managing director of the IMF? Suddenly, there are all manner of tantalizing and exciting possibilities. It’s taken long enough, but I’m very happy this day has finally arrived.