The International Monoline Fund

Posted by Joseph Cotterill on Jun 17 10:18. 3 comments | Share

Odd story in the Guardian on Friday:Under its acting chief, the American John Lipsky, the IMF has taken a more hardline stance. The fund warned the Germans in recent weeks that it would withhold urgently needed funds and trigger a Greek sovereign default unless Berlin stopped delaying and pledged firmly that it would come to Greece’s rescue… More…

Odd story in the Guardian on Friday:

Under its acting chief, the American John Lipsky, the IMF has taken a more hardline stance. The fund warned the Germans in recent weeks that it would withhold urgently needed funds and trigger a Greek sovereign default unless Berlin stopped delaying and pledged firmly that it would come to Greece’s rescue…

Um – hold on. IMF disbursements are supposed to be tied to reforms and conditionality from the countries receiving this lending. Greece has failed conditions in its Stand-By Arrangement left right and centre. The Fund is theoretically going to make new loans subject to the Greek parliamentary approval of fresh budget measures, but even this is supremely risky.

So here’s our question.

What on earth is ‘hardline’ about the Fund taking a third-party sovereign guarantee — a loan wrapper, a monoline — in lieu of all of that?

However that’s not even the most galling thing the IMF is doing with its Greek disbursements now. It’s also becoming a glorified bond insurer itself, this time protecting private credit. It’s absolutely rubbish protection — unlike the old monolines, the IMF is a preferred creditor — but it’s nevertheless what is increasingly becoming expected of its role in Greece.

Fund money, in the form of a July disbursement, will be needed to tide Greece over until September. It is really the only thing stopping a disorderly default in summer, in which Greece’s private creditors would lose their shirts completely. Instead the IMF has effectively declared that it will guarantee bondholders this summer — no fiscal fix necessary.

This getting familiar.

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A brief history of IMF moral hazard

We’ve told this story before, but it’s more relevant than ever.

Time was, the IMF used to make sovereigns burn private creditors as a matter of course, on pain of not disbursing its rescue loans, let alone enforce fiscal reforms into the bargain.

They made Argentina do it in the famed ‘megaswap’ private maturity extension-cum-rollover of early 2001, although this small defence against moral hazard was to be spectacularly besmirched. The Fund came to issue a second loan to Argentina in autumn of that year anyway. It’s really quite familiar what went wrong: IMF officials hugely over-estimated political will or ability to conduct austerity measures. This was not least because the Fund decided to arrange the new loan despite failing to secure a second Stand-By Arrangement setting out revised fiscal conditions. Argentina defaulted within months of the loan.

We were getting closer to that second loan stage in Greece, but this has been kicked forward to September. But already the IMF is committed to financing Greece without an underlying programme that works.

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The future of IMF moral hazard

And you know what, it’s not just Greece either.

As Fistful of Euros noted recently, the Fund has been drawn into a similar bind surrounding its new programme in Egypt. There’s only been an ‘action plan’ for deferred measures to control state finances:

A number of fundamental structural reforms, including the transition to a VAT-like consumption tax and reform of the highly inequitable and costly system of subsidies, are needed to improve the efficiency of public spending and help reduce the fiscal deficit in the medium term. We share the government’s view that immediate implementation of such reforms is not feasible in the context of this arrangement as additional preparatory work is needed to ensure that an effective safety net is in place to protect the low income households. The government intends to prepare a road map to facilitate implementation of these reforms in the future.

Broadly similar – except a defence of the Fund here would state that the Egyptian state is severely fragile, and the risks of moral hazard are worth it, considering the role the IMF should be playing in the Arab Spring, the relatively small ($3bn) sum involved, and so on. Compare all three points, for example, with the Fund’s Greece exposure (or Ireland, or Portugal).

There have been other curious decisions by the Fund which limn moral hazard, if not on the catastrophic scale of Greece, such as the releasing of loans under the new Precautionary Credit Line to Macedonia in March. At the time, Gabriel Sterne, economist at Exotix, thought it was the Fund using its “AAA” credentials as a business model (a bit like you-know-who).

Macedonia was not in serious trouble (the issue revolved around elections and a looming eurobond payment) and the PCL requires low conditionality. The credit line was really only designed for emergency financing for sudden shocks out of a country’s control. The ‘business model’ will blow up if loans go bad.

But it won’t completely blow up for the IMF, which is the problem investors will now have in Greece. They’re already stuck with a German wrapper on this Fund wrapper on their investment anyway.

The IMF can ‘wrap’ Greek bond payments to investors for a time by continuing disbursements, with relatively little risk towards itself, because of its seniority. However, the more disbursements there are, the more subordinated the private sector will be after a Greek default, and the Fund gets to work recovering on its loans. It took the best part of half a decade for Argentina to pay the IMF back.

Still want to go looking for an ‘IMF rally’ in Greece?

Related links:
A fresh (IMF) sovereign contingent liability – FT Alphaville
Why a Greek default won’t ever be priced in – Felix Salmon
The unenviable, uncertain future of the bond insurance industry – FT Alphaville
No shock doctrine for Egypt – FT Tilt

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