How the IMF Could Become a Real S&P for International Debt
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Two key members of Congress, House Majority Whip Tom Delay and House Majority Leader Dick Armey have voiced strong objections to the President’s request for $18 billion to replenish the International Monetary Fund. The IMF’s defenders have solemnly responded that blocking supply would have disastrous consequences, only a well heeled IMF can possibly soothe the intemperate beast of global financial markets. This argument has great rhetorical appeal and has hitherto been a reliable solvent of anti-IMF resistance on Capitol Hill. But if the IMF were wiped out tomorrow, would we be left with a precarious vacuum? On the contrary, the private equivalent to the IMF has been around for some time, and has consistently out-performed its public analogue.
A core function of the IMF is surveillance. This is the process by which the IMF provides credit assessment to private investors about its member countries’ exchange rate policies. As such, the IMF is a political imitation of private sector credit-rating agencies like Standard & Poor’s. Clearly, the analogy is limited: S&P does not have a lending capability whereas the IMF’s charter enables it to provide financial assistance to sovereign governments. But it turns out that the limits to this analogy demarcate precisely what is wrong with the IMF. A close examination of the S&P model suggests that the IMF functions are better handled privately, and that the IMF’s lending role be eliminated—not expanded.
If the IMF is as crucial to financial stability as its defenders make out, why haven’t we duplicated the system at the domestic level? Indeed, why doesn’t the federal government rate municipal bonds? The political problems of such an arrangement are obvious. Democratic administrations would be accused of favoritism by Republican mayors and vice versa. In contrast, while Moody’s and S&P receive occasional criticism—no borrower likes his credit rating lowered—their overall reputations remain intact. The value of a credit assessment lies in accuracy, not the credit rating agency’s political views. In order to survive, S&P must maximize the veracity of its product, this means remaining impartial to political whim. The IMF need not satisfy any such market test, and is thus free to play politics.
By restricting its core function to financial evaluation, S&P minimizes the possibility for conflict of interest. Suppose S&P had to rate <?xml:namespace prefix = st1 ns = "urn:schemas-microsoft-com:office:smarttags" />New York City’s bonds while at the same time it held a quantity of these bonds in a portfolio. S&P would have a strong incentive to avoid any downgrading that would reduce the value of its own holdings. Instead, it would be tempted to “work with” city officials to arrive at a “sound economic program for gradual recovery.” Naturally, city officials would take advantage of S&P’s dilemma to argue against any “severe” readjustments, and advocate increased city salaries and continued public spending. Under such an arrangement, S&P would be exposed to the type of political blackmail to which the IMF is intrinsically subject. S&P leaves the business of lending to others, which leaves it free to let the rating chips fall where they may. Nor does S&P elect to play the paternalistic role assumed by the IMF. S&P doesn’t consider itself competent to run a sovereign government and does not dictate recovery plans to troubled economies. It is well aware that if mayors want management advice, they can hire professional consultants. The IMF would benefit from a similar concentration of function.
Both Moody’s and S&P provide far more detailed and varied credit information than the IMF. S&P, for example, uses a 20-tier rating system (triple-A to single-D) with credit availability and interest rates varying accordingly. In contrast, the IMF uses only two classifications—a nation either is or isn’t within the boundaries of the IMF code. This binary logic makes the enforcement of IMF decrees very difficult and fosters a reluctance to divulge early warning signals to investors; this can exacerbate nascent and existing liquidity crises. Indeed, for those debtor nations already bound to an IMF conditionality agreement, suspending loan payments for minor infractions seems too severe, yet a series of minor infractions breeches the agreement. IMF discipline knows no middle ground. S&P, however, need not second guess investor reactions to financial news or the empty promises of debtor governments. Bad policies of U.S. mayors are immediately reflected in bond ratings and higher borrowing costs, cities are given an immediate chance to rethink their policies.
And the S&P approach works. Cities are aware of the basis of S&P ratings and determine their policies accordingly. Of course, S&P stands ready to discuss its decisions and may elect to revise them if the city modifies its policies. But S&P doesn’t dicker with the city or offer to relax its usual grading terms in hopes of advancing the “bargaining process.” Only the city’s officials decide whether the policy is worth the higher borrowing costs. The egregious track record of the IMF as credit doctor is a foil for the outstanding performance of S&P over the last fifteen years. In that short time, S&P has gone from working exclusively in the US to operating in 28 countries worldwide. The IMF has created a class of permanent bad-credit nations that have grown accustomed to its emergency assistance, and an army of Wall Street banks with an appetite for bail-out pork. In contrast, S&P and other firms have been integral in fording emerging economies into the stream of global commerce, and imparting the market discipline essential for sustained economic growth.
But does this move too fast? If the market penetration of credit-rating firms is so profound, and their performance so superior to the IMF, why didn’t they prevent the Asian crisis? Indeed, some financial analysts have blamed Moody’s tardy response to the baht’s crash for aggravating Thailand’s financial woes. This criticism is overblown, and ignores that the key factor in the Asian crisis was the IMF’s implicit guarantee of a bail-out. The moral hazard created by the IMF’s latent promises vitiates the proper functioning of private credit rating agencies.
Finally, the S&P model has the attraction of being self-financing. The costs of rating and monitoring a bond issue over its lifetime are paid by the concerns or governments issuing the debt. This is an interesting counterpoint to the Clinton administration’s argument that the IMF bail out of nations like South Korea and Russia will enhance export markets and create U.S. jobs. If it is the lure of jobs and exports which is driving the Clinton administration’s policy, it should dissolve rather than fortify the Fund. Doing so would allow the private sector to create wealth where the IMF now drains scarce resources and corrupts market processes.
In brief, the market has much to teach the IMF’s supporters. In particular, the market’s separation of lending and credit assessment argues against any expansion of the IMF’s lending role. More generally, S&P and its private sector competitors demonstrate the superiority of a market based credit-rating system. With this in mind, Dick Armey and Tom Delay can stand firm when the spin-doctors tell us that a world without the IMF is a world of financial chaos.