Review & Outlook - Editorial

A Global Chapter 11.

The IMF searches for a new mission

Just once we'd like to see the International Monetary Fund get the protesters it deserves. Not the usual carnival types chanting about war or whales at this past weekend's IMF meetings in Washington, but people who actually know what the IMF does wrong. Serious demonstrators would be howling over the IMF's scheme for a new international bankruptcy court.

Now, we could be glib and say that the IMF certainly knows about bankruptcies since its ideas cause so many of them (Argentina, Indonesia, Russia…). Or we could point out that this idea would give the Fund one more way to meddle in the world's financial markets and hire more staff to fill the new $250million annex it plans to build across the street from its already huge Washington headquarters. But that would be understating the danger.

The IMF's policy goal, to be sure, is the sensible one of providing a process to work out the problems that arise when debtor nations default. Absent any organizing principle, global creditors can end up fighting each other for the crumbs. A few holdouts can delay restructuring, nothing's quite fair and no one can get on with business, least of all the stricken country.

This wasn't a problem in the 1980s, when developing countries borrowed mainly from a handful of big banks. But today most nations borrow by issuing bonds, which are then traded in secondary markets. Overall this creates a more liquid, cheaper supply of capital. But when a nation goes broke, working out an agreement among these highly diverse bondholders can be a nightmare. Argentina currently has more than 120 different bond issues outstanding, subject to multiple jurisdictions and laws.

Two solutions are on the table. One, favored by the US Treasury, would let markets solve the problem. Think of it as a pre-nuptial agreement for nation-states. Borrowers would simply write into their bond contracts 'collective action' clauses that provide for orderly workouts in case of default. Legal precedents already exist for such clauses, setting terms under which a large majority of creditors could override balky holdouts.

To get this rolling, the trick would be to nudge such investment-grade borrowers as Mexico, Chile or Poland, to adopt such clauses as the new standard. Once countries start to do this, such bonds could become desirable to hold because they would offer much greater certainty about the rules of any default endgame.

All of this has the added virtue of sparing the world from solution number two, which is to put the IMF in charge of a global Chapter 11. The Fund wants to amend its charter to gain authority over sovereign debt restructurings and create an international bankruptcy court.

We know why the Fund loves this idea, but it's hard to see what's in it for anyone else. Private creditors would have to cope with an even more powerful political actor, one that is itself a major creditor to countries in debt trouble. Does anyone think the IMF wouldn't put its own debts ahead of everyone else's?

As for the debtor nations, they're already under pressure to follow IMF dictates in order to receive the Fund's bailout cash. New bankruptcy power would give the IMF even more leverage to impose its policy advise on debtors, which on recent evidence (Argentina) isn't what the world economy needs.

Until recently George W Bush's Treasury Department has pushed for the market solution. But last week US Treasury Secretary Paul O'Neill grave ground and also waved ahead the IMF's bankruptcy project. Perhaps Mr O'Neill is hoping that fear of this new IMF power will spook both developing countries and private lenders into going ahead with the market-friendly collective action clauses. But it's risky business to give the IMF any bureaucratic running room, especially with all of that new Washington office space in the works.

We've been around long enough to recall when the IMF was a small gang of experts whose duty was to preserve a stable currency system. But that task ended with the collapse of Bretton Woods in 1971, and ever since the Fund has been a bureaucracy in search of new missions. The bankruptcy court is only the latest, and among the worst.