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Worries grow over IMF loans to Europe

Source: Reuters - Sun 11th Dec 2011

The prospect of European heavyweights like Italy or Spain turning to the IMF for rescue loans is worrying the United States and other nations that fear they could suffer losses on funds they have extended to the IMF.

The International Monetary Fund cannot be expected to step in as a substitute for a stronger commitment by Europe which needs to assume the brunt of any losses on emergency loans, a senior US official said on Friday.

Despite the International Monetary Fund's stable record - no borrower has ever defaulted on an IMF loan and no country has ever lost money lending to the IMF - there are concerns about the IMF's growing exposure to the euro zone.

That exposure could take a quantum leap if Italy and Spain need bailouts, a level of assistance that would almost certainly dwarf the loans already approved for Greece, Ireland and Portugal in deals engineered with the European Union.

Emerging markets, which are contemplating lending more money to the IMF - which couples monetary assistance with tough conditions that seek to ensure a country does not default - have also raised concerns in the IMF about the risks to the fund's capital, officials from emerging nations told Reuters.

A crucial European Union summit ended on Friday with a historic agreement to draft a new treaty for deeper integration in the euro zone in an effort to rein in a debt crisis that started in Greece two years ago and has continued to spread.

Worries about the IMF's risk are also brewing among congressional lawmakers.

Four U.S. lawmakers who met with IMF chief Christine Lagarde this week expressed unease over the risk the fund would take on with a bigger role in Europe.

A request for a big IMF loan for Italy or Spain would put the United States, which holds veto power over most IMF lending decisions, in an uncomfortable spot.

The American public is still stung by the U.S. government's big bailouts for banks during the 2007-09 financial crisis and fears that mounting U.S. debts imperil the nation's future.

With President Barack Obama facing a tough battle for re-election in November, the White House is not keen to appear as Europe's savior, and the administration's message to Europe has consistently been: Put more of your own money on the line.

Indeed, Republican lawmakers are seeking to yank a $108 billion loan the United States approved for the IMF in 2009, a move that would undercut Washington's ability to influence the conditions attached to IMF loans.

"If the United States wants to help Europe find a way out of its current debt crisis, we must be a strong, world economic leader, not merely the lender of last resort," Republican Senator Jim DeMint wrote in The Wall Street Journal on Friday.

"Members of the Obama administration must focus all of their efforts on strengthening the U.S. economy and balancing our budget, rather than on continuing to borrow from China to pay for Europe's out-of-control debts," he added.

DeMint said he would seek to force another vote to stop U.S. Treasury Secretary Timothy Geithner from supporting more European bailouts. The Senate voted 55-44 in June against a proposal by DeMint to repeal IMF loan authority.

Domenico Lombardi, a former IMF board official now at the Brookings Institution in Washington, said even if the U.S. Congress rescinded the loan, it would not prevent the IMF from lending to Europe. He said the international community has a stake in ensuring the euro zone crisis does not spread further.


The IMF enjoys an understanding among its members that borrowing nations will always pay the IMF back ahead of private creditors.

However, the scale of borrowing troubled euro zone countries might need raises the specter that one of the nation's could default on an IMF loan.

The IMF has about $380 billion available for lending, a figure outstripped by Italy and Spain's debt refinancing needs. Italy needs to roll over 340 billion euros in debt next year, while Spain needs to refinance 120 billion euros.

"The problem with some of these countries now is you're getting to a point where (debt) is large enough that defaulting on the IMF is attractive enough if you want to reduce your debt," said Raghuram Rajan, a former IMF chief economist now at the University of Chicago's Booth School.

"I'm not saying the euro area will act at cross purposes with the fund. But when it comes to writing down the debt, will the euro area respect the (preferred) status of the IMF?"

European leaders agreed at a summit on Friday to provide 150 billion euros in bilateral loans to the IMF to tackle the crisis, with another 50 billion euros coming from non-European countries.

National central banks in the euro zone would pump the capital into the IMF. The funds would not count as a contribution toward Europe's IMF quotas, which determine its voting power in the fund.


There are two ways of channeling the money to the IMF, either through the fund's general resources or a so-called IMF-administered account.

Any lending from the IMF's general resources would spread the risk across the entire IMF membership. In an administered account, the countries contributing would take the losses in the case of default.

Thus far, Europe has indicated it is legally easier for its funds to be part of general resources.

When it comes to additional resources to battle the euro zone debt crisis, the United States prefers the second option, which would put most of the risk on Europe and none on the United States. The Obama administration has argued for months that Europe needs to put more capital on the line.

"The key point is that official funding must also bear losses if necessary," Rajan wrote in a recent column. "Consequently, if support is channeled through the IMF, the fund will need a guarantee from the euro zone that it will be indemnified in case of a (debt) restructuring."

Mario Blejer, a former Argentine central bank governor, argues that Europe should take care of its own and bear the full risk of any default.

"The IMF's seniority is an unwritten principle, sustained in a delicate equilibrium, and high-volume lending is testing the limit," Blejer and Eduardo Levy Yeyati, a senior fellow at the Brookings Institution, wrote recently.

"From this perspective, the proposal to use the IMF as a conduit for ECB resources - thereby circumventing restrictions imposed by European Union's treaties - while providing the ECB with preferred-creditor status, would exacerbate the Fund's exposure to risky borrowers," Blejer and Yeyati said.

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