By Simon Johnson Dec 19, 2011 8:05 AM GMT+0800
Financial rescue plans for Europe are becoming ever more fanciful. Increasingly, policy analysts in Europe and the U.S. turn to the International Monetary Fund to provide what is termed “the bazooka” — meaning a lot of money underpinning a scaled-up bailout for Italy, other troubled countries and, of course, Europe’s failing banks.
This proposal is somewhere between meaningless and dangerous, depending on its precise form. The good news is that it will not happen. The bad news is that no one is prepared for the real consequences of the bazooka proving to be illusory.
The bazooka is a reference to former U.S. Treasury Secretary Henry Paulson, who famously remarked in 2008 congressional testimony: “If you’ve got a bazooka, and people know you’ve got it, you may not have to take it out.” Paulson was arguing that, if he had the authority to seize Fannie Mae and Freddie Mac, he wouldn’t necessarily need to use it. He was quickly proved wrong.
Today’s proposed bazookas are about providing enough financial firepower so that troubled European governments do not necessarily have to fund themselves in panicked private markets. The reasoning is that if an official backstop is at hand, investors’ fears would abate and governments would be able to sell bonds at reasonable interest rates again.
This idea is just as dubious as Paulson’s original notion. Markets are so thoroughly rattled that if a financial backstop is put in place, it would need to be used — probably to the tune of trillions of euros of European debt purchases from sovereigns and banks in coming months. Whether or not it is used, a plausible bazooka would need to be huge.
Involving the IMF in such a proposal is meaningless if the idea is to use the IMF’s own money. According to the fund, its ability to lend will be boosted to $750 billion. For now, the latest available data on how much the fund thinks it can actually lend is just under 300 billion euros.
Even if the IMF went all in for troubled Europe — an idea with little support in emerging markets — it wouldn’t make much difference. Italy’s outstanding public debt of 1.9 trillion euros is bigger than that of Greece, Ireland, Portugal and Spain combined. The country faces about 200 billion euros in bond maturities in 2012 and an additional 108 billion euros of bills, according to Bloomberg News. The euro area’s 2012 sovereign funding needs are estimated at more than $1 trillion next year alone, and any credible financing plan needs to fully cover 2012 and 2013 at a minimum. It remains unclear who is willing to fund European banks in this stress scenario.
The idea that the IMF could tap emerging markets for additional capital to lend to Europe is met with polite public demurrals. Behind closed doors, it’s not so polite.
The more innovative ideas involving the IMF include some financing provided by the European Central Bank or national central banks within the euro area to the IMF, with the fund then lending this back to Europe.
This would constitute a misguided or even dangerous form of financial innovation. If the precise arrangement involves the IMF taking credit risk, its membership should be worried about losing their capital. The U.S., as the largest single shareholder, would have the most to lose.
Some officials argue that they could involve the U.S. in this maneuver without consulting Congress. That’s a controversial point on which experts disagree. But in any case, who really wants to do that in a presidential election year? The Congressional Budget Office already scores part of the U.S. contribution to the IMF as risky. Any further steps in this direction would raise flags across the political spectrum.
Alternatively, the IMF could provide a back-channel way for the ECB to evade its own rules against lending directly to sovereign governments. But if the IMF takes no credit risk, what is the point? European leaders should face the music and be explicit about any bailouts. Hiding behind the IMF veil will only confuse matters more.
Eighty years ago, most prominent officials and private financiers were confident that the gold standard should and would remain in place. Starting in 1931, the gold standard failed as a global financing system, with unpleasant consequences for many.
As 2011 draws to a close, the age of the global bailout also seems to be fading. Perhaps the Europeans will find a way to scale up their own rescues using their own money. Perhaps they will manage to protect creditors fully, and convince investors to lend to Italy again. More realistically, the bazooka standard is about to collapse.
(Simon Johnson, who served as chief economist at the International Monetary Fund in 2007 and 2008, and is now a professor at the MIT Sloan School of Management and a senior fellow at the Peterson Institute for International Economics, is a Bloomberg View columnist. The opinions expressed are his own.)
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