This year and next, Brazil will get new commitments for an estimated $52 billion in foreign cash, and not one cent of it will come from the International Monetary Fund or any other official lender. The money will flow entirely from global capital markets and private investors, just as did the subscriptions to a $3 billion Eurobond that Brazil floated in April. Meanwhile, Goldman, Sachs & Co. and General Electric Capital Services Inc. are working together to restructure $7 billion in Thai consumer and corporate loans. And in South Korea, U.S. venture capitalists Hambrecht & Quist led a group that took over Ssangyong Securities.
Welcome to the new global monetary system, in which the markets rule and bodies like the IMF take a backseat. Reform of the system looms large on the agenda of the IMF/World Bank annual meetings in Washington from Sept. 25 to 28. But while academics, policymakers, and bankers shower each other with a confetti of banking buzzwords and economic jargon, the world has moved on. In the past decade, private investors and lenders have sent a total of $1.2 trillion to major emerging economies, six times the $200 billion that came from all official sources (chart). Meanwhile, new rules proposed by the Basel Committee on Banking Supervision, set up by global central bankers, could encourage banks to lend more money to countries such as Croatia, Malaysia, and Tunisia that have good credit ratings.
The surging conviction that the private sector can play a decisive role in resolving global financial crises is still surprising, considering the traumas of the last two years. During the turbulent months of the Asian crisis, it seemed that only the IMF's billions could save the world from panic. But now, analysts and policymakers see that the private sector proved remarkably adept at seeking out opportunities to restructure banks and other institutions caught in the crisis. Forward-looking leaders in places like Korea and Thailand have let the process work and invited in private players to aid in reform.
Thus, out of the Asian crisis is emerging a possible new blueprint for the global financial order. In it, the IMF has a reduced but still critical role: using its limited funds as seed money to attract private money. The Fund would work much more closely with private capital in bolstering financial institutions caught in crises, providing hands-on crisis management, and transferring ownership of key assets to new players. In short, the august order imposed by Bretton Woods could give way to a more flexible model where many actors would have important roles.
Yet much of this optimistic scenario will remain a dead letter unless the U.S. backs it. The math is simple. With an 18% share of the votes, the U.S. has a veto on IMF decisions. Successive Treasury Secretaries have used the Fund to implement the Administration's foreign policy--and as a handy scapegoat when things go wrong. "The IMF is used as an arm of U.S. foreign policy," says Christopher Frenze, chief economist at the U.S. Congress' Joint Economic Committee. "The problem is, there's been an erosion of support for the IMF from Congress in both parties."
The world can ill afford to delay change until Washington political battles are fought out. As the global economy recovers from the Asian crisis, demand for investment financing and borrowing is set to soar. Already about a third of the world's 150 developing nations have access to global financial markets and rely primarily on private finance.
Because of that reliance, the IMF's traditional solutions are often inadequate and sometimes dangerous. Today, crises are increasingly sparked when companies and banks become insolvent--not by slack government fiscal policies. Thailand's 1997 problems, for example, occurred because local companies borrowed huge amounts in dollars, then couldn't pay when the baht collapsed after jittery foreign lenders stopped rolling over loans. In such circumstances, IMF programs requiring countries to cut budget deficits, slash local subsidies, and hike interest rates don't work. "The IMF found itself involved in issues that it didn't have the capacity, tools, or legitimacy to solve," says Walter Molano, an economist with BCP Inc. in Greenwich, Conn.
"FIRE BRIGADE." Yet the Fund is still hostage to past successes, for example in 1995 after Mexico devalued in 1994. With a bailout of $17.8 billion, supplemented by a hefty $20 billion credit from the U.S. Treasury, it managed to stop a dangerous contagion of other countries. The Fund was accused of bailing out rich bondholders, including many American banks, at the behest of the U.S. Treasury. All the same, the success, says Molano, led to a perception that the IMF was a "global fire brigade" capable of dealing with any problem, anywhere, anytime.
Such high expectations are impossible to meet. And now, support for large IMF-style assistance programs is waning among creditor nations. U.S. and IMF officials are investigating whether any of the $4.8 billion lent to Russia in 1998 found its way into mobsters' pockets. Meanwhile, the agency's $43 billion program for Indonesia initially made the situation worse and hasn't ended the systematic looting of the banks.
Although the IMF finally won a congressional vote for an extra $18 billion of finance last October, it can't rely on automatic support from major shareholders such as the U.S. in the future. So it needs to redefine its role. A blue-ribbon panel of the Council on Foreign Relations suggested that for a start, the IMF should return to previous lending practices. Traditionally, the Fund would lend a member in any one year only the amount it originally ponied up to join the IMF. And the maximum drawings were capped at three times this so-called quota. But Mexico, Indonesia, and Thailand received between five and seven times their quotas, while South Korea got a stupendous 19 times. Returning to the old guidelines in future crises would mean that the IMF used its limited funds to reassure private banks and investors and encourage them to put in their own cash.
Absent a decision on how the IMF should behave, some emerging countries are going to take matters into their own hands. In 1998, for example, Malaysia slammed its doors with currency and capital controls. At the time, its action was condemned as an undesirable step back from free markets. But today the debate has turned. "There has been a fundamental change in the mind-set on the issue of short-term capital flows and these kinds of intervention," World Bank chief economist Joseph Stiglitz said recently.
Clearly, the evolving system still has plenty of flaws that prove that a purely market-based solution to global financial police work is no more desirable than an IMF diktat. Private banks and investors tend to cold-shoulder nations that hit economic turbulence. As banks get worried, the extra interest that emerging countries have to pay on borrowings spikes sharply. Investors then rush for the exit, and lending dries up. After the earlier Asia crisis and Russia's default last year, for example, private capital flows--though still bigger than official flows--shrank to a trickle.
Obviously, institutions like the IMF must step into these situations. Yet reform advocates argue that banks and investors need to participate in crisis management from the get-go, not just as an afterthought. "If banks used their own money [in bailouts], they'd be judicious," says Ian Vasquez, an international monetary expert and IMF critic at the Washington-based Cato Institute, a libertarian think tank. That way, private banks and bondholders could no longer rely so much on being bailed out at taxpayers' expense. The logic of binding banks tightly into the system is so compelling that analysts such as Morris Goldstein of Washington think tank Institute for International Economics predicts the private sector will become increasingly involved in crisis management. "The alternative is very large rescue packages," he adds. "Public support for that will not be forthcoming."
But the private banks may have to be dragged kicking and screaming into these new arrangements. To them, it looks as though they're being set up to take what they call haircuts, in which banks write off a substantial part of what they're owed and even put in new money. Just such a painful trim is in view with Ecuador, which is near to defaulting on $6 billion of bonds.
Still, the banks swear that they are willing to help find answers. The Institute of International Finance (IIF), a Washington-based lobbying group of 300 of the world's leading private banks, says private creditors have taken losses totaling about $350 billion as a result of the crises in Asia and Russia. What angers them is that loose talk by national government and international officials seeking to force financing or rescheduling from private creditors has lately made market conditions far worse than necessary in Pakistan, Romania, and Ukraine. And the banks don't think the IMF is cooperating closely enough on reform.
All the same, major creditor countries are starting to put in place changes to make the system run more smoothly and help the flow of private funds. For example, as of April, the Fund instituted so-called contingent credit lines. The idea, born out of the Asian and Latin American crises, is to provide finance for up to a year to countries that have sound economic fundamentals but are faced with a balance-of-payments crisis because of a sudden loss of confidence. Also, a new IMF grouping is being set up to draw major developing countries into regular consultations. Debtor nations need to help themselves, too. Mexico, for example, holds regular conference calls for fund managers and institutional investors and publishes quarterly statistics--and as a result has a better debt rating. "This [approach] introduces transparency and imposes discipline," says the IIF's Lex Rieffel, "and that is very powerful in preventing crises."
BACKSLIDING BANKS. Private-sector solutions can work even once a crisis hits. Many specialist investors will buy assets at knockdown prices in the hope of turning a profit by making them over. Thailand, for example, agreed with the IMF to close down and sell 56 insolvent finance companies in just 18 months. Now, Goldman is restructuring about $2 billion of nonperforming loans in everything from credit cards to mortgages and corporate loans at Thai Farmers Bank PLC.
Cases of backsliding, such as the slowness of South Korean banks to deal with bad loans, show what still needs to be done. "The pace of IMF reform cannot slow," warns Catherine L. Mann, senior fellow at the Institute for International Economics. "If it does, there'll be hell to pay." Of course, it all sounds good in theory, but an agency with 182 member countries doesn't change with a snap of the fingers. But it had better start: Somewhere on the planet, the seeds of the next financial crisis are already being sown.