Commentary: Imf Bailouts: Some Debtors Are More Equal Than Others

Ripplewood is negotiating to get the government to assume LTCB's worst loans

Bankers call them bail-ins or haircuts--and hate them. The new jargon describes the process by which bankers and other private investors pay the price of bad lending to emerging countries.

Until recently, global banks could be pretty sure that the International Monetary Fund would bail out any country that by mismanagement or bad luck could no longer service its debts. In turn, private investors and bankers were, well, bailed out, too. That unfairly left the taxpayers of major industrial countries to pick up the bill, and the banks to pocket the profits.

No longer. With Ecuador spiraling into bankruptcy, the IMF staged a piece of financial-political theater during its annual meeting in Washington in late September. In a televised address, Ecuador's President Jamil Mahuad announced on Sept. 26 that his country would pay about half the $94 million of interest due on $6 billion of bonds a few days later. Bondholders, mainly big banks and investment funds, would have to use some of the collateral backing the bonds--cash or top-grade financial paper--to pay themselves the rest.

CLEANUP TIME. The attention grabber was that it was the first time any country had defaulted on so-called Brady bonds. Named for former U.S. Treasury Secretary Nicholas Brady, the bonds repackaged debt from the Latin American crisis in the 1980s. And the long-overdue message that the IMF won't bail out investors anymore had two audiences. Private lenders now know they will have to take a hit when a country goes bankrupt. Meanwhile, emerging countries were told: "Get your house in order, get permanent debt forgiveness from the private sector, and then come to us," says Arturo Porzecanski, chief economist for the Americas at ING Barings in New York.

The new approach makes sense: Investors will pay more attention to risk if there's a chance they will lose their shirts. And governments will have to take unpopular measures to keep their access to global markets.

This first became evident last year, when the IMF began to play hardball with Russia's default and followed up with Pakistan and Romania. That points up one weakness in the new system: Bad debtors won't get equal treatment. Foreign policy and security, rather than purely financial, considerations will weigh heavily in some of the decisions. Put bluntly, some deadbeat debtors will be more equal than others. Those whose stability matters to neighbors or the world's heavy hitters will be favored. Small, strategically unimportant countries such as Ecuador will go begging.

The new rules are still murky. But if the IMF is serious about making private lenders pay for their risky bets, then Wall Street investors will have to honor the free-market rules they preach. That will come as a relief to global taxpayers.