April 20, 2004

Note: The Latest Argentinian Crisis, the IMF, and the Treasury

People are asking me why I think that in the end Paul O'Neill was in favor of the 2001 summer Argentina bailout. Let me run and find out...

Aha. I appear to be basing my view on chapter 5 of Ron Suskind, _The Price of Loyalty_, as well as on various things that Larry Lindsey and Glenn Hubbard have said to various people. Here's Suskind:

O'Neill generally opposed bailouts, but he wasn't dogmatic.... To O'Neill, decisions that affected the livelihood of millions in the developing world deserved a case-by-case approach rather than rigid prescriptions. Argentina's specific request in the summer of 2001 was relatively technical.... O'Neill joined fiscal conservatives in opposing the deal. But then he wanted to explain the reasons.... O'Neill was quoted in the _Economist_ saying... tha tthe country's economic problems were, in large part, of its own making....

Senior officials of the administration responded anonymously to the _Economist_ quote, affirming that, this time, O'Neill had gone too far. President Bush placed a phone call to placate Argentine president Fernando de la Rua.

In a meeting with O'Neill, Bush said that he understood what his Treasury Secretary was saying to the Argentinians, even if it was a little sharp-edged. He was going to grant the IMF package in any event, a decision O'Neill felt was sound.... This decision established what would be a pattern on international finance: talking tougher than in the past and delivering an ultimatum that a last chance had arrived, but quietly keeping a teetering country form a full collapse. Bush knew that O'Neill didn't want Argentina to implode, and neither did Condi Rice or Colin Powell. In pushing through the IMF loans, he sided with that trio and overruled Lindsey and Hubbard, who felt that it a country got itself into trouble, it should figure a way to get out of it.

In the confusion of rhetoric and action, Lindsey saw Bush's move as a reversal and blamed it on O'Neill--and on the pressure his comments had brought on the administration.

The view, from Gigot to Lindsey, was that O'Neill was dangerous because his positions were nonideological and he had a tin ear for politics. He was unaware of the repercussions of his public acts.

Those closest to O'Neill at the Treasury Department, some of them seasoned Washington mandarins, dispute this. What was unfolding, they say, was a sweeping philosophical battle, in placing a venerable--and, for the most part, successful--idea of pragmatic governance against a counterclaim of ideology and political mobilization...


And here's Michael Mussa, from his book _Argentina and the Fund_, saying exactly what he thinks about that decision:

More important, large augmentation of the program (the disbursement of an additional $5 billion and the pledge of $3 billion more to support debt restructuring) [in the late summer of 2001] clearly called for a de novo assessment of the entire Argentine program-as was done at the time of the December 2000/ January 2001 decision to augment substantially Fund support for Argentina. Was there a reasonable expectation that the Argentine authorities would be able to implement the policies to which they were committed under the program; and, if so, was there a reasonable expectation that the program would succeed, especially in the key requirement that Argentina would be able to repay the Fund in a timely manner? Arguably, in December 2000, it had been possible to answer these critical questions in the affirmative. Interest rate spreads for the Argentine sovereign had risen sharply to about 750 basis points, up from about 550 basis points a year earlier.

With the commitment of a new, large package of international support, with determined and credible actions of the Argentine authorities to contain this deficit within responsible limits, and with some good luck (such as a shift by the US Federal Reserve toward monetary easing), there was at least a reasonable chance that a disastrous default and likely collapse of the Convertibility Plan might be avoided. Financial market confidence in Argentina could improve, allowing renewed market access at significantly reduced interest rate spreads. With capital market access restored and interest rates reduced, economic recovery could begin and fiscal sustainability could be achieved with a politically feasible degree of budgetary restraint. Indeed, as noted earlier, in January 2001, after formal approval of the new international support package and a clear signal of a shift toward ease in Federal Reserve policy, Argentina appeared, at least briefly, to be moving along this desirable course.

By August 2001, however, prospects for a favorable outcome were pure fantasy. Interest rate spreads for the Argentine sovereign had risen well above 1000 basis points and were generally fluctuating in the range of 1,300 to 1,600 basis points. This implied nominal interest rates for the Argentine sovereign (which generally set the lower bound for other Argentine credits) of 18 to 22 percent, with real interest rates even higher due to deflation. Economic recovery was impossible in this situation: and nominal GDP would surely continue to contract even more rapidly than real GDP, implying significant increases in the debt to GDP ratio even if, by some miracle, the government budget were brought into overall balance. The Argentine government's fiscal policy, with its increasing reliance on unsustainable payments arrears, clearly could not meet its targeted objectives. The political consensus to raise the huge primary surplus that would be required to demonstrate sustainable debt dynamics in these circumstances was, quite understandably, nowhere apparent and never likely to materialize. Substantial reserve losses had already occurred, and further bank runs were a continuing threat. An emergency injection of another $6 billion of cash from the Fund was urgently needed to just stave off immediate default and keep the farce going for another few months. If announcement of a large package of international support had helped to bring only brief respite in the relatively favorable circumstances of January, it was absurd to believe that a more modest augmentation of that package by another $5 billion to $ 8 billion would somehow produce a miracle in the clearly desperate circumstances of August. Looking at the facts, a wide range of analysts outside of the Fund (and several inside the Fund)--often with differing views on many issues--clearly concluded that for Argentina, the game was over. Only a fool would conclude otherwise.

Why, then, did the Fund, and the international community more broadly, acquiesce in this folly? Inside and outside of the Fund, there was rightly a great deal of concern about the deteriorating situation in Argentina and about the disaster that would accompany a sovereign default and a likely simultaneous collapse of the Convertibility Plan and the Argentine financial system. Also, Argentina was generally seen as a country deserving of sympathy and support; and the Argentine authorities were certainly willing to draw on this sympathy and support. President Bush publicly expressed the concerns of the US government and its support for further assistance to Argentina. Prime Minister Blair traveled to Argentina to emphasize similar views on part of the United Kingdom. Chancellor Schroeder voiced the concerns and support of Germany, as did senior political leaders from many other European countries. And, beyond the genuine sympathy that was felt for Argentina, there was undoubtedly the desire, both inside and outside the Fund, to avoid the appearance of responsibility for Argentina's collapse.

In fact, however, the Fund's large September disbursement would do no more than postpone the catastrophe in Argentina by three months. This was known or should have been apparent to the top officials in the Fund and among the Fund's major members who together determined how the Fund would respond to Argentina's request for augmented support. Here there was a failure of intellectual courage-to face up to the realities of the situation in Argentina-and a failure of moral courage-to take the difficult decision to decline substantial additional support to policies that no longer had any reasonable chance of success.

Argentina was not helped. Indeed, external assistance that was potentially far more valuable in helping to contain the damage once a de facto sovereign default had occurred was instead squandered in a futile effort to avoid the inevitable. And, a last opportunity to persuade the reluctant Argentine authorities to face very unpleasant realities and prepare for a potentially more orderly (although still difficult and dangerous) retreat was lost. Indeed, through the autumn of 2001, until early December, the Fund maintained a dialog with the Argentine authorities on the assumption that the measures needed to implement Cavallo's zero deficit policy (including the cooperation of the provinces) might somehow be implemented and that Fund disbursements related to performance through the third quarter and year end 2001 might be made (possibly with waivers or under somewhat revised performance criteria). Perseverance by the Fund in this charade clearly did not encourage the Argentine authorities to face up to the reality of their situation and to the painful but necessary decisions implied by this reality.

Damage was also done to the Fund and to its usefulness to the international community. Although much skepticism has been voiced in recent years, I believe that experience clearly demonstrates that there are important situations where large official support packages can be useful in containing the damage from international financial crisesÅ\without putting the public funds lent in such packages at substantial risk. This was so for Mexico in 1995, for Korea in 1998, and for Brazil in 1999. (Thailand in 1997-98 is less clear, in my view; and Indonesia in 1997-98 and Russia in 1998 were clearly not successes.) However, even most advocates of occasional use of large official support packages recognize that there must be limits, both on their size and on the circumstances where they are appropriate. Otherwise, problems of moral hazard could potentially become quite serious, and the official community could run the danger of assuming risks from private creditors that should not be transferred to the general public.

The Fund, and the power structure through which its decisions are made and approved, is the instrument through which the international community determines the conditions and circumstances in which large official support packages will, and will not, be provided. If the Fund fails to act (or not act) in a responsible manner, in accord with the principles and practices that are generally agreed should govern its behavior, then the interests of the international community will not be properly served. In the end, if the Fund fails to do its job properly, its resources and its role as a valuable instrument of the international community will surely diminish. The Fund's performance in the case of Argentina during the summer and autumn of 2001 surely added to concerns in this regard....

Posted by DeLong at April 20, 2004 02:17 PM | TrackBack | | Other weblogs commenting on this post
Comments

Having just purchased Robert Rubin's book and reading the first chapter on the decision making regarding Mexico in early 1995, Michael Mussa's thought processes seem to be similar to the decision making processes in the discussions between Rubin, Summers, and Greenspan. But then the kind of Lindsey-esque thinking suggested by this narrative seems as far removed from rational policy-making as one can get.

Posted by: Harold McClure on April 20, 2004 02:37 PM

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Good analyses, but I think that the game was up long before August 2001. Mussa's idea of a recovery by way of improved financial markets confidence and a balanced budget was in retrospect a clear mistake. Argentina had gotten several rescue packages already and they didn't work. There was no way to balance the budget in a recession that big and there was no way to get out of the recession with a currency so overvalued. The question is ¿Why were IMF economists (and the "Washington consensus") so opposed to a relatively conventional measure such as letting the currency float? I can understand Argentina reluctance at the measure but not the IMF's.

Posted by: Carlos on April 20, 2004 02:50 PM

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"The view, from Gigot to Lindsey, was that O'Neill was dangerous because his positions were nonideological and he had a tin ear for politics. He was unaware of the repercussions of his public acts."

Oh no, you know how those nonideological people are! They'll destroy us all!

Posted by: Jason McCullough on April 20, 2004 06:34 PM

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It seems to me that ideological politicians have more of a "tin ear", and that ones who know how to be pragmatists, such as by supporting the IMF's lending of specie to Argentina when it was in a crisis, know how to be more flexible and responsive, and, in the long run, liked by more people.

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