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Bailouts Go International--The IMF, the U.S., and the Fiscal Crisis |
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"Greece is going to default despite all the talk, despite the liquidity package.
Martin Feldstein, Harvard University Economics Professor, April 29, 2010
On April 23, 2010, after months of failed stability measures, the country of Greece made a formal request to the European Union (EU) and the International Monetary Fund (IMF) for billions in financial assistance to rescue the nation from its debt crisis. On May 2, 2010, the IMF and EU formally announced their decision to provide approximately $146 billion to temporarily keep Greece afloat. The IMF will meet Sunday, May 9th to consider the $40 billion IMF portion of the bailout. With markets struggling around the world and larger nations on the brink of the same costly turmoil, some fear this could set a dangerous precedent for U.S.-financed rescues of debt ridden EU countries.
Greece's Financial Time Bomb: Since adopting the euro as its primary currency in 2001, the Greek government has borrowed heavily from other countries in order to fund high levels of spending. According to the Congressional Research Service (CRS), Greece has maintained an average annual deficit of 5 percent of gross domestic product (GDP) since joining the EU. The EU's growth pact suggests deficit ceiling of 3 percent of GDP and a total debt limit of no more than 60 percent of GDP.
Greece's nation debt now hovers near 115 percent of GDP and its FY 2009 deficit was estimated to be more than 13% of GDP. Greece's abysmal financial situation is a result of runaway government spending and a huge entitlement burden. Greece has the EU's most generous government pensions, subsidizing all workers retirements with 80 percent pay and full benefits after just 35 years of employment. According to the IMF, wages and social benefits constitute 75 percent of total government spending. These unsustainable obligations resulted in government spending which accounted for 50 percent of Greece's GDP in 2009. Now, as a result of their failed policies, Greece is due to default on government bonds that will mature on May 19, 2010. Greece is now slated to be rescued and forced to accept austerity measures that have caused riots and unrest among Greek civilians.
Nation | Percentage of Funding Quota | Percentage of Executive Board Votes |
U.S. | 17.09% | 16.74% |
Japan | 6.12% | 6.01% |
Germany | 5.98% | 5.87% |
France | 4.94% | 4.85% |
U.K. | 4.94% | 4.85% |
The Greek Bailout: On Sunday, May 2, 2010, the IMF and the EU announced that they had agreed to terms on a $146 billion assistance package to bail out Greece before they default on their debt obligations. According to the IMF, the Greek assistance package will be provided under a $40 billion Stand-By Arrangement (SBA), which will be funded through a 50-50 ratio of standard IMF quota resources and bilateral borrowing agreements with countries. The IMF refers to the SBA as its "workhorse lending instrument for emerging market countries." A SBA is a loan arrangement where the IMF agrees to stand-by with funds available to a borrower.
Under the IMF agreement, the loan arrangement will be made using its fast-track procedures. Under fast track arrangements, the funds are generally disbursed right away, instead of in tranches when certain conditions are met. According to the IMF, rapid IMF lending procedures can be used, "When a member country faces an exceptional situation that threatens its financial stability and a rapid response is needed to contain the damage to the country or the international monetary system." The rapid lending is implemented in a three-step process:
Ø The Executive Board is informed about a member's request for assistance.
Ø A staff team is quickly deployed to the country.
Ø As soon as staff reaches an understanding with the government, the Board considers the request to support a program within 48-72 hours.
Under these procedures, Greece could receive $40 billion in IMF funding prior to fully implementing the agreed upon austerity measures.
The IMF Executive Board is scheduled to meet on Sunday, May 9, 2010, to approve of the bailout funding. Generally, IMF lending decisions have consensus support from members prior to the formal approval process. Thus, formal votes are rarely called on loan requests, which require only majority support for passage. Approval of the Greece loan request is expected to be passed unanimously and without a vote, according to the IMF.
America's Burden: Currently, the IMF receives its primary financing through a member quota system which requires members to contribute to the fund based on the proportion of the world economy which they represent. The U.S. has by far the largest single quota contributor burden with a quota requirement equal to 17 percent of all members' contributions. As a comparison, the next largest supporter, Japan, provides 6 percent of the total contributions. Regardless of their support level, all members that provide contributions to the IMF are entitled to a claim on the overall balance sheet, not on specific loan arrangements with countries, such as Greece. If, however, the $40 billion from the IMF's quota resources and bilateral agreements for Greece were looked at proportionally, the U.S.'s 17 percent contribution would be equivalent to $6.8 billion.
Under the SBA lending terms, Greece would begin paying the loans back within 3¼ to 5 years. If there is a default, the IMF's membership as a whole bears any risk from lending to Greece. While the U.S. would also bear a larger risk as the largest quota member, the IMF points out that in its history no participating member has experienced a loss from contributing to the fund. However, the fact remains that contributions from the U.S. quota will be used to bail out an independent nation that-by no fault of the U.S. or the IMF-behaved in a fiscally irresponsible manner and created a sovereign debt crisis. And unfortunately, Greece may not be the only EU nation seeking international relief for a debt crisis in the near future. A number of EU member nations-countries which combined their efforts to compete against the U.S. dollar-may soon be in a similar situation.
The Expanding EU Debt Crisis: Other European nations such as Portugal, Spain, Italy and Ireland could all be in a similar situation soon. Last week, Portugal's credit rating was lowered from A+ to A- and Spain's rating dropped from AA+ to AA. If a larger economy like Spain were to need a similar rescue, it is estimated that it would need hundreds of billions more than Greece. Some estimates surmise that if a larger bailout including the other most likely countries to need assistance-namely Portugal and Spain-could require as much as $650 billion. The IMF's support of the Greek bailout may have the effect of setting a new precedent for Europe. If further bailouts become necessary to save the EU from collapse, will the IMF and its leading contributor continue to supplement the efforts? Will the IMF's new borrowing authority be enough to continue to supply record-level bailouts to European nations with sovereign debt crises? Is the U.S. ultimately willing to participate in more bailouts in the EU? Do we have choice?
The unrest in Greece and fears of contagion in Europe have caused large scale market disruptions around the world. Since late in 2009, the euro has lost more than 10 percent of its value. Markets in both the U.S. and Europe have experienced sharp drops as a result of the Greek bailout and fears of more crises in other countries with high debt risks. Some argue that the Greek bailout is merely a backdoor handout to Greece's creditors, whose fears of default may be contributing to the market downturns. In addition, some maintain if the EU is concerned that a Greek default will damage the Euro's reputation (and its ability to compete with the dollar) than the EU should take sole responsibility for assisting Greece.
Will it Work?: Even at $146 billion, some experts contend that the bailout will not be enough to solve Greece's financial crisis. While the assistance will allow Greece to stave off default in the short term-especially when more than $10 billion in bonds mature on May 19-it will not be enough to fix the long-term problems in Greece, according to some analysts. The austerity measures are designed to bring Greece's deficit down from 13.6 percent of GDP to less than three percent by 2014. However, the changes will not have enough impact to significantly bring down Greece's debt to GDP ratio since the nation will still be running an annual deficit under the best-case scenario. Furthermore, many of the measures imposed on Greece will increase taxes on businesses and individuals, which could slow economic growth ultimately necessary for Greece to see its way through this crisis.
To make matters even worse, the Greek public appears to be ardently opposed to the austerity measures their government agreed to when they accepted the bailout deal. At least three people were killed in riots that coincide with a nationwide strike on May 5, 2010. The general strike was supported throughout Greece by a broad spectrum of the labor force, including store owners, journalists, bank employees, teachers, court workers, lawyers and doctors. As the EU and the IMF move closer to approving the bailout, the strike-the third nationwide strike of the year-has reached a new pinnacle of violence. Since the Greek populous is so opposed to the spending cuts and tax increases, it cannot be a foregone conclusion that the Greek government will live up to the agreed austerity measures. If Greece were to abandon some or all of the austerity measures Greece could find itself in the same situation as soon as the bailout funds are depleted. Even with these measures in place, it still may.
What Can be Done?: As noted, the IMF will hold a meeting to give final approval to the Greek bailout package on Sunday, May 9th. Some major IMF decisions require 85 percent approval by the IMF's Executive Board, but loan requests require only a majority vote. Voting power on the Board of Governors is allotted based on the size of the member's quota. As such, the U.S. holds 16.7 percent of all IMF voting power. As the leading vote holder on the IMF, the U.S. wields the largest amount of say in determinations made by the IMF. However, the U.S. cannot unilaterally block the Greek bailout loan request because such requests require only a majority vote. The IMF does not expect that a formal Executive Board vote will be held. However, the U.S. could call a vote. While the U.S. cannot unilaterally stop this loan request, a no vote would send a clear message. Europe needs to put its own fiscal house in order with spending restrictions, entitlement reform and pro-growth economic policies instead of looking to the American taxpayer to bear the risk for one more government bailout.
