Can Europe Make It?

Is it time for Christine Lagarde to resign as head of the IMF?

The IMF disregarded its own rules and its management of the Greek debt crisis has been an unmitigated disaster. It's time for Christine Lagarde to do the honourable thing and step down.

John Weeks
8 July 2015

Christine Lagarde. Demotix/Omar Franco Perez Reyes. All rights reserved.Reports out of Berlin and Brussels convey the message that the major powers in the European Union want regime change in Athens. British MP Caroline Lucas labels this rhetoric equivalent to "an attempted coup". Allegations of incompetence and duplicity motivated this apparently fervent desire by the EU leaders for the political exit of Alexis Tsipras along with the euro exit of his country.

For example, Jean-Claude Juncker, president of the European Commission, feels "betrayed" by the Greek prime minister. That being faithful to the EC president would have required Mr Tsipras to betray his election pledges to the Greek people seems not to have occurred to Mr Juncker; or if it occurred to him it was dismissed as irrelevant.
Duplicity and incompetence have certainly characterized the Greek debt crisis, though these emanate not from Athens, but Washington, Brussels and Berlin. Indeed, the duplicity and incompetence shown by the head of the International Monetary Fund would result in pressure to resign or even prosecution in organizations with meaningful accountability mechanisms (the IMF and its staff are immune from prosecution for actions carried out in pursuit of their official work).
Throughout the negotiations between the Troika and the Syriza government the spokespersons of the IMF have justified the organization's position by the argument that "it has rules" that must be followed, and these rules preclude any flexibility.
One set of these rules specifies the conditions under which the IMF makes loans to a government and provides guidelines for the amount to lend in each case. All loans require a "debt sustainability analysis" (DSA).  The purpose of the DSA is to " the borrowing decisions of [the debtor government] and [match] financing needs with...prospective repayment ability, taking into account each country's circumstances."
The components of this guidance are quite specific: 1) analysis of a government's debt twenty years into the future; 2) "stress" tests for "vulnerability to external and policy shocks"; and 3) assessment of "debt distress" at the time of the IMF lending.
Another IMF document summarizes the possible outcomes for a DSA as follows:

...[P]ublic debt can be regarded as sustainable when the primary [fiscal] balance needed to at least stabilize debt under both the baseline and realistic shock scenarios is economically and politically feasible...Conversely, if no realistic adjustment in the primary balance—i.e., one that is both economically and politically feasible—can bring debt to below such a level, public debt would be considered unsustainable. [Emphasis added] 

If someone wishes to do a simple DSA exercise, the IMF provides an online calculating tool for doing so. 

No one can fault the technocrats at IMF for not doing their job and carrying out the rule that a DSA had to precede a lending agreement with the Greek government.  This was done several times since 2010 (see for example the 2012 lending document).  The DSA verdicts were unanimous -- the Greek debt was/is unsustainable; i.e., "no realistic adjustment in the primary balance" can achieve a manageable debt level. 

A recent IMF document conceded this and more (see Joseph Cotterill's detailed deconstruction of text), which implies that the heads of the IMF -- Dominique Strauss-Kahn (until May 2011) followed by Christine Lagarde -- violated the allegedly sacrosanct rules of the IMF by joining the "bailout" programs of European Central Bank and the European Commission. 

Ben Chu in the Independent calls this a violation of IMF rules by its managing directors as the organization's biggest blunder since it was founded (I would nominate the Fund's program for Indonesia in the late 1990s for that distinction).

In mid-April Chris Giles had an article in the Financial Times wondering "how to deal with a problem child like Greece". In keeping with this early childhood development approach to sovereign debt, I pose the question, "how do we deal with a problem institutional like the IMF"?

In the medium term the IMF needs "serious structural reform" to place the institution on a "sound financial basis" in wake of its disastrous lending to the various pre-Syriza Greek governments. At 10% of over 300 billion, Greece is by far the IMF's largest debtor and the Fund could lose it all (as a reckless lender should, otherwise we get "moral hazard", lenders such as the World Bank, African Development Bank and Asian Development Bank acting just as foolishly).

To be effective this structural reform needs external oversight to monitor its progress.  For this IMF-monitoring Troika I suggest the Bretton Woods Project (for the technical reforms), Human Rights Watch (performance monitoring) with Thomas Piketty as convener (he speaks French).

In the short run (as in "immediately") Christine Lagarde must resign, as she should have done in 2014 when the French Cour de Justice de la République "placed her under formal investigation" in a case of electoral fraud.  Since this is the second consecutive French Managing Director embroiled in domestic legal difficulties, consideration might be given to seeking out a candidate from another country, even another continent.

To pursue further the child metaphor, I quote from The Bible, Isaiah 11:6, "The wolf will live with the lamb, the leopard will lie down with the goat, the calf and the lion and the yearling together; and a little child will lead them", which I paraphrase, "The IMF shall be reformed to serve the interest of all its members, and a small country in Europe shall prompt that reform".

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