Over Their Heads: The IMF and the Prelude to the Euro-zone Crisis that many countries in the former Communist bloc bore alarming similarities to the economies of East and Southeast Asia in the mid-1990s prior to their financial crises. It is now clear that Bakker was right; crises battered a number of Eastern European countries in 2008 and 2009. If anything, he was understating the case, because more advanced European economies that use the euro also underwent severe turmoil starting in 2010, necessitating major international bailouts. But at the time his analysis was produced, it drew a sharply negative retort from members of the IMF’s European Department, which had chief responsibility for overseeing the economies of the countries involved. European Department economists contended that Bakker was exaggerating the peril in Eastern Europe, and although a couple of countries might be at risk, he was misconstruing the situation in the region. As for the possibility of crises in the euro zone, the Fund missed the boat completely.1 This is the story of that period — a peculiar one in the IMF’s history, when it was struggling to define its role in a seemingly crisis-free world, even as trouble was brewing in countries it would later help to rescue. In the course of researching a book on the IMF, I have been struck by the profound ramifications of developments at the Fund during this era. A look back at this period is highly illuminating for anyone seeking to understand the Fund’s strengths and weaknesses in the wake of the series of calamities that swept the globe following the bankruptcy of Lehman Brothers in September 2008. Those calamities have underscored the importance of a healthy IMF capable of fulfilling missions that its founders envisioned seven decades ago — fostering international economic cooperation, maintaining financial stability and assisting countries undergoing temporary hardship. Three major developments at the IMF during the years 2005 to 2009 are chronicled in this paper. First, the IMF’s very purpose and relevance came under question amid a global boom in financial markets that raised doubt about whether the world needed such a large institution dedicated to crisis prevention and crisis management. The Fund was compelled to downsize in 2008, mainly because of pressure from its major shareholder nations. A second element, related to the first, is the IMF’s surveillance shortcomings — that is, its failure to perceive or raise the 1 Information about Bakker’s presentation, and certain other matters reported in this paper, comes from a number of documents not available in the public record, from which excerpts will be quoted. Henceforth, such documents will be cited without footnotes. Information about the debate that took place within the IMF about Bakker’s presentation comes chiefly from interviews with participants, as does other information in this paper about internal IMF deliberations and positions that various Fund officials took. These interviews were conducted on a “deep background” basis, with interviewees assured of confidentiality unless they gave permission to be quoted. Thus, some information derived from these interviews will also be presented without footnotes.
alarm about the forces that would eventually trigger the crises in Europe. Had the Fund been more perspicacious about these forces, it might have been able to rebut the claims about its irrelevance and, conceivably, it could even have resisted the demands for downsizing. Indeed, when the global crisis erupted in late 2008, world leaders began to realize that they needed a bigger IMF, rather than a smaller one. But then the third key development materialized — a crisis in Latvia, where the Fund was, for the first time, relegated to the status of “junior partner,” contributing a minority share of the rescue money while Europe put up the lion’s share, and got a commensurate amount of influence over certain terms and conditions. These developments merit extensive exploration and accentuation because they provide historical perspective on controversies that have flared over the IMF’s actions during the euro-zone crisis. This crisis was the greatest the Fund has ever faced, taxing its resources and testing its mettle in ways that were inconceivable a few years earlier. The sums the Fund lent to three euro-zone countries — Greece, Ireland and Portugal — were of unprecedented magnitudes, far exceeding the rescues launched previously for emerging economies such as Mexico, Indonesia and South Korea. Also unprecedented was the scale of risk, and complexity of forces, that the Fund was confronting as it laboured to keep a financial conflagration from engulfing a regional economy comprising nearly one-fifth of global output as measured by gross domestic product (GDP). The IMF is widely credited with analyzing the euro-zone crisis reasonably well after the crisis erupted, certainly compared with European officialdom. But the Fund has also come under intense criticism, because at key junctures it succumbed to pressure from powerful European policy makers, who maintained heavy influence over the Fund’s levers of control. In the “Troika,” the tripartite grouping of crisis lenders that also included the European Commission and European Central Bank (ECB), the Fund accepted a junior partner role. Then, despite grave misgivings among many of its top officials, the Fund joined in emergency loan packages that piled debt atop of existing debts, extracted crushingly high interest charges and imposed inordinately harsh conditions on the countries that were borrowing the money. The most salient case is that of Greece, where in retrospect the country was saddled with an excessively high debt and should have received relief from its indebtedness much earlier than it eventually did. Among the most unsparing critics of the Fund’s performance have been some of its former staff members, who fear it has been sapped of its most precious asset — its credibility as an independent, neutral arbiter and fixer of economic problems besetting countries, regions and the world as a whole. According to one former staffer, Ousmene Mandeng (2013), the Fund “has been dragged along in an unprecedented set-up as a junior partner within Europe, used as a cover for the continent’s policy Paul Blustein • 1