Two farmers meet. ‘I have just insured myself against fire and hail,’ says one. ‘I can see your point about fire,’ replies the other, ‘but how do you make hail?’
The issue of moral hazard, stemming from the IMF acting as a lender of last resort in the international monetary system, is becoming far more prominent. Moral hazard, as it pertains to the IMF, questions whether the availability of fund support encourages unsound risks being taken.
Does the existence of the IMF transfer the economic risk of its member countries onto itself? Ultimately, does the nature of the IMF as a safeguard, lead to an economic system of poor management and unsustainable government debt; the very system that the IMF was created to prevent?
It is this issue that has also haunted governments in deciding whether to let banks and large financial institutions go bankrupt in the case of a financial meltdown. The most recent example of this is the collapse of Lehmann Brothers as a result of the Global Financial Crisis in 2009 and the decision by the US government to allow them to collapse. Whether this action was the right call to make will always be questioned, but one cannot argue that it sent a wake-up call to the private sector.
Through their decision not to step in, the government was showing the banks that their recklessness would not go unpunished. It silenced the notion that institutions were ‘too big to fail’ and provided a great incentive for firms to take on only a conservative level of risk because they could not rely on government for financial support in times of crisis. In the case of the IMF, economies are effectively being encouraged to take on more adventurous and unsustainable economic endeavours because they know the IMF will provide a bailout over and above a country’s designated quota; as much as needed to return them to sustainable levels.
In the example of Greece, the IMF has given Greece financial resources equivalent to 32 times their quota as designated by the IMF. By the IMF ignoring its policy criteria in approving financial bailout packages, it is sending a signal to other economies that the IMF will give them unquestionable access to its pit of funds. The IMF can no longer afford to be the ‘insurance policy’ for countries that have consistently implemented unsustainable economic measures. The IMF needs to make an example to show that it’s not going to be the global economic firefighter.
It can be argued that, without the IMF, individual countries would be less likely to get into balance of payments difficulties because they could not rely on the Fund to bail them out. The IMF needs to grit its teeth and have the gusto to make the necessary tough decisions. If the IMF learns how to say ‘no’, other countries will consequently become more financially independent. They will start taking a more conservative approach to their economic future because of the uncertainty of IMF intervention.
If the IMF were to create this dimension of uncertainty, the IMF could cease being the global economic insurance policy and could revert back to its true purpose, being a lender of last resort. By complying with all Funding requests in the blink of an eye, the IMF appears weak and powerless. It is this image that it must change to return to being the respected organisation it once was.
Above all else, the IMF seeks to promote conservative economic management. This outcome cannot be achieved however, if the IMF itself continues to perform unsustainable actions by using its resources over and above set rules and at the will of countries’ requests. Instead, the IMF must lead by example and conduct sensible action, to instill this conservative nature of management in its member countries.
The issue of IMF induced moral hazard is something the organisation must address to prevent countries from being so dependent on IMF support. The financial workload of the IMF therefore would also be reduced, with fewer countries requiring their aid. The Fund must address the question of whether the additional risks associated with moral hazard outweigh the benefits of the Fund’s financial assistance. How long is the IMF going to be the lender of first resort?
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