How exactly would the IMF bail out Europe?
The latest twist in the euro zone crisis is that Europe’s leaders are now asking the International Monetary Fund to step in and help supplement their bailout efforts for countries in debt crisis. So how would this work? Would it work? Here’s a quick way to think about it.
Recall what’s at the root of the current market panic. Italy and Spain need to refinance roughly €1 trillion in debt over the next three years (and that’s before any additional borrowing they might do). Investors are nervous about lending money to either country and are demanding unsustainably high rates. That, in turn, makes it ever less likely that Italy and Spain can repay their debts. Voila, crisis! So it would help to have some sort of “lender of last resort” to help out countries like Italy and Spain that are having trouble raising money on the world market.
So far, European leaders have set up the European Financial Stability Fund for that purpose, especially since Germany doesn’t want Europe’s central bank to start printing euros and doling them out left and right. But, as the chart on the right shows, the EFSF has only raised about €440 billion — and nearly half of that is already committed to Ireland, Portugal, Greece, and (possibly) some troubled banks. There’s nowhere near enough left to bail out Spain and Italy, which is why markets are so nervous. Europeans have talked about “leveraging up” the EFSF through complicated financial maneuvers, but that hasn’t worked so far.
Now, enter the IMF. The IMF, on its own, can’t make up the shortfall. Right now, the fund has just €390 billion in uncommitted resources. That won’t get to the to €1 trillion or more needed to protect Italy and Spain — and maybe Belgium, if it came to that. On the other hand, the IMF does have 187 member nations, and some of those countries could, in theory, lend additional money to the IMF to aid Europe. European member states could do this, for one. So could countries like China, Russia, Saudi Arabia and Brazil. Heck, the United States could even lend additional money to the IMF to help backstop Europe’s debts, although the political fallout from that here at home would be… interesting.
The advantage, for Europe, of taking this route is that all 187 member countries would be liable for any IMF loans handed out to help backstop Europe’s sovereign debts. That makes the IMF a very solid lender of last resort. (It also explains why countries like Germany would prefer to go this route, rather than put even more of its own money at risk with the EFSF.) The downside is that the IMF, at least thus far, hasn’t sounded particularly keen on bailing out Europe, and its member states are a little reluctant to pony up further resources. Obama administration officials keep insisting that there's been no discussion of putting up more U.S. money.
Over at the Financial Times, Martin Wolf seems to think the whole convoluted IMF scheme is a little harebrained. He argues that the European Central Bank, which has unlimited resources since it can print euros, should just backstop Italy and Spain’s debts itself — here’s an explanation of how that would work. And he might get his wish. Over at The Wall Street Journal, Simon Nixon reports that the European Central Bank is sounding like it’s finally ready to “fire the bazooka.” Of course, there’s still the possibility that the crisis has now advanced so far that even the ECB can’t save the euro from ripping itself apart. See Karl Smith and Austan Goolsbee for more on that.