How the IMF reasserted its power in Greece’s debt crisis

On a crisp day last October, the prime minister of Greece, George Papandreou, strode along a red carpet into an emergency summit of European leaders in Brussels and boasted to reporters of his government’s “superhuman” response to its debt crisis.

But in the private reports flowing from Athens, the International Monetary Fund’s point person for Greece, Poul Thom­sen, could see a different reality unfolding.

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Greece was stiffing government contractors as a way to make its books look better, one set of data revealed. Other figures showed that the government was financing its daily operations with debt, like a family paying for food with a home-equity loan. And Greece was making only halting progress in fulfilling its pledges to reduce public payrolls, shut down money-losing state-owned companies and enforce tax laws.

Greece had made a long list of promises in return for emergency help from the IMF and from other European countries, but agency officials increasingly felt they were being taken for a ride. Having extended the country record amounts of money, the agency was in so deep that it could not just walk away. Nor could it continue pouring good money after bad.

Over the decades since its creation after World War II, the IMF has taken responsibility for ensuring the health of the global economy. The agency has repeatedly rescued teetering governments and restored confidence to panicked markets by coupling its unrivaled expertise with money provided by member countries, most prominently the United States.

But the debt crisis roiling Europe — and threatening to snuff out the U.S. economic recovery — has challenged the IMF like no previous upheaval. By last fall, with the Greek debt disease spreading to larger European countries, there was a real risk that the world economy no longer had an effective backstop.

The worsening situation in Greece recalled the IMF’s traumatic experience a decade earlier with a major assistance program for the government of Argentina. After that effort collapsed, the agency’s internal auditors found that the program had continued well after it became clear that Argentine authorities were not living up to the agency’s conditions and had taken “multiple policy initiatives that the IMF viewed as misguided but felt compelled to endorse.” Argentina had continued to receive loan installments based on political considerations, not economic ones, the auditors concluded.

The prime lesson was that in future rescue programs, the IMF should have a clear strategy for exiting if local officials refused to deliver on promised reforms.

This story, based on interviews with more than 20 principal officials from inside and outside the IMF, is an account of how the agency once again became entangled in a failing rescue effort. It is also the story of how the agency, under the stewardship of its new chief, Christine Lagarde, eventually reasserted control with a tougher line toward Greece and increasingly hard-nosed diplomacy with other European governments.