SYNOPSIS: No one would argue that there should be no domestic lender of last resort, so why is George Shultz arguing that there should be no international one?
Suppose a group of prominent experts declared that the Federal Reserve should no longer be allowed to lend money during bank runs. Far from helping prevent financial panics, they say, such lending actually fosters them by encouraging the public to be careless; if we returned to the good old days when banks were free to fail, depositors would make sure that a bank was sound before placing money in its care.
Most sensible people would reject this view as irresponsible, no matter how eminent the authors. As Charles Kindleberger showed in his classic study "Manias, Panics and Crashes," those good old days were marked by frequent and often devastating panics, in which even people who thought their money was in safe hands could be wiped out. Both theory and evidence suggest that no matter how much due diligence individual investors may exercise, financial markets are vulnerable to self-reinforcing collapses of confidence unless there is a "lender of last resort": some institution like the Fed that can provide emergency cash to threatened banks and companies. The Fed makes mistakes, sometimes grievous ones; nonetheless, we all sleep better knowing that Alan Greenspan has the power and resources to help fight whatever crises may arise.
Some people who should know better have waged a campaign to prevent the International Monetary Fund from fulfilling that same role in an international crisis. Congress has effectively blocked consideration of a potentially crucial $18 billion increase in the I.M.F.'s financing, motivated in large part by the anti-fund views of people like George Shultz, the former Secretary of State.
Mr. Shultz has argued that the fund should withdraw from its role as the "self-appointed lender of last resort." When faced with a crisis, he says, the "private parties most involved" should share the pain and resolve the problems themselves. To see how irresponsible that view is, try the same argument on a purely domestic crisis.P> Suppose that, worried by tales of bad management, depositors began trying en masse to withdraw money from Citibank -- and that the bank, unable to raise that much cash on short notice, was about to be forced to close. Would you really want the Fed to stand on principle and refuse to supply the needed cash, leaving it instead for the "private parties most involved" -- the bank and its depositors -- to work it out themselves? Not likely. Even those who do not have money at Citibank would be concerned that a bank run would spread, perhaps engulfing many banks and companies that would otherwise have been perfectly sound.
If we need a domestic lender of last resort to deal with domestic financial crises, doesn't the globalization of financial markets mean that now, more than ever, we need a lender of last resort to cope with international crises?
You can argue that the I.M.F. is not ideally suited to be that backstop. Unlike the Fed, which can regulate banks on a continuing basis, the I.M.F. has little power until a country plunges into crisis. That means that sometimes its efforts to save a country from financial collapse also end up providing a safety net for the undeserving -- careless international bankers, even corrupt local politicians. The I.M.F. also makes mistakes; its programs in Asia have been bitterly criticized (although the critics seem to disagree as much with each other as with the I.M.F.).
But the International Monetary Fund is all that we have, and it is a lot better than nothing at all. To hobble the I.M.F. in the belief that world financial markets will take care of themselves is to gamble the stability of those markets on a speculative theory -- a theory that even most of the theorists think is refuted by the lessons of history.
Originally published in The New York Times, 5.15.98