Today is D-Day for Europe, and soon, the world. Shortly, the IMF will take its historic place as the cash cop of last resort, a post traditionally reserved for the Federal Reserve, which incidentally was rumored to have activated its FX currency swaps with European banks last week (whether or not that is true will be disclosed by next week's H.4.1). This action will open a floodgate of consequences, as every semi-bankrupt country forces itself into a spending frenzy to guarantee that it is truly bankruptcy, no ifs about it, and qualifies for IMF (and thus 20% US) aid. And at that point the politics of a US-funded world bailout really will come to the fore. Because while the Fed bailing out America is one thing due to the Fed's untouchable and unsupervisable status, the IMF, as a corporation, does not share the same "above the law" privileges. And in an election year, with Americans slowly realizing that the fate of the world is truly in their hands, and their tax money is being involuntarily taken away from them as we speak yet again, ahead of midterm elections, all bets are off. For those interested in the actual mechanics of the IMF rescue mechanisms available, as well as some of the political implications likely to follow, here is an overview via Bank Of Countrywide Lynch.
IMF Lending Capacity (Jeffrey Rosenberg )
The IMF has nearly $250 bn in lending capacity currently available. To lend beyond that, the IMF needs consent of participants representing 80 percent of total credit arrangements in their backstop lending facility – the New Arrangements to Borrow (NAB). While legislative approval is not required in some countries, it is required in others. In either case, it would be a politically sensitive issue in any non-European country to support the peripheral European countries, especially if this comes on heels of Germany rejecting the aid proposals for Greece next week.
The IMF primarily funds itself through payments of quotas from member countries based on their relative sizes in the world economy. Currently, these quotas total SDR 217 billion (SDR or special drawing rights, is an international reserve asset created by the IMF and is based on a basket of four currencies), or $328 billion. Additionally, the IMF supplements quota subscriptions through two credit arrangements between the IMF and a group of member countries – New Arrangements to Borrow (NAB) and General Arrangements to Borrow (GAB). The GAB enables the IMF to borrow from participant countries, or their central banks, under certain circumstances at marketrelated interest rates.The NAB is used as a credit facility intended to backstop quota resources, and was recently approved to be expanded to nearly $550 billion from 38 participants, up from $50 billion and 26 participants earlier. Until the expansion goes into effect, the additional lending amounts are available as bilateral agreements, which would eventually be folded into the multilateral (According to a recent IMF conference call, since the NAB is a multilateral loan framework, the IMF usually draws upon it on a proportionate basis to member commitments) expanded NAB.
In reality, the amount the IMF has readily available for new lending is primarily determined by the one-year forward commitment capacity (though this figure is not a rigid maximum). The amount equals usable resources, including unused amounts under loan and note purchase agreements, plus projected loan repayments over the subsequent twelve months, less the resources that have already been committed under existing lending arrangements, less a prudential balance (The prudential balance is an amount set aside to safeguard members’ quotas and claims, also taking into consideration potential erosion of the IMF’s resource base. The prudential balance is set at 20% of member’s quotas used and any amounts activated under NAB and GAB). Currently, the one-year forward capacity stands at SDR 165 billion, or $248 billion.
Spreading the Political Risk Beyond Europe
The lack of a ready liquidity support mechanism for sovereigns in Europe highlights the importance of the IMF in the Greek bailout. Absent the ability or willingness of member states to extend bilateral loans to Greece, the IMF would
be the only support available, in our view. While its current facilities are of sufficient size, the much larger NAB facilities both are not yet operational and in our view require significant political support to execute. Given that the US represents nearly 20% of the total IMF lending capacity (both current and NAB), the failure of Europe to agree to support Greece would shift that political debate to the US and elsewhere.
Until an actual EU/IMF/Greece agreement has been reached and approved in all relevant countries – including by the parliament in some - uncertainty remains elevated in financial markets. Bear Stearns, Lehman Brothers, and AIG all faced shorter time lines at the end of their crises. The abbreviated time line in financial crises stems from the instability of funding. In the case of Greece, that instability may come from what is otherwise regarded as a source of funding stability – deposits. Under normal circumstances, government guarantee schemes generally support stable deposit bases but these are clearly not ordinary circumstances. This week the risk of restructuring – a Greek sovereign default – roiled financial markets.
Whether this concern spreads to depositors in domestic Greek banks will determine whether time will have finally run out on an EU brokered liquidity bailout. Absent that, the IMF stands as the only viable source of funds to avoid further spillover to systemic risk, in our view. And while they currently have enough capacity to fulfill this role, they would likely need to tap the NAB to enable them to support the broader periphery of Europe’s financing needs in a worst case scenario. Such an outcome would test the NAB and the political willingness of a much broader group of countries to support the fiscal deficit challenges of Europe.
The Bank Run
Much has been said over the ongoing Greek bank run by depositors. Some (RBS) did not believe us. They are now stuck holding bonds about 20% lower from where they could have sold them had they listened to us instead of mocking us. But that seems to be a recurring theme. We harbor no ill will toward the nationalized and failed banking institution. Yet, once again we are reminded that once a cascade of events is in motion, depositors, no matter what the level of assurances, simply refuse to keep their money in a banking system in troble. And while Greece is now done, and reliant on the ECB to collateralize its junk-rated sovereign debt, the spotlight now shifts to Spain, Portugal and Italy: are deposit redemptions in those 3 countries approaching the level seen in Greece? Stay tune and find out. In the meantime, as the TimesOnline reports, Europe has, too late, discovered that by the time the liquidity cascade begins, it is far too late.
Central bankers are also working on a separate scheme to stop Greek banks from succumbing to a run on their funds.
The European Central Bank plans to introduce a new emergency liquidity scheme as part of the wider bailout of the country, said sources close to the talks.
Greek banks have suffered a huge outflow of corporate deposits in recent weeks, reducing their financial strength, according to senior bankers.
The scheme would allow the banks to post junk-rated Greek government bonds as collateral in exchange for emergency loans. It will require a change in the European Central Bank's rules: at present it allows only government bonds with a high credit rating to be used in its emergency lending facilities.