Who’s In, Who’s Out, and Why? Selecting Whom to Bail Out, 1983-1999

Why should the US taxpayer be involved in bailing out the bad loan decisions of the money center banks?

Rep. Denny Smith (R-OR) (Hearings before the Subcommittee on International Trade, Investment and Monetary Policy, 1984)

When the Exchange Stabilization Fund is used, it is used to try to stabilize the world economy, not to help another country but to defend our own country, to defend our own prosperity, to defend our own jobs.

Rep. David Obey (D-WI) (House floor debate on HR 2490, Treasury and General Government Appropriations Act, 2000, 1999)

US actions as an international lender of last resort (ILLR) during the 1980s and 1990s were intended to complement the International Monetary Fund (IMF)’s effectiveness as an international financial crisis manager. At times, Exchange Stabilization Fund (ESF) credits were designed to provide a quick liquidity injection until IMF funds could be disbursed; in other cases, the United States provided supplemental resources designed to increase the overall size of the international financing package being provided. Either way, the United States opted to provide liquidity outside of the Fund in order to correct for that institution’s shortcomings as an ILLR. However, although the IMF’s problems ofunre- sponsiveness and resource insufficiency generated the need for US actions, they do not fully explain why some countries received US assistance and others did not. What interests were US economic policymakers acting to protect? What "selection process” did Treasury use in determining

Figure 5.1

IMF Loan Requests and ESF Credits, 1977-2002

whom to bailout? In his testimony before the Senate in 1977, Anthony Solomon—who served at Treasury under President Carter and then later as president of the Federal Reserve Bank of New York (FRBNY) from 1980 to 1984—summarized the process by which ESF credits are made:

It may be that some country that will be approaching the IMF which we feel is subject to very difficult circumstances, and yet is making a major effort to undertake a stabilization program with the IMF. If such a country approaches us, we would consult with the chairman of the committees and the subcommittees . . . before we would consider this ESF financing. We believe that [it] should be used very selectively, and in relatively few cases is it justified. It is such a short-term bridging operation that it can be of use only in limited circumstances.[1]

Solomon was making assurances to Congress that US dollars would not be put at risk willy-nilly. Treasury would use utmost discretion in making decisions about which countries to rescue and which countries to pass over. In practice, Solomon’s statement was quite accurate. Although a select group of countries benefited from US bailouts (see Table 4.1 in chapter 4), most countries facing financial hardship that approached the IMF during the 1980s and 1990s did not find themselves on the receiving end of US assistance. To illustrate this, Figure 5.1 reports the total number of requests for IMF assistance by year from 1977 through 2002.1 [2] Next to the total number of Fund requests are the number of countries that received an ESF loan the same year.

Why did the United States decide to act as an ILLR on behalf of some countries but not others facing similar problems? Put more precisely, what criteria determined which countries the United States selected for rescue? In the quote above, Solomon indicates that the United States was likely to consider countries facing "very difficult circumstances.” Of course, any country approaching the Fund for a loan is likely to be in that boat, so alone it does not really tell us much. In addition to economic and financial hardship, what factors increased the likelihood that the United States would provide an emergency credit to countries in need? It is my contention here that the primary driver behind Treasury’s bailout selection during the 1980s and 1990s was policymakers’ desire to protect vital US financial interests from threatening foreign spillovers. In the first section below, I further develop this argument. Next, I present an empirical model of ESF bailout selection and then test my argument. The results support my assertion that increased US bank exposure is associated with a higher likelihood of an ESF bailout; however, this relationship only holds when systemic risk facing the broader financial system is elevated.

  • [1] US Senate 1977, p. 28. Emphasis added.
  • [2] These include only standby arrangement (SBA) and EFF requests, the two primarylending mechanisms for addressing short- to medium-term balance of payments imbalances. Concessional IMF loan requests are excluded.
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