New York City is abuzz with the news of the arrest of Dominique Strauss-Kahn, the Managing Director of the International Monetary Fund, after a hotel room housekeeper accused him of assaulting her. While the city’s tabloids never tire of a good sexual assault story, it is more interesting that this scandal has garnered interest from the financial press and from investors in general. Who is this fellow, what on earth is the International Monetary fund, and why should investors care about his arrest and resignation?
First, the International Monetary Fund is an intergovernmental organization that was set up in 1945 to stabilize exchange rates across countries and to help reconstruct the international financial system following the Second World War. Prior to this sex scandal, I would doubt that most Americans ever even heard of the IMF. That is because – even though the US is by far the IMF’s largest funder – the country has needed to use the fund. In fact, until the recent financial crisis, no major industrialized country had borrowed from the fund since 1977 (when Italy did to help stabilize the Lira).
Over the past 30 years, the IMF’s role has been to work with lower- and middle-income countries facing government debt problems that were denied access to the normal capital markets. When a financial crisis occurred in one of these countries, the IMF provided loans and required that governments put in place strict economic reforms to give other lenders confidence.
More recently, debtor governments have complained about these strict financial conditions, and have been unwilling to accept assistance from the IMF. The volume of outstanding loans fell to only $10 billion by 2007. This is risen to about $80 billion following the financial crisis – small change in world financial terms.
The sovereign debt crisis in Europe has brought the importance of the Fund back to the fore. Today, rather than lending to developing countries, almost 60 percent of the Fund’s loans are to European governments – with most of that to Iceland, Greece and Ireland. This money is being used by these countries to help pay interest on and to roll-over outstanding sovereign debt, keeping them technically solvent. The fund has over $1 trillion in lending capacity available to help prop-up European debt if it is needed. Since much of the developed world’s investment capital is internationally invested, it is important for American bondholders, insurance companies, banks, and pension funds to see that European debts are paid-in-full. The IMF is an important source of the capital needed to do this.
Clearly, investors should care about the IMF; however, the importance of Mr. Strauss-Kahn himself is much more questionable. That is probably why stock markets barely budged after the announcement of his arrest. Although the Managing Director’s position at the IMF is highly compensated (Mr. Strauss-Kahn received well in excess of $500,000 net of taxes) the role is more of a figure-head held by a European politician or appointee. In fact, the acting director of the fund has stated that it was “business as usual” following Mr. Strauss-Kahn’s arrest. Neither the managing director nor anyone else at the IMF is ultimately in charge of policy, as it is run by its governors and executive directors who are appointees of the US Treasury Department, and the major European countries.
As the trail in New York begins, we are sure to hear much more about the IMF and its ousted director, but it is doubtful that the scandal will have any lasting or real impacts on the international financial system.