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IMF shifts its approach to bailouts

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The International Monetary Fund, convinced that Europe erred in forcing debtor countries like Greece and Portugal to bear nearly all the pain of recovery on their own, is pushing hard for a plan that would impose up front losses on bondholders the next time a country in the euro area requests a bailout.

Scarred by its role in misjudging the depth of the Greek recession and rebuffed in its attempt to get European governments to write down their Greek loans, the I.M.F. is advocating a more aggressive approach to debt restructuring to try to ease the rigors of German-style austerity.

But the proposal — which is still being hashed out behind the scenes by top economists and lawyers at the fund — is encountering stiff resistance, not just from the powerful global banking lobby, but also from European policymakers, and more recently, the United States government, which is the I.M.F.'s largest financial contributor.

Indeed, despite tough talk on both sides of the Atlantic about making bond investors share the cost of bailouts with taxpayers, the world's largest economies seem to have accepted the dire warnings advanced by investors and bankers that the I.M.F.'s proposed new approach would badly roil still-fragile credit markets in Europe.

"The fund has been bruised and abused," said Susan Schadler, a former I.M.F. economist and the author of a recent paper that argues the fund broke its own rules in lending to near-bankrupt Greece. "But in the end there is no trade-off between austerity and debt restructuring — you have to do both," she said.

(Read more: Troika set to get tough over Greece budget shortfall)

Germany is leading the opposition. Policy makers in Berlin and Frankfurt see the Greek debt restructuring in 2012 as a one-off. And they regard any deviation from their core principle — that debilitating debt is to be reduced almost solely via the hard medicine of spending cuts and tax increases — as an escape from fiscal responsibility.

The I.M.F.'s debt plan has been endorsed by the body's top leadership,including the first deputy managing director David Lipton, a widely respected former Treasury official. The initiative is seen by a number of outside sovereign-debt experts as the best of a range of admittedly tough choices in responding to future debt crises.

But the push back against the proposal, which has caught I.M.F. officials off guard, has delayed a planned introduction early next year, with any blueprint now not expected to be presented to the fund's executive board until June, at the earliest.

The fund declined to make any executives involved in the project available for comment.

(Read more: 'Uneasy Calm' in Euro Zone Bonds Could Be Over)

At the root of the issue is the long-simmering dispute between Europe and the I.M.F. over who should pay the bill the next time a country in Europe needs a bailout: taxpayers and workers, or bankers and investors.

These tensions were on full display during the I.M.F. meetings in Washington this fall, when Jörg Asmussen, the powerful German representative on the European Central Bank's executive committee, explained why Germany vetoed the fund's idea that some of Greece's debt, most of it now held by Europe, should be written down.

"The fund is talking about other people's money," Mr. Asmussen, cracking a thin smile, said at a German-sponsored policy forum.

In some ways, the clash is a function of whose money is at stake.

With Europe on the hook for around 340 billion euros ($460 billion) in loans to bailed-out countries in the euro area, compared to €79 billion for the I.M.F., it is not surprising that Mr. Asmussen and his sponsors in the German finance ministry have responded to the I.M.F.'s push for others to accept losses on existing debt by saying, in effect, you first.

(Read more: Will the euro 'speak' German or European?)

That could never happen given that the I.M.F.'s status as a preferred creditor — meaning its loans get paid back before those of any other lender — is perhaps global finance's most sacred writ.

Greek finance minister: 'Cannot take more austerity'

The proposal recalls an earlier era when the fund was the dominantlender to flailing economies in Asia and Latin America, rather than the junior partner it is today in Europe. In that respect, the initiative is being seen by some I.M.F. watchers as a sly move by the fund to reposition itself as a leader and not a follower the next time there is a bailout in Europe.

"Countries at risk may simply reject even talking to the I.M.F., for fear of spooking investors," said Douglas A. Rediker, a former investmentbanker and onetime member of the fund's executive board now at the PetersonInstitute in Washington. "In an effort to remain central, in Europe at least,the I.M.F. could find itself the odd man out."

According to recent data from the European Central Bank, euro area countries have €6.4 trillion in government bonds outstanding, 70 percent of annual economic activity in the currency zone.

Given the strains within the euro zone, a fiscal crisis of some sort is considered highly likely, especially in countries with higher debt burdens like Italy or Spain. Under the fund's proposal, the next time a country has trouble tapping debt markets, it would be given a brief period to resolve its problems. During this so-called standstill — and here is the rub — private sector creditors would be forced to hold on to their bonds (and take a loss), as opposed to just dumping them.

(Read more: The euro was made for Germany: Ex Spanish PM)

"What it comes down to is that next time around, the I.M.F. does not want to just repay private creditors," said Jeromin Zettelmeyer, a sovereign debt expert and a lead author of a recent paper that supports the fund's emerging position on the topic.

The proposal's rough ride recalls an effort a decade ago, when Anne O.Krueger, then first deputy managing director of the I.M.F., staked her career on a similar, even more ambitious attempt to create a bankruptcy regime for debt-heavy countries, akin to what exists for corporations.

The Sovereign Debt Restructuring Mechanism, or S.D.R.M., as it came to be known, was shot down by the United States, bruising egos as well as reputations in the process, and raising questions about the fund's clout on the global stage.

For months now, Mr. Lipton and his colleagues have insisted that their idea should not be viewed as Ms. Krueger's S.D.R.M. proposal in sheep's wool.

While it was expected that the global banking lobby and German officials would oppose a plan requiring them to accept debt losses as inevitable, the emerging opposition from the Obama administration has come as a bit of a surprise.

"It is important that efforts to increase the orderliness and predictability of the sovereign-debt restructuring process be undertaken on the basis of a consensual, market-based contractual framework," Holly Shulman, a Treasury spokeswoman, said regarding the I.M.F. proposal.

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Translation: We don't like plans that mess around with the rights of bond investors. We didn't like them 10 years ago, and we don't like them now.

Amid the dense, carefully couched jargon of the fund's initial paper on the topic, critics have latched on to one sentence in particular.

In making the case for the private sector to share the cost of a bail out at the outset of a rescue, the authors suggested that "a presumption could be established that some form of a creditor bail-in measure would be implemented as a condition for Fund lending."

It was a bland bit of bureaucratese, but to many it crossed a red line.

"If you are talking about debt reduction at the beginning of a program, then it's a problem for me," said a senior government official in Europe, who was not authorized to speak publicly. "Middle-income countries in Europe must pay their creditors — it's the normal thing to do."

But to I.M.F. policy makers it is precisely this resistance to debt restructuring that has made Greece's economic recovery so elusive and kept much of southern Europe mired in recession. And they want to be sure that next time, things are done differently.

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