For European Union leaders looking for ways to contain the bloc’s worsening debt crisis, news of the weekend arrest of Dominique Strauss-Kahn on sexual assault charges came as a cruel and ill-timed shock. The fallout is almost certain to hit European debt markets and the euro this week.
With Greece failing to meet budget targets and seeking an increase in its E110 billion EU-IMF bailout package, the former managing director of the International Monetary Fund had been due to confer with German Chancellor Angela Merkel on Sunday and then participate in a key meeting of euro area Finance ministers in Brussels on Monday. Instead, his detention removes a key power broker from the scene at a time of heightening political and financial tensions.
Speculation about a Greek debt rescheduling has been intensifying in recent days, sending yield spreads on Greek government bonds to unprecedented heights and causing the euro to decline. Last week’s forecast by the European Commission that Greece’s deficit would hit 9.5 percent of GDP this year, well above the 7.4 percent target under its bailout package, persuaded many analysts and investors that Greece would need to extend maturities or write down some of its debt to have any chance of recovery. Raising the stakes, Finance Minister Wolfgang Schäuble warned over the weekend that Germany wouldn’t agree to any extension of maturities – a technical default – unless private-sector creditors did the same.
It’s hard to overestimate the role that Strauss-Kahn, or DSK as he’s known in France, has played in the debt crisis, and in pushing the IMF to the forefront of global policymaking since the outbreak of the financial crisis. In January 2008, he was the first senior policymaker to urge governments to adopt stimulative policies to counteract the crisis, a position that was quickly taken up from Washington to Berlin to Beijing. And when Greece’s debt problem first became acute a little over a year ago, Strauss-Kahn travelled to Berlin with Jean-Claude Trichet, the ECB president, and persuaded a skeptical Merkel and German Bundestag that the EU – aided by the IMF – needed to support Greece or see the euro unravel. More recently, he has been regarded at the IMF and in European capitals as a voice of relative moderation on Greece, arguing that austerity alone is unlikely to restore the country to economic and fiscal health. That’s a message that many politicians in Germany, Finland and other northern countries don’t want to hear.
The IMF is more than a one-man shop. The fund can still call on Poul Thomsen, a senior Dutch IMF official who led the fund’s negotiating team on the Greek, Irish and Portuguese bailouts. John Lipsky, the deputy who was named by the board to succeed Strauss-Kahn temporarily as acting managing director, has been actively involved in the EU bailouts and in coordinating the fund’s response to the global financial crisis. But forging timely agreements on contentious debt issues requires the clout of someone who can look a prime minister in the eye as a virtual equal. Strauss-Kahn, a former Finance minster and, until this weekend, the bookmaker’s favorite to defeat President Nicolas Sarkozy in next year’s French election, had the requisite stature and influence. Lipsky is well regarded, but a man who served as JP Morgan’s chief economist before coming to the fund in 2006 doesn’t carry the same clout.
Strauss-Kahn’s arrest has almost certainly ended his political career, even if does manage to beat the charges. The fund’s board members must be second-guessing their decision to let him off with a verbal reprimand back in 2008, when it was revealed that he was having an affair with an IMF economist. The scramble to replace Strauss-Kahn will almost certainly generate fresh political tensions. The old duopoly whereby Europeans named the head of the IMF and the US got to appoint the head of the World Bank no long holds in this multipolar world. The leaders of Brazil, Russia, India, China and South Africa demanded more influence over global economic institutions at their recent summit meeting in Hainan, China. Emerging markets have never managed to coalesce behind a single candidate before, though. Europeans meanwhile will be reluctant to cede the IMF post at a time when the fund’s biggest job is monitoring EU bailouts.
French Finance Minister Christine Lagarde would reassure Europeans, but many countries are bound to oppose the idea of yet another French leader at the fund. Other presumed candidates include Kemal Dervis, the former Turkish Economy minister; Mohamed El-Erian, the Pimco CEO and a former IMF official; and Arminio Fraga, the former Brazilian central bank governor and founder of the hedge fund group Gavea Investimentos, now a part of JP Morgan.
The fund’s key shareholders typically don’t reach consensus easily. They had better make an exception this time.
