Author Archives: Deborah Lucas

Who pays when Greece defaults on the IMF?

Greece recently failed to pay $1.7 billion due to the IMF, thereby becoming the first developed country to default on an IMF loan. That missed payment represents only a portion of the approximately $23 billion in IMF credit outstanding to Greece, suggesting the ultimate losses to the Fund could be much bigger.

The good news is that the potential losses are small in comparison to the IMF’s $350 billion in pledged resources from its members. Barring massive contagion, there is no threat from Greece to the Fund’s solvency.

Nevertheless, the costs to the IMF are likely to be significant. And ultimately it is the taxpayers from the IMF’s 188 member countries that will bear them. The losses are distributed unevenly because membership shares across countries vary widely. The U.S. holds the largest stake, at 17.6 percent of the total. The next largest shares belong to Japan, Germany, France, the UK and China, at 6.6, 6.1, 4.5, 4.5 and 4.0 percent respectively.

The IMF’s opaque financial disclosures and the vagaries of member government accounting practices will allow those taxpayer losses to go largely unnoticed. Member exposures arise through their “quotas,” which are obligations to deposit funds with the IMF. The deposits are backed by the IMF’s substantial holdings of gold, its loans and other assets. The IMF offers a succinct description of its funding structure here.

Some contend that quota payments made to the IMF are investments and not a taxpayer expense. They argue that balances earn interest at the fund and can, at least in theory, be withdrawn if a participating country so chooses. However, when the price of an investment exceeds its value, the investors take an immediate loss. When the IMF offers financing at concessionary terms to distressed countries, it provides subsidies that are paid for by taxpayers. Those subsidies are much smaller than the total amounts paid in, but nevertheless significant.

Of course the benefits of the IMF’s support of the international monetary system and aid to troubled economies may greatly exceed the associated costs to member countries. The point here is that in the interest of transparency, it is worthwhile to quantify the costs (and benefits) more carefully than has typically been done. Work at the CFP has looked at the cost of related guarantees – such as our work to evaluate the cost of government credit support in the OECD context – but we have not yet studied the IMF deeply.

Apart from IMF loans feeling a bit like play money, another factor that may have muted the repercussions in financial markets of Greece’s default to the IMF is that the event didn’t trigger payments on Greek CDS contracts. This is a reminder that CDS contractual terms do not always align with one’s intuitive notion of what constitutes a default, and complicates the relation between CDS pricing and bond valuations.

Professor Deborah Lucas is the Sloan Distinguished Professor of Finance at MIT’s Sloan School of Management, and the Director of the MIT Center for Finance and Policy. Doug Criscitello is the Executive Director of  the MIT Center for Finance and Policy.

For more information, please visit the CFP website http://cfpweb.mit.edu.

Unfunded State and Local Healthcare Benefits, the Elephant in the Room?

Last week Bob Pozen, a Visiting Senior Lecturer here at MIT Sloan with a distinguished background in government, business and education gave an eye-opening lunch talk. The topic was “Other Post-Employment Benefits” or OPEBs—which is accounting jargon for the liabilities governments incur for retiree healthcare.

Here’s what he found:

“The 30 largest American cities had over $100 BILLION in retiree healthcare deficits in 2013, as estimated by the Pew Charitable Trust. In that year, New York City showed the most serious retiree healthcare deficits at $22,857 per household. The retiree healthcare deficits of the States were even larger in 2013 — a total of $528 BILLION according to the credit rating agency Standard & Poor’s.”

How have such enormous liabilities gone largely under the radar? One reason appears to be lack of transparency in how they are reported. Governments are not required to fund those liabilities, and in most places they don’t appear on balance sheets. (That omission will be corrected if GASB, the government accounting standards setter, prevails.) OPEBs also lack the constitutional protections of pension promises. That means cities like Detroit that run into financial trouble may find a way out of those obligations. In most places though, taxpayers will foot the bill unless benefits are renegotiated.

You can read more about OPEBs and Bob’s suggestions for how to address them at:

Real Clear Markets – “Unfunded Retired Healthcare Benefits are the Elephant in the Room

Boston Globe – “Boston Must Rein Retiree Health Plans

Bridging the knowledge gap on governments as financial institutions

Ask most finance experts about the “world’s largest financial institutions,” and you’ll hear names like Citigroup, ICBC (China’s largest bank) and HSBC. However, governments top the list of large financial institutions, with investment and insurance operations that dwarf those of any private enterprise. For instance, last year the U.S. federal government made almost all student loans and backed over 97% of newly originated mortgages. Add to that Uncle Sam’s lending activities for agriculture, small business, energy and trade, plus its provision of insurance for private pensions and deposits, and you’ll discover it’s an $18-trillion financial institution. By comparison, JP Morgan Chase, the largest U.S. bank, had assets totaling about $2.4 trillion.

While government practices differ across countries, the basic story is much the same everywhere. As the world’s largest and most interconnected financial institutions — and through their activities as rule-makers and regulators — governments have an enormous influence on the allocation of capital and risk in society. And as financial actors they are confronted with the same critical issues as their private-sector peers: How should a government assess its cost of capital? How should its financial activities be accounted for? What are the systemic and macroeconomic effects? Are the institutions well-managed? Are its financial products well-designed?

Surprisingly, little research has focused on governments as financial institutions in their own right, and on finding solutions to the challenges they face. While private-sector financial theory and practice have benefited from decades of transformational innovations, public-sector financial thinking and education have not kept pace.

To help to bridge this knowledge gap, MIT is launching the Center for Finance and Policy (CFP) under the aegis of MIT Sloan’s Finance Group. A primary goal of the CFP is to be a catalyst for innovative, cross-disciplinary, and non-partisan research and educational initiatives. Its activities will address the unique challenges facing governments in their role as financial institutions, and also as regulators of private financial institutions. The aim is to provide much-needed support for policymakers and practitioners that will ultimately lead to improved decision-making, greater transparency, and better financial policies.

A quick look at recent headlines shows just how much is at stake and some of the significant decisions that need to be made. There’s the announcement by the BRICs about the formation of the New Development Bank, which will serve as a channel for large government-backed investments in those countries. In the U.S. there’s been heated debate over whether the Export-Import Bank should be reauthorized and whether the federal student loan programs are adequately serving students. There’s also the question of if, how and when the U.S. mortgage market will be reprivatized.

Research supported by the CFP is organized around three main tracks: the evaluation and management of government financial institutions, the regulation of financial markets and institutions, and the measurement and control of systemic risk. A critical focus of the CFP is the dissemination of knowledge to turn theory and data analysis into practice. That will be accomplished through policy briefs, conferences, the website, a visiting scholars program, and other initiatives.

We’re also focusing on education. The aim is to provide greater access to the tools of modern financial analysis to current and future regulators, policymakers and other stakeholders in the public sector. People working in the public sector have traditionally faced barriers to obtaining high-level financial education due to the cost and lack of a developed curriculum. We’re planning to use MIT edX to develop and offer material that will reach a broad audience free of charge. We also plan to offer special executive education programs and short courses at Sloan. To support those efforts, the CFP is investing in curriculum development in the application of financial concepts to public policy contexts.

The CFP will be officially announced in conjunction with our inaugural conference, which will take place Sept. 12-13. The conference will highlight new research related to its three main research areas. It features six paper sessions, three panel discussions, and a keynote address. Over 100 participants are expected to attend including policymakers, practitioners, and academics. The event will be available afterwards online.

I believe that the CFP’s research and educational initiatives will significantly move the needle on how policymakers think about their role as financial decision-makers and regulators, and ultimately have transformative effects on the quality and conduct of financial policy.

Deborah Lucas is the Sloan Distinguished Professor of Finance at MIT Sloan and Director of the MIT Center for Finance and Policy