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13 July 2011, Gateway House

Christine Lagarde: In the hot seat

As the new head of the IMF, Christine Lagarde’s experience in cajoling world leaders will go some way in negotiating the European bailouts. The real challenge, however, will be trying to raise funds for anything as large as Italy.

Editorial Advisor, Gateway House

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Christine Lagarde, the new managing director of the International Monetary Fund (IMF), was a rising star at the U.S. law firm Baker and McKenzie before she became a French government official just six years ago. Lagarde spent 24 years with the Chicago-based firm, which calls itself the second largest in the world by number of lawyers. It’s heavily international in Asia as well as Europe.

Lagarde’s specialty, anti-trust and labor law, are not disciplines usually sought in IMF leaders.

But her work provided years of experience handling complex negotiations. She made partner in six years, managed the Western Europe part of the firm from Paris, and was fully acquainted with the politics of European nations. She leapt into ministerial posts in France in 2005, winding up in 2007 in the top job of Minister for Economic Affairs.

Lagarde’s bid to succeed the disgraced and ousted Dominique Strauss Kahn as IMF chief was led by France to keep the IMF post in the hands of the developed nations versus rising stars from China, India and Mexico. In winning the seat, Lagarde becomes one of the few without an economics background and the IMF’s first woman leader.

That negotiating history may be important as the IMF stared down the widening EU debt crisis–a crisis second only to the 2008 subprime disaster as a global threat.

Cajoling leaders around the world, not just Europeans, to go along with a big bailout is going to be her job. Bringing along the majority of developing countries, and giants, like China and India, will require a skilled sell. It’s no longer just about Greece.

Greece commanded headlines for the last six months, with tear gas, rioting citizens and corrosive charges of official corruption at all levels. But if it were just about Greece, only 5% of the European Union economy would have been hit. It would have been a smelly mess without real danger. It’s now clear that Portugal, Spain and Italy are roped in, and that the contagion could spread. Why? Because like the sub-prime crisis, no one is sure of who owes what to whom. The shadowy off-book world of international banking that brought down U.S. and European banks in 2008 hasn’t reformed a bit yet, despite new regulations to bring the off-book markets into the open. Credit default swaps, which pay off to holders when bonds default, remain in a murky backwater. No one wants to trigger them.

So without creating more panic, Lagarde’s job will be to convince global politicians that contagion from a Greek default now could open the floodgates to a liquidity crisis across Europe and the world. Greece, Spain and Italy have counter party credit with large French, German and UK banks. They may have third party obligations with Asian and Latin banks not yet revealed. In the worst case, these unknown black holes are the fodder for a liquidity crisis.

To quell the panic and line-up broad bailout support, Lagarde has been reaching out for IMF support. On her second day in the job, she gave a big nod to developing nations, saying they should have a larger role in IMF decisions.  “The world is going to continue to change. We have these tectonic plates that are moving at the moment, and that needs to be reflected in the composition of governance and employment at the Fund, “she said at her first press conference.

The question is, how quickly? Lagarde made a world-win campaign tour to win the job, with high profile stops in China and India. China’s leaders backed her early. India held off, and Mexico ran its own candidate for the post.

So when Lagarde says the IMF has to do its part to help Europe, implying that’s necessary to save the world financial system, it wouldn’t be surprising if a developing nation leader asks why the institution has to help bail out the screwed-up rich nation banks again. One answer is that the IMF isn’t a democracy. The rich nations, led by the U.S. have the highest voting share based on their quota for financial contributions. Rising emerging market nations like China, India and Brazil, want to pay higher quotas in exchange for more power.

Lagarde, lawyer and deal-maker, will have to convince them their time will soon come. She can also remind them of IMF bailouts for Asia in 1997 and Latin America in the 1980’s that put those now-powerful regions back on their feet. It’s the same game plan today – but in Europe.

The betting is that Europe and the U.S. will keep Greece going with handout loans – called “kicking the can down the street” until a real bank bailout plan is constructed that would take bad loans off the Greek bank books. The model touted today is America’s Troubled Assets Relief Program – TARP – that bailed out U.S. banks but angered voters for letting the bankers walk with bonuses and large payouts.

Lagarde could not likely sell a TARP bailout to IMF members now, thus the slow-motion Greek drama, in time, is manageable. But the real shadow over her office will be trying to raise funding for anything as large as Italy. The IMF has laid aside $750 billion to lend in emergencies – about what the TARP plan used in the U.S. But if Greece, Ireland, Portugal and Spain line-up for help, they would exhaust what Europe and the IMF have well before heavyweight Italy, a core economy, came calling.

 Then the U.S. and Asian nations would either have to approve a large second round of credits of up to $1 trillion, or risk calamity with a refusal.

To be sure, Italy’s ratio of debt to its economic size – around 5% – seems manageable. But Lagarde and European leaders will need to snuff out bond default fears soon, before Europeans head out on August holidays leaving thin markets and “believe anything” junior traders in charge.

Like the subprime crash, the escalating fear of “who can you trust” is driving the euro debt selloff. Lagarde has the U.S. experience for some guidance. She even shares a personal trait with then-embattled U.S. Treasury Secretary Hank Paulson. She doesn’t touch alcohol. Clairvoyance and a clear head will be helpful.

Bob Dowling is Editorial Advisor to Gateway House.

This article was exclusively written for Gateway House: Indian Council on Global Relations. You can read more exclusive content here.

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