IMF Bazooka Is Between Meaningless and Dangerous

by Simon Johnson

Bloomberg
December 19, 2011

Financial rescue plans for Europe are becoming ever more fanciful. Increasingly, policy analysts in Europe and the U.S. turn to the International Monetary Fund to provide what is termed “the bazooka” -- meaning a lot of money underpinning a scaled-up bailout for Italy, other troubled countries and, of course, Europe’s failing banks.

This proposal is somewhere between meaningless and dangerous, depending on its precise form. The good news is that it will not happen. The bad news is that no one is prepared for the real consequences of the bazooka proving to be illusory.

The bazooka is a reference to former U.S. Treasury Secretary Henry Paulson, who famously remarked in 2008 congressional testimony: “If you’ve got a bazooka, and people know you’ve got it, you may not have to take it out.” Paulson was arguing that, if he had the authority to seize Fannie Mae and Freddie Mac, he wouldn’t necessarily need to use it. He was quickly proved wrong.

Today’s proposed bazookas are about providing enough financial firepower so that troubled European governments do not necessarily have to fund themselves in panicked private markets. The reasoning is that if an official backstop is at hand, investors’ fears would abate and governments would be able to sell bonds at reasonable interest rates again.

This idea is just as dubious as Paulson’s original notion. Markets are so thoroughly rattled that if a financial backstop is put in place, it would need to be used -- probably to the tune of trillions of euros of European debt purchases from sovereigns and banks in coming months. Whether or not it is used, a plausible bazooka would need to be huge.

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