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News Release

Congress Should Support the Exchange Stabilization Fund

April 21, 1999

Contact:    C. Randall Henning    (202) 328-9000

Washington, DC—The Exchange Stabilization Fund (ESF) at the Treasury Department is an important instrument of US international monetary and financial policy and should be maintained in its present form. In The Exchange Stabilization Fund: Slush Money or War Chest? C. Randall Henning concludes that the availability of the Fund for both foreign exchange intervention and credits to foreign governments should be preserved. Congress should not impose any new constraints on the use of the Fund for international financial support operations, including for medium-term credits when these become necessary. The Secretary of the Treasury should continue to be given exclusive control over the ESF. The new study opposes any effort to require congressional approval for stabilization loans above $1 billion, or to place further requirements on the executive when engaging in such lending, as proposed recently by Rep. Jim Saxton (R-NJ), Vice Chairman of the Joint Economic Committee.

Henning's study examines the ESF's history, rationale, and financial performance as well as the controversy surrounding its deployment in the Mexican crisis of 1995 and its current use in Brazil. His conclusions contrast sharply with some observers' calls to curtail or even abolish the ESF, which would convey an extremely negative signal to world financial markets and to other governments concerning the international role of the United States.

The study's endorsement of the status quo is qualified in several respects, however. The Secretary of the Treasury should continue to administer the account conservatively, according to the guidelines enunciated below. Despite substantial recent progress on transparency, further disclosure related to the ESF is warranted. Congress, and the banking committees in particular, should conduct consistent oversight of the Fund.

The new study examines: (1) the ESF law and legislative history, as reflected in hearings and congressional reports over the 65 years since the creation of the account; (2) delegation of authority by Congress to the Treasury to administer the account, as part of the broader pattern of congressional delegation to the executive; (3) the financial performance of the ESF, particularly its profitability; and (4) the lending record, particularly the results of the Mexican loan of 1995.

In doing so, the book responds to accusations that the ESF (1) is a "slush fund" that is neither transparent nor accountable to the Congress; (2) is unconstitutional, because loans from it evade congressional appropriation; (3) is excessively centralized in the hands of the Secretary of the Treasury; (4) exceeds its mandate when making medium-term loans; and (5) is superfluous because, critics argue, foreign exchange intervention and stabilization lending do not work.

After surveying the evidence, Henning concludes that:

  • the ESF is not a "slush fund";
  • the delegation of authority to the Treasury to administer the account is constitutional;
  • Secretarial control is justified by the requirement of quick, flexible response to financial crises;
  • currency and financial markets do not always operate efficiently, and there is a need to maintain a capacity for at least occasional intervention;
  • and, in particular, medium-term loans are permissible under the ESF law and occasionally desirable on economic and financial grounds.

The ESF, to answer the question posed in the title of the study, is a legitimate "war chest" for international monetary and financial crises.

Although the ESF is best known for the Mexican rescue of 1995, foreign exchange intervention rather than stabilization lending has been its more important activity. Much larger quantities of funds have been involved in intervention than stabilization loans. Over time this intervention has been quite profitable for the ESF, which suggests that the account has been used in a stabilizing fashion. The second Reagan administration and the Bush administration intervened far more heavily with ESF funds than have the first and second Clinton administrations.

The study offers six principles that should guide the use of the ESF for international financial support, most of which are already being largely implemented:

First, loans from the ESF should be issued sparingly. The Treasury should make the account available only after borrowers have exhausted their access to the private financial markets and, preferably, other official creditors.

Second, loans should be conditioned on policy reforms within borrowing countries to correct economic problems and facilitate international adjustment.

Third, large medium-term loans should usually be made in parallel with programs administered by the IMF, which should continue to take the lead in negotiating policy conditions. The IMF is often better positioned to determine conditionality and has greater legitimacy in insisting on policy reform.

Fourth, ESF loans should be backed by a reasonably assured source of repayment and generally receive an interest-rate premium, relative to the pre-crisis market rate.

Fifth, loans from the ESF should be effectively senior to the borrower's obligations to previous creditors.

Sixth, US officials should do their utmost to persuade private lenders and investors to also contribute to rescue packages—through some combination of debt relief, rescheduling and new money—so that official financing does not simply substitute for private financing.

These principles are designed to maximize the likelihood that the financial operation will effectively stabilize markets, assure repayment to the Treasury, encourage an early return by the borrowers to private capital markets, and minimize the moral hazard effects of official lending. They cannot be imposed rigidly on the credit activities of the ESF, however, and require flexible application in light of prevailing economic and perhaps political circumstances. Nevertheless, the Secretary should respect the spirit of these principles when using the ESF for stabilization loans.

In conducting oversight, members of Congress should ensure that these principles are respected. The Congress, and the banking committees in particular, have a litany of Treasury reports and multiple opportunities to question the Secretary and other Treasury officials privately and publicly. They thus possess the tools necessary to exercise effective oversight related to the ESF.

Three measures would nonetheless further strengthen transparency and oversight. First, the many reports that Treasury issues regarding the ESF and international monetary and financial policy more broadly could be streamlined, thereby economizing on scarce time of Treasury staff and providing "one-stop shopping" for Congress and the public. Doing so would require amending each of the several statutes that require the existing reports.

Second, it would be desirable for the Treasury to release ESF balance sheet information more frequently. The department could release monthly balance sheets of the ESF with a few months' lag.

Third, and more important, credit agreements with foreign countries, such as the 1998 agreement with Brazil, renegotiated in March 1999, should be released to the public. Such agreements are often classified out of deference to other creditors or to the borrower. Releasing these agreements should be part of the "enhanced transparency agenda" of the IMF, the finance G-7, and other international bodies as actively sought by the Congress and others.

Disclosure to the Congress is part and parcel of the broad delegation of authority to the Treasury to manage the ESF. But it is incumbent on Congress to better organize itself to review and assimilate the information that the Treasury provides. Capitol Hill should oversee the ESF more consistently than in the past. Moreover, Congress should recognize the substantial costs in staff time of reporting to it and strengthening transparency, and should provide for them in budgetary appropriations for the administrative expenses of the Treasury.

The United States, other leading countries, and the international financial institutions are searching for solutions to the global financial crisis and mechanisms to prevent and contain future crises. Treasury Secretary Robert E. Rubin has advocated designing a "new international financial architecture" that could lend greater stability to the international system. The ESF has been an important part of the financial architecture in the past and remains critical to any future set of arrangements.

In the absence of the ESF, international cooperation and US participation, let alone leadership, in international financial support operations would suffer considerably. Market confidence that governments could handle crises would decline. Governments of emerging market economies would be tempted to backtrack on external liberalization. The intensification of international financial instability in recent years requires that the ESF be maintained rather than constrained. If it did not now exist, the ESF, or something like it, would have to be created. Abolition, or serious truncation, of the ESF at this point in time would convey a very negative signal both to markets and to other governments concerning the global economic role of the United States.