By THOMAS CATAN and IAN TALLEY, The Wall Street Journal

The International Monetary Fund proceeded with its record 2010 bailout of Greece despite deep internal divisions over whether it would work, according to confidential documents that contradict the fund's public statements.

The new details of the rift come as the crisis lender is now pressing European governments to forgive some of the country's debt in a fresh round of difficult talks. The idea is unpopular with Germany and other European nations because their taxpayers would take the hit. But it stands a chance because the IMF is now making future support conditional on significantly reducing Greece's debt burden.

The topic will be high on the agenda when finance ministers from around the world gather in Washington this week for the IMF's annual meeting. 

The fund's determination to see Greece's debt burden reduced stems in part from lingering bitterness over how the first bailout was approved at a contentious May 9, 2010, IMF board meeting, according to some fund officials. The cache of papers documenting that decision—marked "Secret" or "Strictly Confidential" and reviewed by The Wall Street Journal—offers a rare glimpse inside the IMF as the international emergency lender struggled to avert a rapidly unfolding financial disaster.

Nearly a third of the board's members, representing more than 40 non-European countries, raised major objections to the bailout's design at the meeting, according to the internal records. Many objected that it placed all the burden of a painful adjustment on the Greeks while asking nothing of its European creditors. Several suggested the bailout was doomed to fail unless Greece's creditors reduced some of the financially troubled country's towering debt burden.

"The alternative of a voluntary debt restructuring should have been on the table," Argentina's then-executive director at the IMF, Pablo Andrés Pereira said at the 2010 meeting. The fund, he said, risked merely "postponing, and maybe worsening the inevitable"—a Greek debt default.

Directors from Brazil, Russia, Canada, Australia—representing 38 additional countries—worried about the "immense risks" of the program, according to minutes of the meeting. The program could prove to be "ill-conceived and ultimately unsustainable," Brazil's executive director at the IMF warned, or simply "a bailout of Greece's private-sector bondholders, mainly European financial institutions."

U.S. and most European directors, representing more than half of the IMF board's voting shares, were able to win approval for a program that required the Greek government to adopt wrenching spending cuts and tax increases. It included no debt restructuring, such as forgiving principal, reducing the interest rate on the debt or stretching out the payment schedule to make servicing easier. That spared the holders of the debt—chiefly European banks—the losses that would have come with restructuring.

Some of the IMF dissenters at the meeting and some IMF staff believe the interests of the European powers were placed above those of Greece, which has seen its economy contract by a fifth since 2009 and its jobless rate reach nearly 28%. That helps shape the IMF's position today going into the negotiations with the Europeans over debt restructuring, according to some current and former fund officials.

"The Greek bailout was not a program for Greece, but for the euro zone itself," one participant at the 2010 meeting says today.

The 2010 documents show that several IMF directors were deeply skeptical of the staff's economic projections from the beginning, calling them "rather optimistic," "overly benign," even "Panglossian."

An IMF spokesman said the lender still expects a recovery in Greece as its economic overhaul takes effect. "But we are more conservative than before, and we certainly realize it will take longer for Greece to catch up on the growth side," he said.

In several key respects, the confidential documents rewrite the story of the biggest bailout in IMF history.

For instance, then-IMF Managing Director Dominique Strauss-Kahn told reporters after the May 2010 meeting that the fund had "no doubt" that the bailout would work. But behind the scenes, a considerable share of non-European directors had expressed serious doubts—and even anger—about the bailout plan, according to board-meeting minutes, staff briefs and board-member comments written in the days before and after the meeting.

The scale of the fiscal adjustments to be required of Greece would be "a mammoth burden that the economy could hardly bear," India's former director at the IMF, Arvind Virmani, told the meeting. He questioned whether the magnitude of the belt-tightening that the IMF was expecting would cause the rescue program to fail and the country to default on its debt.

Efforts to reach Mr. Strauss-Kahn for this article were unsuccessful. The IMF has since, though, conceded some failures. In hindsight, it had been too rosy about the financial projections that underlay the program, it said in a report in June.

IMF officials always have maintained that they didn't think Greece would have to restructure its debt when the rescue program was approved in 2010.

"In May 2010, we knew that Greece needed a bailout but not that it would require debt restructuring," IMF Managing Director Christine Lagarde said in a June interview. "We had no clue that the overall economic situation was going to deteriorate as quickly as it did."

By early 2011, as it became clear that Greece's debt had become unsustainable, the IMF did advocate Greece's debt be restructured, an IMF spokesman said.

But the IMF documents show there were heated discussions about the need to write off part of Greece's debt from the start. At the May 2010 meeting, directors from Middle Eastern, Asian and Latin American countries repeatedly asked why they weren't being presented with the option.

European directors were "surprised" when Switzerland "forcefully" weighed in on the dissenting side, the minutes show. "Why has debt restructuring and the involvement of the private sector in the rescue package not been considered?" the Swiss executive director, Rene Weber, asked at the time.

The IMF says today that debt restructuring simply wasn't feasible in 2010, because the risk of Greece's financial turmoil spreading to other countries was so high.

Much of the debt was held by already fragile French and German banks, so European nations wouldn't consider it. And the U.S. feared its own trillion-dollar exposure to European banks.

Ms. Lagarde was French finance minister at the time and keen to avoid losses by her country's banks, which had lent heavily to Greece. Mr. Strauss-Kahn—widely known to be angling for the French presidency at the time—backed off a tentative effort to press the issue after encountering European opposition before the IMF meeting.

The June 2013 IMF staff report conceded "notable failures" in its first Greek bailout while concluding the fund had broadly followed the right policies. "An upfront debt restructuring would have been better for Greece although this was not acceptable to the euro partners," it said.

In retrospect, the report said, the "program served as a holding operation" that allowed "private creditors to reduce exposures…leaving taxpayers and the official sector on the hook."

Several IMF directors had warned of just that outcome three years earlier. The program "may be seen not as a rescue of Greece, which will have to undergo a wrenching adjustment, but as a bailout of Greece's private debtholders, mainly European financial institutions," Brazil's executive director, Paulo Nogueira Batista, said at the May 2010 meeting.

The doubters were ultimately proved right. Greece couldn't meet its financial targets and required a second bailout in 2012. The remaining private creditors took a haircut as part of the largest debt restructuring in history.

Greece's debt has ballooned since then as the economy collapsed, forcing euro-zone governments to now confront the prospect of a third bailout in which they would also forgive some of Greece's debt.

 

IMF Document Excerpts: Disagreements Revealed

These excerpts from confidential International Monetary Fund documents, including board meeting minutes, staff briefs and board-member comments reveal considerable disagreement at the May 9, 2010 meeting at which the IMF board approved Greece’s first bailout.

 

Swiss executive director Rene Weber in a prepared statement to the board for the May 9, 2010 meeting:

We have “considerable doubts about the feasibility of the program…We have doubts on the growth assumptions, which seem to be overly benign. Even a small negative deviation from the baseline growth projections would make the debt level unsustainable over the longer term…Why has debt restructuring and the involvement of the private sector in the rescue package not been considered so far?”

 

Brazil’s executive director Paulo Nogueira Batista in a prepared statement to the board for the May 9, 2010 meeting:

“The risks of the program are immense…As it stands, the programs risks substituting private for official financing. In other and starker words, it may be seen not as a rescue of Greece, which will have to undergo a wrenching adjustment, but as a bailout of Greece’s private debt holders, mainly European financial institutions.”

“Our decision to go along with this problematic and risk-laden program should not be taken to mean that we will support it in the future. Going forward, we will consult with our authorities and other chairs to make sure that the fund is not led along the path of endorsing a program that may prove to be ill conceived and ultimately unsustainable.”

 

Argentina’s executive director Pablo Andrés Pereira in a prepared statement to the board for the May 9, 2010 meeting:

“The alternative of a voluntary debt restructuring should have been on the table…The European authorities would have been well advised to come up with an orderly debt restructuring process. The bottom line is that the approved strategy would only have a marginal impact on Greece’s solvency problems…It is very likely that Greece might end up worse off after implementing this program.”

 

Iranian executive director, Jafar Mojarrad in a prepared statement to the board for the May 9, 2010 meeting:

“We would be interested in staff clarification regarding the option of debt restructuring. We would have expected such an option to be discussed in the staff report, even if the intention were not to retain it.”

 

Egyptian director Shakour Shaalan in a prepared statement to the board for the May 9, 2010 meeting:

“We would be grateful for further elaboration on the assumptions…underlying staff’s medium-term growth projections. They appear to us to be rather optimistic…We would be interested to learn from staff whether debt restructuring was among the options considered in the assistance package. Debt restructuring may be looked upon disfavorably, but it should be envisaged.”

 

India’s executive director Arvind Virmani in a prepared statement to the board for the May 9, 2010 meeting:

“The scale of the fiscal reduction without any monetary policy offset is unprecedented…(It) is a mammoth burden that the economy could hardly bear. Even if, arguably, the program is successfully implemented, it could trigger a deflationary spiral of falling prices, falling employment, and falling fiscal revenues that could eventually undermine the program itself. In this context, it is also necessary to ask if the magnitude of adjustment…is building in risk of program failure and consequent payment standstill…There is concern that default/restructuring is inevitable.”

 

China executive director He Jianxiong in a prepared statement to the board for the May 9, 2010 meeting:

“The risks to the program are significant…The growth projection appears optimistic.”

 

From the minutes of the May 9, 2010 board meeting on the Greek bailout:

“The exceptionally high risks of the program were recognized by staff itself, in particular in its assessment of debt sustainability.”

“Several chairs (Argentina, Brazil, India, Russia, and Switzerland) lamented that the program has a missing element: it should have included debt restructuring and Private Sector Involvement (PSI) to avoid, according to the Brazilian ED, ‘a bailout of Greece’s private sector bondholders, mainly European financial institutions.’ The Argentine ED was very critical at the program, as it seems to replicate the mistakes (i.e., unsustainable fiscal tightening) made in the run up to the Argentina’s crisis of 2001. Much to the ‘surprise’ of the other European EDs, the Swiss ED forcefully echoed the above concerns about the lack of debt restructuring in the program, and pointed to the need for resuming the discussions on a Sovereign Debt Restructuring Mechanism.”

“The Swiss ED (supported by Australia, Brazil, Iran) noted that staff had ‘silently’ changed in the paper (i.e., without a prior approval by the board) the criterion No.2 of the exceptional access policy, by extending it to cases where there is a ‘high risk of international systemic spillover effects.’”

 

Christine Lagarde, IMF Managing Director, in June 2013:

“In May 2010, we knew that Greece needed a bailout, but not that it would require debt restructuring…We had no clue that the overall economic situation was going to deteriorate as quickly as it did.”

 

Gerry Rice, Director of Communications Department at the IMF, September 19, 2013:

“Debt restructuring was not feasible at the outset of the program. First, risks of contagion were very high, and Europe lacked proper firewalls. Second, it was not apparent that Greece needed debt restructuring—this only became apparent as growth fell well short of program assumptions, reflecting political shocks and incomplete program implementation. By early 2011 it had become clear that Greece’s debt had become unsustainable, and the IMF advocated debt restructuring.

“The current program has already internalized the lessons from the previous one. It has a framework for reducing Greece’s debt and a commitment from the Europeans to provide additional debt relief, if needed to keep the debt on the path projected in the program, and provided that Greece meets its fiscal targets in 2013 and 2104. In addition, Greece has sought and received debt relief. On growth assumptions, we are projecting a recovery driven by an improvement in sentiment, as reforms take hold, but we are more conservative than before and we certainly realize it will take longer for Greece to catch up on the growth side.”