The CIGI-INET conference on sovereign debt restructuring wound up Sunday afternoon. The quality of interventions was uniformly high; thanks to all who participated.
There was much pessimism with respect to Greece. While not all participants expressed a view, those that did thought that a default at some point over the next year is pretty much a given.
While it was not unanimous, the clear consensus emerged that it would be wise to try and provide some ex ante clarity on the rules of the game for sovereign debt restructurings to prevent capricious ex post modification of covenants — Greece comes to mind. For simplicity, call this framework for the timely, orderly restructuring of sovereign debt a Sovereign Debt Restructuring Mechanism (SDRM).
The same old criticisms of a framework for debt restructuring were voiced — "it's better to have good policies." Well, yes. But what do you do when sovereigns don't follow good policies and private markets don't provide the necessary discipline?
As one participant noted, Paul O'Neil was absolutely right when he argued a decade ago that the official sector needs a better option than choosing between irresponsible lending and a catastrophic default. And, as I pointed out in the session I chaired, there is a basic problem of dynamic inconsistency in relying on "no bail-out clauses." However much it is desirable to enforce no bail out clauses ex ante (before governments accumulate unsustainable debts), if doing so invites disaster, the rule won't be enforced ex post (after inter-temporal solvency constraints have been violated).
One participant gave a great explanation of the role of the Fund: briefly, to assist its members strike a judicious balance between financing and adjustment. No, it wasn't me (see previous post "Financing and Adjustment for Greece"), but the remarks were fully consistent with my views. In this respect, the SDRM would help the IMF better serve its members deal with the capital account crises of today; in contrast to the current account balance of payments problems of the Bretton Woods era.
There was agreement that a well-designed SDRM proposal designed to create a structured bargaining environment would facilitate the resolution of debt re-contracting by:
- providing a stay on litigation (to "get the attention" of creditors and bring them together);
- solving the creditor co-ordination problem by providing a "cram down," enforcing a restructuring that is acceptable to the majority of creditors over the objections of a few creditors that are acting opportunistically to delay a deal in order to extract higher payouts; and
- providing a means of aggregating across various bond issues and other claims.
Ideally, however, the provisions are not used and debt restructuring deals are done through voluntary deals, analogous to negotiating in the "shadow of the (bankruptcy) court" at the domestic level.
Moreover, there was a good discussion on how a framework could change the incentive structures sovereign borrowers and creditors face. Hopefully borrowers would call in their creditors earlier, when there is a problem; not a crisis. Private creditors, meanwhile, recognizing that a restructuring is possible, may discount the expectation of a bail out. The result may be a better pricing of risk.
There was less agreement on the role of the Fund in all of this. The way I look at this, the Fund can play useful monitoring/bonding role during the stay on litigation to ensure that the sovereign is pursuing policies that "grow the pie", increasing the potential payoffs to creditors and eschewing policies "destructive of national and international prosperity." The Fund can also provide the equivalent of debtor-in-possession financing through its lending into arrears strategy, while creating incentives to grow the pie.
Concerns were raised with respect to the Fund's role is the challenge of determining whether a country is facing a solvency versus liquidity problem: if the Fund gets its analysis wrong, private creditors subordinated by the Fund's preferred creditor status stand to suffer larger loses (see previous post "The Future of International Lending").
While the difficulties of assessing the debt sustainability are real, the question is whether they are insurmountable. Regardless, given the challenges in the global economy, the fundamental question is whether it and other criticisms of the SDRM are sufficiently great to outweigh the potential benefits from the creation of a framework for the timely, orderly restructuring of claims. In this respect, the fact that policy instruments in many advanced economies are already fully utilized means that the scope to offset the disorderly defaults of the future may be limited. Failure to take measures to reduce the costs of sovereign default could be tantamount to wilful neglect.