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Foreign Affairs
Chapter 11 for Countries?
By Richard N. Cooper
Dishonor Before Debt
Late in 2001, the new first deputy managing director of the International Monetary Fund, Anne Krueger, made a bold suggestion. Under certain conditions, she proposed, a government’s international debt repayments should be temporarily suspended while negotiations take place on restructuring that debt. With her statement, the IMF officially endorsed one of the more radical suggestions for improving the international financial architecture to have come forth since the Mexican and Asian crises in the 1990s. If implemented properly, the Krueger proposal would represent some improvement over the IMF’s current prescriptions for states facing financial collapse. But given the domestic origins of most financial crises, her plan cannot eliminate them altogether.
The problem that Krueger addressed is straightforward. When any debtor nation develops economic difficulties, its creditors worry about being repaid, so they move as quickly as they can to protect their positions. For example, they can decline to roll over (that is, extend) loans that have matured. They may even sell the loans before maturity, although that move, of course, requires willing buyers. The difficulty that some governments faced in rolling over maturing debt played an important role in several recent debt crises: Mexico (1994-95), Russia (1998), Brazil (1998-99), and Argentina (2001-2). Even those creditors willing to roll over their loans at a satisfactory interest rate may hesitate for fear of being alone—and thus caught in a payments crisis.
This problem can arise for any debtor and its diverse creditors. Within national borders, such crises are dealt with through bankruptcy proceedings. When a debtor, such as a private firm, gets in trouble, it can “file Chapter 11” under U.S. bankruptcy law, thereby legally suspending payments to all creditors except the tax authorities. That suspension gives the ailing firm breathing space, in which several things can happen. The debtor can reorganize its finances to make resumption of debt service more likely. It can borrow additional funds, with repayment preference given to these new creditors. And it can negotiate with its old creditors to extend those loans’ maturity and perhaps ease their terms. All this reorganization is done in the United States with the protection and guidance of a court of law. Only if the debtor cannot restore its financial health are its assets liquidated and the proceeds distributed to its creditors—again, under the guidance of a court.
Another key feature of U.S. bankruptcy proceedings is that not every creditor needs to agree to the negotiated deal in order to be bound by it. Under the “cram down” provision of bankruptcy law, if a settlement is reached by creditors carrying two-thirds of each class of claims (that is, each group of loans ranked by the urgency with which they need to be repaid), all creditors are covered. A single small creditor is therefore powerless to hold up a deal in an attempt to get better treatment.
No such procedure, however, . . .
Richard N. Cooper is Maurits C. Boas Professor of International Economics at Harvard University and a regular book reviewer for Foreign Affairs.