|
|
|
CIAO DATE: 03/01
Foreign Policy
Global Newsstand: First Aid for Financial Crises
Deepak Gopinath
*
Geneva Reports on the World Economy, Special Report I, September 2000, Geneva
In the three years since the beginning of the debate over reforming the "international financial architecture"-a formulation used by former Treasury Secretary Robert Rubin in the aftermath of the Asian financial crisis-policymakers have focused on crisis prevention. But crisis prevention measures (encouraging transparency, better dissemination of data, and the like) were the relatively easy part. Now, policymakers are turning to the more controversial topic of crisis management: actually changing the rules by which the market operates. Heading their agenda is the vexing question of how best to ensure that private investors do not perceive multilateral assistance as a bailout and thereby invest frivolously.
Berkeley economist Barry Eichengreen provides a timely overview of the issues involved in the annual Geneva Reports on the World Economy series, jointly published by the Centre for Economic Policy Research and the International Center for Monetary and Banking Studies. Eichengreen identifies two sources of crises-market panic and weak economic fundamentals-and measures to deal with each. An officially sanctioned payments standstill, he argues, could defuse investor panic by providing a cooling-off period for markets. Like a corporate bankruptcy, a payments standstill allows a country to delay temporarily payments to creditors. As for countries suffering from bad fundamentals, they could benefit from collective action clauses (CACS) introduced into bond contracts to facilitate debt restructuring. CACS would allow a majority of bondholders to agree on a restructuring and prevent rogue creditors from blocking a deal and going to the courts to get what they can. That's exactly what Elliott Associates L.P., a New York-based hedge fund, did in October 2000 when they opted out of a 1996 deal between Peru and its creditors and insisted on being paid in full.
Neither payment standstills nor CACS are new ideas. Economists have discussed amending the International Monetary Fund's (IMF) articles of agreement to allow capital or exchange controls needed to support standstills. But standstills, as even Eichengreen admits, are not politically feasible, since they would undermine U.S. Treasury, IMF, and World Bank efforts to encourage countries to liberalize their capital markets. Meanwhile, 46 percent of the international bonds issued between 1990 and 2000 under British and Luxembourg law already include CACS. But the United States, the regulator of Wall Street and issuer of the majority of the world's bonds, hasn't been very enthusiastic: U.S.-issued bonds do not contain CACS.
Eichengreen presents empirical evidence that refutes the main objection to standstills and CACS-namely, that they would raise the probability of debt restructurings, thereby increasing borrowing costs for emerging markets. He finds that a standstill provision "designed to prevent a creditor grab race does more to attract investors than any consequent weakening of creditor rights does to repel them." As for CACS, he finds that they reduce borrowing costs for the most creditworthy borrowers while increasing them for less creditworthy issuers. He argues that the benefits to less creditworthy borrowers of an orderly restructuring compensate for the increased borrowing costs.
Eichengreen concludes with a call to action: "While wishful thinking can wish away the bailout problem-it can assume away the sources of moral hazard-institutional reforms that speak to the underlying dilemmas are needed if the international policy community is to succeed in developing new approaches to resolving financial crises." But, in a nod to current political realities, he doesn't push for the more controversial standstills and calls only for collective action clauses on bond contracts, arguing that most crises "reflect problems with fundamentals, not simply investor panic."
Endnotes:
*: Deepak Gopinath is a senior writer at Institutional Investor magazine. Back.