Bailouts or Bail-Ins: Responding to Financial Crises in Emerging Markets

443 Pages·2004·6.36 MB·English

by  Nouriel Roubini Brad Setser

BAILOUTS
BAIL-INS?
OR
Responding to Financial Crises
in Emerging Markets
Praise for Bailouts or Bail-ins?
“Roubini and Setser bring valuable experience from the policymaking process to
their analysis of responding to 21st century financial crises in emerging economies.
Bailouts or Bail-ins? will prove to be a useful tool for those confronting these crises,
and a clear, accessible overview for those studying global markets.”

—Lawrence Summers, former US treasury secretary,
president, Harvard University
“Bailouts or Bail-ins? is masterful. It is by far the best book written in recent years on
the vexing subject of how the international community should address international
financial crises of emerging market economies. Roubini and Setser put it all together:
a masterful overview of theoretical issues, a skilled and accurate account of recent
crises, and a wise, balanced, and judicious discussion of the policy debates. They
don’t shy away from reaching clear policy recommendations. Even when one
disagrees with one or another these recommendations, the reader is bound to feel
that the issue has been treated with care, forthrightness, thorough empirical
knowledge, and good judgment. This book will be read with enormous benefit by
students, scholars, policymakers, and financial market participants.”
—Jeffrey D. Sachs, director of the Earth Institute,
Columbia University
“This is the most intelligent and comprehensive analysis yet of how the international
community should respond to financial crises. Its analyses of the theoretical literature
on the causes of crises, the evolution of official doctrine, and recent experience with
crisis management are especially strong. It will be the definitive work on this subject
for some time to come.”
—Barry Eichengreen, George C. Pardee and Helen N. Pardee
Professor of Economics and Political Science, University of California-Berkeley
“A fluid and deeply informed synthesis of the recent debate on how to improve
sovereign debt workouts. Roubini and Setser’s book will likely be a standard reference
for many years to come.”
—Kenneth Rogoff, Thomas D. Cabot Professor of Public Policy and
Professor of Economics, Harvard University
“The Rubin-Summers era policy wonks take on financial architecture, matured by
distance, turbocharged with academic authority.”
—Jeromin Zettelmeyer, International Monetary Fund
InstItute FoR InteRnAtIonAl eConomICs
BAILOUTS
BAIL-INS?
OR
Responding to Financial Crises
in Emerging Markets

Nouriel Roubini and Brad Setser
Washington, DC
August 2004
A Council on Foreign Relations Book
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Nouriel Roubiniis an associate professor COUNCILON FOREIGN RELATIONS
of economics and international business at Founded in 1921, the Council on Foreign
the Stern School of Business, New York Relations is an independent, national mem-
University. He was a faculty member of the bership organization and a nonpartisan cen-
economics department at Yale University ter for scholars dedicated to producing and
(1988–95). He was senior economist for inter- disseminating ideas so that individual and
national affairs at the White House Council corporate members, as well as policymakers,
of Economic Advisers (1998–99) and senior journalists, students, and interested citizens
adviser to the undersecretary for interna- in the United States and other countries, can
tional affairs and the director of the Office of better understand the world and the foreign
Policy Development and Review at the US policy choices facing the United States and
Treasury Department (1999–2000). He has other governments. The Council does this by
been a long-time consultant to the Inter- convening meetings; conducting a wide-
national Monetary Fund and a number of ranging Studies program; publishing Foreign
other public and private institutions. He is a Affairs, the preeminent journal covering
fellow at the National Bureau of Economic international affairs and US foreign policy;
Research and the Centre for Economic Policy maintaining a diverse membership; sponsor-
Research. He is coauthor of Political Cycles: ing independent task forces; and providing
Theory and Evidence(MIT Press, 1997). up-to-date information about the world and
US foreign policy on the Council’s Web site,
Brad Setser is a research associate at the www.cfr.org.
Global Economic Governance Programme
at University College, Oxford. He was an Copyright © 2004 by the Institute for
international affairs fellow at the Council on International Economics. All rights reserved.
Foreign Relations and a visiting scholar at No part of this book may be reproduced or
the International Monetary Fund (IMF). He utilized in any form or by any means, elec-
served in the US Treasury from 1997 to 2001, tronic or mechanical, including photocopy-
where he worked extensively on the reform ing, recording, or by information storage or
of the international financial architecture, retrieval system, without permission from
sovereign debt restructurings, and US policy the Institute.
toward the IMF. He was the acting director
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www.iie.com Roubini, Nouriel
Bail-ins or bailouts : responding to
C. Fred Bergsten, Director financial crises in emerging economies /
Valerie Norville, Director of Publications Nouriel Roubini, Brad Setser
and Web Development p. cm.
Edward A. Tureen, Director of Marketing Includes bibliographical references and
index.
Typesetting by BMWW ISBN 0-88132-371-3
Printing by Automated Graphic Systems, Inc. 1. Loans, Foreign—Developing countries.
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Printed in the United States of America 3. International finance. 4. Debt—Develop-
06 05 04 5 4 3 2 1 ing countries. I. Setser, Brad. II. Title.
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This publication is part of the overall program of the Institute, as endorsed by its Board of
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The Council takes no institutional position on policy issues and has no affiliation with
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Contents
Preface ix
Acknowledgments xiii
1 Introduction 1
Why Crisis Resolution? 5
Purging Unhelpful Myths 7
Closing the Gap Between Rhetoric and Reality 13
Agenda for Reform 19
Structure of the Book 22
2 New Nature of Emerging-Market Crises 25
Sources of Vulnerability in Emerging-Market Crises 32
Interpreting Recent Crises 52
Conclusions 70
3 Analytical Literature on Crisis Resolution 73
Four Approaches to Crisis Resolution 76
Crisis Resolution in IMF’s Absence 79
IMF, Crises of Creditor Coordination, and Moral Hazard 93
Do Partial Bailouts Ever Work? 108
Policy Implications and Suggestions for Further Research 114
v
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4 Experience with Bailouts and Bail-ins 119
Experience with Official Financing 121
Experience with Bail-in Policies: Rollover Arrangements
and Debt Exchanges 139
Lessons for the Official Sector 160
Lessons from Bond Restructurings 166
Lessons from Restructuring of Bank Claims 174
Conclusions 178
5 Official Policy Toward Crisis Resolution 181
Reaction to Mexico’s Bailout 183
Reform of the International Financial Architecture 186
The Debate Fractures 191
ANew Administration, a New Policy? 199
Conclusions 203
6 Responding to Liquidity Shortages 207
When Is Official Liquidity Support Warranted? 208
Are Targeted Debt Reschedulings Inequitable? 219
Risks of Gradual Escalation 220
Case for Pragmatism 220
Private-Sector Financial Difficulties 221
Alternative Approaches to Liquidity Crises 230
What Is the Right Policy? 247
7 Seniority of Sovereign Debts 249
Relative Treatment of Different Sovereign Claims 251
Domestic Versus External Debt 263
Arguments in Favor of a Formal Debt Seniority Regime 277
Conclusion 285
8 Legal Reform 289
Potential Obstacles to Sovereign Debt Restructuring 291
Approaches to Legal Reform 308
Codes and Committees 326
Assessing Reform Proposals 332
Conclusion 334
9 Recommendations for Reform 335
“Hardware” Largely in Place 338
Problems with Crisis Resolution “Software” 351
Moving from Problems to Solutions 365
Conclusion 376
vi
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Appendix A Tables 379
References 391
Glossary 407
Index 415
Tables
Table 1.1 IMF financing 8
Table 2.1a Crisis countries’ aggregate balance sheet
vulnerabilities 28
Table 2.1b Policy adjustment, bail-ins, bailouts, and other
policies to resolve crises 30
Table 4.1 IMF and bilateral first- and second-line financing 125
Table 4.2 Rate of IMF loan disbursement and repayment 126
Table 4.3 Changes in IMF/bilateral exposure and
international bank claims on crisis countries 131
Table 4.4 Changes in IMF/bilateral exposure and in
international debt securities outstanding 132
Table 9.1 IMF lending limits compared with actual lending 353
Table A.1 Exposure of official sector, annual data 380
Table A.2 Exposure of private creditors, annual data 382
Table A.3 Summary of past restructuring cases 383
Figures
Figure 1.1 IMF loans outstanding, 1993–2003 9
Figure 1.2 IMF lending, 1997–98 versus 2000–02 10
Figure 4.1 IMF and BIS loans outstanding 127
Figure 4.2 IMF and ESF loans outstanding 128
Figure 4.3 IMF and bilateral loans outstanding 130
Figure 9.1 Net private debt flows to emerging markets,
1993–2004 346
Figure 9.2 Matrix formulation of crisis resolution approach 374
Boxes
Box 2.1 Recent academic literature on currency and
financial crises 35
Box 2.2 Contagion 43
Box 3.1 Defining moral hazard 74
Box 7.1 Different haircuts for domestic and external creditors 268
Box 8.1 Argentina will test the current restructuring process 298
Box 8.2 More on bond documentation 310
Box 9.1 Crisis prevention 340
Box 9.2 The Argentine debt restructuring process 342
vii
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Preface
The international financial system, and especially the problems of inter-
national debt, have long been a focal issue at the Institute for International
Economics. In 1999, Morris Goldstein produced Safeguarding Prosperity in
a Global Financial System: The Future International Financial Architecture(as
project director of an Independent Task Force Report sponsored by the
Council on Foreign Relations). We have published comprehensive sys-
temic analyses by two outstanding visiting fellows: Toward a New Interna-
tional Financial Architecture by Barry Eichengreen (1999) and The Inter-
national Financial Architecture: What’s New? What’s Missing?by Peter Kenen
(2001).
Over the past decade, a number of major emerging economies have en-
countered serious financial trouble. The International Monetary Fund
(IMF) and the IMF’s major shareholders often faced a sharp choice: Bar-
ring a major rescue loan or an agreement—which was always difficult to
achieve—with the crisis country’s creditors to defer payments, the coun-
try would default. Few international economic issues have generated
more controversy among policymakers than deciding what to do in such
circumstances.
This book breaks new ground on that issue in several ways. It provides
a comprehensive analysis of the series of crises that started with Mexico
in 1994–95, looking at recent large IMF loans to Argentina, Turkey, Uru-
guay, and Brazil (in 2001–02) as well as IMF lending to Mexico, the Asian-
crisis countries, Russia, Brazil (in 1998–99), and several smaller cases. It
integrates analysis of large IMF loans with analysis of attempts to con-
vince private creditors to provide emergency financing to crisis countries,
whether alongside the IMF or as a substitute for large-scale IMF lending.
ix