By Mohamed A. El-Erian
Argentina's long battle with a small group of creditors, in which the latter won an important court decision this week, highlights a crucial issue in the management of financial and economic crises: What to do when a country is either unable or unwilling to pay its debts.
The Argentine case dates back to 2001, when a severe economic depression rendered the government unable to make payments on some $95 billion in bonds. Holders of more than 90 percent of the debt accepted new bonds worth roughly 30 cents on the dollar, but a group of creditors ended up betting that they could get the government to pay more on the rest. This week, the U.S. Supreme Court effectively supported the holdouts: If the government wants to keep making payments on the restructured debt, it must pay them, too.
The decision may further complicate what is already a very difficult coordination problem. When a sovereign faces severe payment difficulties, the best option for the collective good is to find an orderly way to reduce debt and put the country on the path to economic recovery. The parties involved, though, tend to have a hard time agreeing on what constitutes "fair" burden sharing. Private creditors would rather get bailed out by governments and organizations such as the International Monetary Fund than accept losses on their investments. Small groups of private creditors have an incentive to seek better deals at the expense of the majority. And public creditors are loath to see their exceptional support used to pay off private creditors who underestimated the risks.
The task of striking deals and enforcing them often falls to outsiders such as the IMF, which are able to provide emergency financing to governments. As the intense negotiations surrounding Greece's 2012 debt restructuring illustrated, this requires them to deal with some controversial questions and make difficult judgments. Is the government insolvent or merely temporarily short on cash? How much can it really afford to pay and when? How to navigate the complexities of global restructuring agreements that involve several jurisdictions? How to verify and enforce compliance among all those involved, creditors and debtors?
According to media reports this week, the IMF is rightly seeking a better way to manage such crises. In the past, it often found itself constrained to two options: Bail out private creditors, or require them to take immediate losses. Officials are considering a third option, in which the maturity of debt outstanding would be extended while the government worked out its financial difficulties with the aid and advice of the IMF.
The IMF’s proposed middle way harks back to the successful Uruguayan debt restructuring and, before that, the “new money” packages that banks were forced to adopt in the Latin American debt crisis of the 1980s. The idea is a simple yet extremely powerful one: Keep existing creditors engaged so that all stakeholders can contribute to an orderly, well-coordinated, pro-growth solution. While implementation may be challenging, it also has the important advantage of providing time to collect proper information, assess the situation and derive proper solutions — something that has often proved lacking, complicating the crisis management process.
The ultimate aim is to find creative and workable approaches to encourage what theorists call a cooperative game, as opposed to one in which competing interests seek to maximize their individual payoffs with no concern for the collective outcome.
Private sector bail-ins are hard to implement smoothly. Public sector bailouts are unpopular and unfair. Doing neither leaves countries and their citizens worse off. Crisis prevention is of course the best way to avoid such quandaries. Where prevention fails, hopefully the IMF's efforts will contribute to better outcomes.
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