SOVEREIGN BANKRUPTCY Goals of Bankruptcy Regimes Expost efficiency

SOVEREIGN BANKRUPTCY

Goals of Bankruptcy Regimes • Ex-post efficiency: once bankruptcy is triggered – Maximize total value – Ensure growth: clean slate • Ex-ante efficiency: prior to bankruptcy – Preserve priority of claims defined prior to bankruptcy – Different regimes => different incentives and actions prior to bankruptcy

Goals of Bankruptcy Regime Ex-ante equity and efficiency • In an efficient market creditors are never cheated: interest rates adjust • Choice of regime influences behavior prior to bankruptcy: risk taking, amount of debt, signaling, timing, etc.

For example, in a creditor friendly regime • Default is a messy process with high costs • Countries try to avoid default… this can Ø costly delay; e. g. overly tight monetary and fiscal policy to be able to repay debt • Lower probability of default • Lower interest rates • Creditor moral hazard; less monitoring of loans (more market herding) • Debtor moral hazard; more lending

EM countries: Alternative scenarios • Countries might act strategically to get bailouts (as some say happened in the 1990 s) • Some countries might choose to restructure using measures that are simple, quick, and orderly Ø‘market based swaps’

Ecuador: Successful Restructuring? Default: October 1999 Restructuring: July 2000

Ecuador: Successful Restructuring? Analyst report: May 2002 • “We do not see at risk the coupon payments on Global bonds in 2002 as long as oil prices remain at current levels and the government implements a fiscal adjustment. However, arrears with bilateral institutions and suppliers are likely needed in 4 Q 02 in order to service external bonds. ” • “Public expenditures are not being controlled. We estimate a 2002 fiscal deficit of US$46 million or 0. 2% of GDP. ” -- Salomon Smith Barney, Economic and Market Analysis, Country Analysis and Commentary, May 13 2002

Uruguay: Successful restructuring? debt rescheduling 2003 In 2004, analysts stated that Uruguay was in a good position to grow -- except for its debt burden.

Is this ‘market based mechanism’ efficient? • Debt exchanges => orderly workout, but without much debt relief • Recovery values on defaulted debt are high – Coporates [Altman]: market estimates 45% • Post default prices average 35% • ultimate recovery is 42% – Sovereigns: market estimates 25%; ultimate recovery… depends on how measured • Post default price average 31% [Moody’s] • Post restructuring prices are at least 20% higher [prelim] • Based on holding periods investors receive, on average, slightly over full recovery within 18 months • A diversified portfolio across the emerging markets does very well • EM has been the best performing asset class, even on a risk adjusted bases, even excluding recent rally – Investors being paid for cost of default without absorbing cost of default • Sovereigns not getting ‘clean slate’; low screening? ; excessive borrowing?

Recent debate on sovereign restructuring • The recent debate focused on collective action • But modern bankruptcy theory has other crucial elements – including : debtor-in-possession (DIP) financing, bankruptcy triggers, reorganization plans, and other issues necessary for efficiency.