Today's date:
Winter 2002


Should Argentina Be Able to Declare Bankruptcy?

Anne Krueger is first deputy managing director of the International Monetary Fund.

Washington-Walter Wriston, former head of Citibank, famously remarked that countries don't go bust. But over the past two centuries, more than 90 have in fact defaulted on their debts, and a number have done so several times. When it announced a moratorium late last year, Argentina became only the latest example.

Defaults are always painful, for debtors and creditors alike. And so they should be. Countries-just like companies and individuals-should honor their debts and suffer when they fail to do so. Otherwise people will not be prepared to lend to them, and they will find it much more difficult to finance investment. But when a country's debts become truly unsustainable, it is in everyone's interest that the problem is addressed promptly and in an orderly way.

Alas, all too often that does not happen. Like a toothache sufferer delaying a visit to the dentist until the last possible moment, governments frequently try to put off the inevitable. The result is that the citizens of the defaulting country experience greater hardship than they need to, and the international community has a tougher job helping pick up the pieces.

The lesson is clear: We need better incentives to bring debtors and creditors together before manageable problems turn into full-blown crises. International Monetary Fund (IMF) staff have been examining how this could be done-by learning from corporate bankruptcy regimes like Chapter 11 here in the United States. We are some way from having a formal proposal, but we look forward to discussing these ideas with our executive board and other interested parties in coming months.

In thinking about a possible new approach, we began by asking why some countries wait so long to restructure unsustainable debts. Reluctance to confront the economic and political disruption involved is obviously part of the answer-and no new approach can or should entirely eliminate those concerns. But logistical and legal barriers are important as well.

Debt restructuring was difficult enough in the 1980s, when you could bring the holders of most of a country's debt together simply by gathering 15 bankers around a table. Things are much more complicated now. In recent years, countries have increasingly borrowed by issuing bonds as well as turning to banks. Bondholders are more numerous, anonymous and difficult to coordinate. This increases the "collective action problem" of getting agreement among creditors on the terms of a restructuring-even if almost all of them would benefit.

The resulting expectation that restructuring is likely to prove difficult and disorderly means that creditors may scramble to get their money back, in an attempt to beat others to it. We need to create stronger incentives for creditors to stay engaged rather than rush for the exits.

Another obstacle to orderly restructuring has been the growing threat of legal action. In part this is because bondholders seeking repayment do not have to share the proceeds of litigation with other creditors-as banks have to do. A second reason is that litigants have recently overcome one of traditional barriers to suing debtor governments, namely the difficulty of locating and seizing their assets. In one recent case, for example, a "vulture fund" in effect held Peru ransom by persuading courts in the United States and Europe to prevent it servicing its debts to other creditors. It is not clear whether this technique would survive legal challenge in future cases, but it highlights a more general problem.

So how could the international community help? One answer would be for the IMF to lend a country all it needed to repay its creditors. But this would leave countries accumulating debt indefinitely. In any event our resources are limited, not least by the reluctance of our members to see taxpayers' money used to bail out private creditors. This reluctance is well justified. Investors and lenders will act imprudently if they see the IMF waiting on the sidelines to ensure they get their money back. Just as we expect borrowers to repay their debts, so we should expect lenders to accept responsibility for the risks they take.

Looking to corporate bankruptcy regimes for inspiration makes much more sense. We could put a better set of incentives in place by creating a predictable legal framework that would in all probability rarely need to be activated formally. A country would have legal protection from its creditors for a fixed period while it negotiates a restructuring. In return, it would be under an enforced obligation to negotiate in good faith and to adopt policies that will get its economy back on track. Finally, once a restructuring has been approved by a big enough majority of creditors, any dissenters would have to accept the same terms.

These key features would need the force of law throughout the world, which won't be easy to achieve. But if and when they are in place, they are likely to act as a catalyst, encouraging debtors and creditors to reach agreement of their own volition. As in domestic bankruptcy regimes, most restructuring would likely take place "in the shadow of the law."

The benefits could be considerable, and not just for the debtors. By removing much of the uncertainty from the restructuring process, creditors should find that the value of their claims on an emerging market country hold up much better if it runs into economic trouble. And by helping investors and lenders discriminate more clearly between good and bad risks, an international workout mechanism could help countries with good policies secure capital more cheaply. It will also increase the efficiency and stability of the global financial system.

There are, of course, many practical and political obstacles to getting such an approach up and running. With the best will in the world, it would take two or three years to put in place. This is too late, alas, to help Argentina in its current difficulties. But as an investment in a stronger and less crisis-prone world economy for the future, the idea is well worth pursuing.