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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
 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
1990s)
• Some countries might choose to
restructure using measures that are
simple, quick, and orderly
‘market based swaps’
Ecuador: Successful Restructuring?
Default: October 1999
Restructuring: July 2000
1997
1998
1999
2000
2001
2002
DOMESTIC
ECONOMY
Real GDP % change
3.4
External Debt % GDP 63.9
0.4
70.5
-7.3
97.6
2.3
85.1
5.1
68.5
3.4
66.6
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 4Q02 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
IIF DATABASE: URUGUAY
External Debt % GDP
Total Debt Service % Exports goods, services & income
2001
2002
2003
2004
81.5
44.4
96.8
49.8
110.8
53.9
99.3
45.5
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.