Managing International Financial Crises: Alternatives to "Bailouts," Hardships and Contagion

Since 1995, a number of measures have been adopted to help prevent future international financial crises. Similar progress, however, has not been made in the management of such crises. Currently there is no clear alternative to large loans (often called bailouts) by the IMF or letting the debtor country fend for itself (which may lead to severe recession in the debtor country and/or the spread of the crisis to other countries). Two recent proposals -- one by Anne Krueger of the IMF and the other by John Taylor of the U.S. Treasury - aim to resolve this dilemma by establishing a more orderly and predictable way to manage financial crises. Anne Krueger proposes to establish a framework, based on bankruptcy procedures in the United States, to restructure unsustainable sovereign, or country, debt. John Taylor proposes that collective action clauses (which specify the procedure to be followed when a country needs to restructure its debt) be included in debt contracts. The IMF proposal has been described as a more centralized, structured approach, while the Treasury proposal is considered a decentralized, market-oriented approach. Both proposals are concerned with sovereign country debt owed to private creditors, such as banks or bondholders. Moreover, both proposals involve the private sector in managing crises, would probably reduce the need for large IMF loans in the future. A major difference is how they would be implemented. The IMF proposal would likely require a change in the IMF's Articles of Agreement, while the Treasury proposal might require incentives to encourage lenders and borrowers to use collective action clauses in their debt contracts. Both proposals are fairly broad and do not specify all the details involved in implementation. The important contribution of these proposals is that they are stimulating a debate about how to better manage international financial crises. Opinion in the international financial community is divided on support for the two proposals. Some economists favor the IMF proposal, and others the Treasury proposal. The private creditor community discouraged the IMF proposal, but supports collective action clauses along with establishment of a private sector advisory group. Many of the debtor countries oppose collective action clauses, which they believe will cause an increase in interest rates they pay. The major industrial countries support both proposals, but maintain that the Treasury proposal, which is easier to implement, should be acted on first. More orderly procedures for sovereign debt restructuring are of interest to the Congress because they might reduce the number and severity of international financial crises. This, in turn, might reduce the need for additional funding for the IMF, or for direct U.S. loans (which were given in the Mexican crises of 1995). Moreover, if an amendment to the IMF Articles of Agreement were needed to implement a proposal, the Congress would have to vote on it.