SOVEREIGN BANKRUPTCY

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SOVEREIGN BANKRUPTCY
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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 gt different incentives and
  actions prior to bankruptcy

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Goals of Bankruptcy RegimeEx-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.

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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

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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

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Ecuador Successful Restructuring?

• Default October 1999
• Restructuring July 2000

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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 US46 million
  or 0.2 of GDP.
• -- Salomon Smith Barney, Economic and Market
  Analysis, Country Analysis and Commentary, May 13
  2002

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Uruguay Successful restructuring?

• debt rescheduling 2003

In 2004, analysts stated that Uruguay was in a
good position to grow -- except for its debt
burden.
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Is this market based mechanism efficient?

• Debt exchanges gt 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 Moodys
• 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?

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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.