Fixing Financial Crises in the 21st Century

By Andrew G. Haldane | Go to book overview
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Reflections on moral hazard and private sector involvement in the resolution of emerging market financial crises

Michael Mussa



Beginning with the Tequila crisis of 1995, the past decade has seen a remarkable number of very damaging financial crises affecting most of the world's emerging market economies. The list now includes Mexico and Argentina in 1995, Indonesia, Korea, Malaysia, the Philippines, Thailand, and (to a lesser extent) most other Asian emerging market countries in 1997-1998, Russia in 1998, Brazil in 1998-1999, Argentina and Turkey in 2000-2003, and Brazil in 2002-2003, as well as many smaller emerging market countries that have endured crises during the past decade. This remarkable series of crises has rightly focused intense concern on what can be done to lessen the likelihood of, and reduce the damage from, such crises in the future.

One of the most important issues in this regard has been the perception that past efforts to deal with such crises utilising programmes of policy adjustment and packages of international support organised by the International Monetary Fund have, in fact, made the problem worse. The mechanism for this purported perversity is "moral hazard". Specifically, the accusation is that expectations of official international support to assist emerging market countries facing external payments difficulties induces these countries and their private creditors to be less prudent than they should be in taking on risks because they believe that, if adversity strikes, the official international community will help to bail them out of their difficulties.

If such moral hazard is a substantial problem, then the solution presumably involves making sure that borrowers and their creditors do more, and expect to do more, to contain and correct the damage when adversity strikes. Because emerging market borrowers generally suffer substantial economic damage in a financial crisis, while at least some private creditors (particularly short-term creditors of banks and of the sovereign) are often seen to escape with limited losses, much of the emphasis in recent discussions of this issue has focused on more efficient and effective mechanisms for involving private creditors in avoidance and resolution of emerging market financial crises. This is reflected in extensive discussions during the past few years, in many official fora, of better mechanisms of "private sector involvement" (PSI).


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Fixing Financial Crises in the 21st Century
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