Fixing Financial Crises in the 21st Century

By Andrew G. Haldane | Go to book overview

7

Private sector involvement in crisis resolution and mechanisms for dealing with sovereign debt problems

Nouriel Roubini


7.1

Introduction

In the last decade, many emerging market economies experienced a currency and/or financial/banking crisis (Mexico, Thailand, Indonesia, South Korea, Russia, Brazil, Ecuador, Turkey and Argentina, to name the main ones). In each one of these crises, in addition to sharp falls in asset prices and economic activity, the crisis country faced a large external (and sometimes domestic) financing gap that was the result of a combination of large pre-crisis current account deficits and large reversals of capital flows ("sudden stops", "capital inflows reversals", short-term government debt rollover crises and/or liquidity runs on the banks' domestic or cross border short-term liabilities). These facts support the new view that the financial crises in the past decade have been mostly "capital account" crises (or "sudden stop" crises) having to do with balance sheet stock imbalances (maturity, currency and capital structure mismatches) rather than just traditional flow imbalances.

While one would ideally want to prevent crises from occurring in the first place, once one occurs the central issue becomes one of crisis management and resolution. And once an external financial gap emerges in a crisis, one of the main policy issues is how to fill it. Domestic policy adjustment and a painful economic contraction may lead to a reduction or reversal of the current account deficit, but large capital outflows (and the unwillingness of investors to rollover short-term claims on the country, its government and its residents) usually imply that the financing gap will remain large. Thus, in addition to the role of the country's adjustment, there are two ways to fill such a gap: official financing (or "bail-outs") by IFIs and other official creditors, or private financing in the form of "bail-ins" of private investors, also referred to as private sector involvement (or PSI) in crisis resolution. This bail-in can take various forms along a spectrum going from very coercive to very soft forms of PSI: at one coercive extreme are defaults on external (and domestic) claims (Ecuador, Argentina, Russia); in the middle are debt/suspensions and standstills, semi-coercive debt exchange offers and semi-coercive rollover agreements (Ukraine, Pakistan, Korea, Indonesia, Thailand); on the softer end of the

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