Fixing Financial Crises in the 21st Century

By Andrew G. Haldane | Go to book overview

14

Comments on "Sovereign bond restructuring: collective action clauses and official crisis intervention"

Willem H. Buiter1

Chapter 13, by Kletzer, is excellent. It brings rigorous economic theory to bear on an important practical policy issue and reaches conclusions that make sense. But I will concentrate my remarks on the issues where Kletzer and I appear to be in less than complete agreement.

The formal model has a number of familiar features as well as a few non-standard ones. A single, infinite-lived, risk-averse borrower with time-additive preferences and a random, perishable endowment faces a large number (probably a continuum) of infinite-lived risk-neutral lenders. The borrower's objective is to maximise expected utility of lifetime consumption. There is no third-party enforcement of contracts (contingent or simple). There is uncertainty, but no asymmetric information. The fallback position of the borrower and the lenders is financial autarky. It is not clear to me whether it might ever be individually rational for the borrower to become a lender. Is it ever rational for him or her to build up a stock of financial assets which can then be run up or down to buffer endowment shocks?

The strict concavity of his or her period utility function implies that the borrower is interested in two kinds of consumption smoothing: (1) consumption smoothing over time (intertemporal consumption smoothing); and (2) consumption smoothing across states of nature (diversifying consumption risk). And the borrower fails to achieve the command optimum because he or she labours under two handicaps: (1) an inability to commit his or her future actions; and (2) he or she is restricted to simple (non-contingent) debt contracts.

Third-party enforcement or some other ad hoc commitment mechanism is required to solve the commitment problem. Simple, multi-period debt contracts with third-party enforcement permit full consumption smoothing over time, but not across states of nature. Renegotiation can be used to mitigate the restriction on risk sharing caused by the assumption that only simple debt contracts can be used, but without third-party enforcement it will not resolve inefficiencies due to lack of commitment.

My main disagreement with Chapter 13 (or rather the main reason why the conclusions of the chapter cannot be applied directly to real-world renegotiation of sovereign debt contracts) is that the set-up of the model, and therefore its conclusions, are too "Coasian".

-254-

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