International Financial Governance under Stress: Global Structures versus National Imperatives

By Geoffrey R.D Underhill; Xiaoke Zhang | Go to book overview

17

Bail-outs, bail-ins and bankruptcy:
evolution of the new architecture

MANMOHAN S. KUMAR AND MARCUS MILLER

The problem is that we have no accepted framework in which a country in extremis
can impose a payments suspension or standstill pending agreement with its creditors…
[This is] compounded by the absence of an accepted legal framework in which the debtor
and its creditors can work to seek to restore viability.

Stanley Fischer1

Legal and institutional aspects of global economic governance, particularly the management and resolution of financial crises, are the focus of this chapter. To avoid ever-larger public sector bail-outs (and their adverse incentive effects), increased involvement of private bankers and investors in resolving sovereign debt crises is called for. In the short term this may be achieved by standstills and other ‘bail-in’ devices such as forced roll-overs, collective action clauses and bond swaps. In the longer term, however, an International Bankruptcy Procedure accompanied by private arrangements for contingent credit provision and debt restructuring will probably be required.

We begin with an interesting historical precedent. When the United States left the Gold Standard in 1933, the dollar price of gold rose by almost 70 per cent and the Gold Indexation Clause embedded in most private long-term debt contracts and in much of the public debt – mandated a matching increase in the dollar value of debt. To prevent a credit crunch, President Roosevelt secured a resolution of Congress suspending the Gold Clause; but this was challenged by creditors going to the law, all the way to the Supreme Court. But on the day the Court handed down its judgement in favour of the president and against the creditors, the private sector debt for which the Gold Clause had been cancelled went up in value. How could this be? The answer suggested by Randall Kroszner in his fascinating account of the episode is that creditors as a whole were better off with their pre-existing nominal claims on viable corporations than they would be with greater claims on companies driven into liquidation.2 This episode essentially involved domestic debt, but the principle applies to sovereign debt externally held: even the finest debt contracts may sometimes need to be restructured.

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