1. SOVEREIGN BANKRUPTCY

2. 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 => different incentives and actions prior to bankruptcy

3. Goals of Bankruptcy Regime Ex-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.

4. 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

5. 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’

6. Ecuador: Successful Restructuring? Default: October 1999 Restructuring: July 2000

7. 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 US$46 million or 0.2% of GDP.” -- Salomon Smith Barney, Economic and Market Analysis, Country Analysis and Commentary, May 13 2002

8. Uruguay: Successful restructuring? debt rescheduling 2003 In 2004, analysts stated that Uruguay was in a good position to grow -- except for its debt burden.

9. Is this ‘market based mechanism’ efficient? Debt exchanges => 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% [Moody’s] 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?

10. 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.