Abstract

One of the foundation stones of the new international financial architecture needs to be better ways of “bailing in” the private sector when crises strike. Recent experience has heightened concerns that international rescue packages have let creditors “off the hook” and are a source of moral hazard. In this view, the 1995 Mexican rescue allowed that country to pay off its tesobono holders, sheltering them from losses and encouraging them to rush back into investing in emerging markets, including the Asian markets. The 1997 Asian rescues, similarly, are said to have substituted official funds for private funds, permitting foreign creditors to scramble out of Asian markets, courtesy of the IMF and, ultimately, the Asian taxpayer. Additional subsequent risk-taking was thereby encouraged in the expectation that the same official behavior would recur. The denouement came with Russia. The belief that IMF assistance would be provided in the event of debt-servicing difficulties encouraged the “moral-hazard play” in which investors poured funds into Russian treasury securities. When the expected level of assistance failed to materialize and Russia defaulted on its obligations, the market was seized by a creditor panic and a global credit crunch.