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Interview with Rogoff and Zettelmeyer: Success of SDRM idea has many fathers

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
January 2002
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“When it becomes necessary for a state to declare itself bankrupt, in the same manner as when it becomes necessary for an individual to do so, a fair, open, and avowed bankruptcy is always the measure which is both least dishonorable to the debtor, and least hurtful to the creditor.”

This quote comes from Adam Smith in 1776—one of the many surprises that an IMF study turned up on the history of proposals to apply bankruptcy procedures to resolving sovereign debt crises. The IMF Survey talked with the authors of the study, Kenneth Rogoff, IMF Economic Counsellor and Director of the Research Department, and Jeromin Zettelmeyer, Senior Economist in the Research Department.

IMFSurvey: Why did you do the study? How can history help us?

Rogoff: There were two motivations. First, we noticed in the press that many people were rushing forward to take credit for First Deputy Managing Director Anne Krueger’s proposal as soon as it started to receive acclaim. Note that success has many fathers: for example, a New York Times article attributed the idea largely to Jeffrey Sachs. Second, we were aware that there was an earlier literature, but we had no idea how extensive it was. We were interested in tracing out who had said what and when. In the process, we really learned a lot. At some level, the fact that the SDRM [sovereign debt restructuring mechanism] proposal represents an evolution in thinking, rather than something out of thin air, is reassuring.

IMFSurvey: Who have been the stars in this history?

Rogoff: The dark horse celebrity is a lawyer named Christopher Oechsli, who wrote an article in the Virginia Journal of International Law in 1981 that can only be described as prescient. It explored how bankruptcy laws could be applied in the sovereign context. He wasn’t as worried about the free-rider problem as some of the later proposals were, but he was very worried about the slow nature of negotiations between private creditors, official creditors, and the debtor countries. He definitely stands in the limelight as the unknown star of this literature. Zettelmeyer: However, he stands in the limelight only if we shine it on him now. There were no stars until 1995, when Jeffrey Sachs gave his Princeton University lecture. There were also three lawyers fresh out of Harvard Law School—Barry Barnett, Sergio Galvis, and Ghislain Gouraige—who wrote a path-breaking article in the Harvard Journal of International Law in 1984. So there were people who came up with these ideas in the 1980s, but their names didn’t really stick in the public debate—not even in the academic debate—and they aren’t cited very often in the papers that come later. As for the recent stars, one has to point out Barry Eichengreen and Richard Portes. Their 1995 book really kicked off the idea of collective-action clauses as the main vehicle for orderly workouts—an idea that is very hot in the current debate. U.S. Treasury Undersecretary John Taylor’s recent proposal is all about applying such clauses.

IMFSurvey: Why do you quote Adam Smith? Was he an early star?

Zettelmeyer: It’s a great quote, because he says there are certain situations where the best a country can do is face up to bankruptcy and proceed in an orderly way. The context is one where he tries to argue against high inflation as a way of“solving” public debt problems. But he doesn’t go into any details about how one would go about organizing an orderly bankruptcy.

IMFSurvey: Were there any IMF stars in this history?

Rogoff: There was an Executive Board discussion of these issues and a Board paper in 1995, written by the Legal Department. It was far more detailed than Sachs’s lecture on how a sovereign bankruptcy mechanism would work in practice. Even in the late 1980s, there was significant discussion of this issue within the IMF. The IMF was not behind the curve. But in November 2001, the First Deputy Managing Director brought it to the fore in the policy debate.

IMFSurvey: What did you learn about the assumed inefficiencies motivating the various proposals?

Rogoff: In the early 1980s, Oechsli was worried about the ex post inefficiencies following deep debt crises—cleaning up after the problem occurred. Sachs’s 1995 lecture was the first to argue that a bankruptcy mechanism could deal with liquidity crises as well. This question appears in the academic literature in the 1980s, including in IMF work, but it wasn’t in the public consciousness. However, with a modern eye, we don’t view that distinction as sharply as they did some years ago; it’s not easy to distinguish between solvency and liquidity crises. Then, after the Mexican crisis, moral hazard caused by international crisis lending surfaced as a major worry. Most of the modern proposals try to deal with this problem. Zettelmeyer: Another way to look at it is that the counterfactual has changed. Initially, the alternative to an orderly bankruptcy procedure was only disruptive defaults. Now, the alternative also includes moral hazard caused by large-scale international crisis lending.

IMFSurvey: How have the proposed solutions changed over time?

Zettelmeyer: There are two phases. The first is from the early 1980s until 1995, during which the spectrum of suggested remedies was staked out. At one end was the voluntary, public policy–based approach, where no institution would be changed, no new laws would be passed, and no treaties would be amended. However, the official sector would behave differently, thereby hopefully imparting different incentives. This is the Oechsli, minimalistic approach. At the other end of the spectrum—as proposed in 1984 by Barnett, Galvis, and Gouraige and a few years later by Benjamin Cohen—were very ambitious proposals for creating a new international institution. In the middle, a number of proposals popped up in 1995 after the Mexican crisis, basically pushing the contractual approach that plays such a big role in the current debate. The idea of using collective-action clauses in private bond contracts wasn’t new, but it was new to suggest that they be used as a universal tool for crisis management.

IMFSurvey: How about post-1995? Has there been a convergence?

Zettelmeyer: Since then, we’ve seen a little bit of a narrowing, at least in the official community. On one side, we now recognize that in order to have an effective statutory solution we might not need a broad range of functions concentrated at the international level. Instead, we could have a statutory system that is largely self-enforcing and requires international arbitration only to a very limited extent—the so-called less heavy-handed approach. This idea was put forward both by Krueger in her modified proposal [see page 193] and by Steven Schwarcz, a Duke law professor, in 2000. On the other side, the proponents of collective-action clauses have realized that they really need to be clear about how to create the incentives for private actors to adopt such clauses.

IMFSurvey: How political is all this?

Rogoff: There’s clearly an interplay. Fundamental to the whole problem of sovereign debt is that you don’t have an international legal system that is the same as national legal systems. There’s also a transition issue. You can say, this is where I want to be in 25 years. But what do you do about the existing stock of bonds and those issued while a new proposal is being formulated? This may raise distributional issues, even though, in principle, the large potential efficiency gains to be had from a better debt resolution mechanism can still make everyone better off, even in a transition.

IMFSurvey: Isn’t the whole issue of sovereignty quite political?

Rogoff: Yes it is. If you subject yourself to an independent forum to resolve disputes between creditors and debtors, as envisaged by Krueger’s proposal, it’s a small subordination of sovereignty. The same is true if you sign an international treaty that commits you to incorporate collective-action clauses and workout rules into your bonds—as in the newer variants of the Eichengreen and Portes proposal. But it’s very much in line with other ideas aimed at achieving a better, smoother globalization.

In terms of solutions, the debate has been remarkably frank and nonpolitical. In fact, I would argue that the debate has become less political in the sense that the desirability of an orderly debt-workout regime for countries is now widely recognized. The very first institutional proposal in the late 1970s occurred in a very political context. The proposal, put forward by the Group of 77 developing countries at the UN Conference on Trade and Development, was to create an international debt commission. Its focus was distribution, debtor interests versus creditor interests. That’s why it didn’t fly—the creditor countries didn’t support it. Now, we have a large part of the official community, including the main creditor countries, supporting some form of international bankruptcy.

IMFSurvey: What are the policy implications of your study?

Rogoff: Many of these ideas have a long legacy and a long history and have been thought through quite carefully, and we are really reaching a stage where it’s possible to move from an academic idea to something concrete—which is what the IMF is trying to do.

IMFSurvey: Any final thoughts?

Rogoff: Just one other thing: I view the moral hazard problem as actually having existed significantly in the 1980s. The World Bank and the IMF did substantially step in as private creditors pulled out of many countries, but it all happened in slow motion. It took place over five years instead of over a few weeks or months. I think there’s a feeling that the way the IMF intervened in the Asian crisis was much more efficient in that we didn’t have five years of stagnation over the bargaining process between the debtor- and creditor-country governments. But it may have exacerbated the moral hazard problem—and raised the world’s awareness of it—by lowering the deadweight cost of default.

This interview is based on a forthcoming expanded study by the authors. For an initial version of the study, see Early Ideas on Sovereign Bankruptcy: A Survey, IMF Working Paper 02/57, available on the IMF’s website (www.imf.org).

How do the main proposals for improved sovereign bankruptcy procedures differ?

approaches
Change statutes
International law
Change mainly official policiesChange debt contractsNational lawNarrow role for international institutionsBroad role for international institutions
Inefficient workoutsOechsli (1981)
Debevoise (1984)Barnett and others (1984)
MotivationCohen (1989)
Raffer (1990)
Miller (1991)Reinisch (1994)
Inefficient workouts + debt runsEichengreen andSachs (1995) IMF Legal
Portes (1995)Hurlock (1995)Department (1995)
Inefficient workouts and/or debt runs + moral hazardMacrnfflan (1995)
G-10 Deputies Working Group (1996)Chun (1996)
Eichengreen (2000)Schwarcz (2000)
Haldane and M. Kruger (2001)Taylor (2002)Krueger (2002)Krueger (2001)

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