IMF Rethinks Sovereign Defaults, Again

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By Delusional Economics, who is determined to cleanse the daily flow of vested interests propaganda to produce a balanced counterpoint. Cross posted from MacroBusiness

I noted back in January that the IMF had started to do its own “lessons learned” on its European financial crisis response and had begun to admit it had made some fairly terrible mistakes in its assessment of the debt sustainability of a number of nations, including Greece, under its current programs.

Late last week the IMF released another discussion paper (available below) that covers recent developments in sovereign debt restructures and their effect on IMF policy. The paper concludes that:

First, debt restructurings have often been too little and too late, thus failing to re-establish debt sustainability and market access in a durable way. Overcoming these problems likely requires action on several fronts, including

(i) increased rigor and transparency of debt sustainability and market access assessments,
(ii) exploring ways to prevent the use of Fund resources to simply bail out private creditors, and
(iii) measures to alleviate the costs associated with restructurings

Second, while creditor participation has been adequate in recent restructurings, the current contractual, market-based approach to debt restructuring is becoming less potent in overcoming collective action problems, especially in pre-default cases. In response, consideration could be given to making the contractual framework more effective, including through the introduction of more robust aggregation clauses into international sovereign bonds bearing in mind the inter-creditor equity issues that such an approach may raise. The Fund may also consider ways to condition use of its financing more tightly to the resolution of collective action problems;

Third, the growing role and changing composition of official lending call for a clearer framework for official sector involvement, especially with regard to non-Paris Club creditors, for which the modality for securing program financing commitments could be tightened; and

Fourth, although the collaborative, good-faith approach to resolving external private arrears embedded in the lending into arrears (LIA) policy remains the most promising way to regain market access post-default, a review of the effectiveness of the LIA policy is in order in light of recent experience and the increased complexity of the creditor base. Consideration could also be given to extending the LIA policy to official arrears.

In short, the assessments of debt sustainability have been woeful, there aren’t strong enough binding terms (read CACS) in sovereign securities, the official sector, but not the IMF itself, need to play a part in defaults and the IMF should investigate the optimal debt resolution mechanisms available for negotiating between creditors and debtors.

The paper discusses the implication of the ongoing litigation against Argentina as well as the experience of the fund in the recent case of Greece. Of note is the admission by the fund that it was forced to lower its assessment of the country due to contagion worries from the official sector in Europe:

Accordingly, when a member’s sovereign debt is unsustainable and there are concerns regarding the contagion effects of a restructuring, providing large-scale financing without debt relief would only postpone the need to address the debt problem.

Instead, the appropriate response would be to deal with the contagion effects of restructuring head-on by, for example, requiring that currency union authorities establish adequate safeguards promptly and decisively to cushion the effect of spillovers to other countries (via, e.g., proactive recapitalization of creditor banks, establishment of firewalls, and provision of liquidity support). In the context of the first Greece program, financial assistance was delayed until Greece had lost market access. In response to concerns about possible spillovers from debt restructuring, the Fund lowered the bar for exceptional access (second criterion) by creating an exception to the requirement for achieving debt sustainability with a high probability in the presence of systemic inter national spillover effects. In light of these issues, the modification of the exceptional access policy could usefully be reviewed

In other words, Europe, and its banks, weren’t prepared for a Greek default so the IMF was forced to pretend that the country’s position was better than it actually was. That was obviously a mistake and the country, like many before it, was forced to take a second bailout followed by a re-structure that should have occurred up front. As noted by the paper:

A review of the recent experience suggests that unsustainable debt situations often fester before they are resolved and, when restructurings do occur, they do not always restore sustainability and market access in a durable manner, leading to repeated restructurings. While the costs of delaying a restructuring are well recognized, pressures to delay can still arise due to the authorities’ concerns about financial stability and contagion. Delays were also sometimes facilitated by parallel incentives on the part of official creditors, who accordingly may have an interest in accepting, and pressuring the Fund to accept, sanguine assessments of debt sustainability and market reaccess.


In hindsight, the Fund’s assessments of debt sustainability and market access may sometimes have been too sanguine.

The existing DSA framework does not specify the period over which debt sustainability or market access is supposed to be achieved (although it is generally understood that debt would be sustainable within a five-year horizon) or how maximum sustainable debt ranges should be derived, leaving this mostly to Fund staff judgment. Sustainability was generally assessed on the basis of an eventual decline in the debt-to-GDP ratio—Argentina, Seychelles and St. Kitts and Nevis were the only three cases that provided for a quick and sizable reduction in the debt-to-GDP levels post-restructuring. St. Kitts and Nevis also targeted an explicit debt threshold, i.e., the ECCU debt target of 60 percent of GDP by 2020. Most other cases allowed more than five years for the debt level to fall significantly below safe levels.

For example, in Greece the debt-to-GDP ratio in the most recent program projections is not expected to be reduced substantially below 110 percent before 2022, while in the forthcoming Fund-supported program with Jamaica, debt is still projected to remain close to 120 percent of GDP in five years’ time. In Grenada, the debt ratio at the end of the five-year horizon actually turned out much higher than staff projections at the time of the restructuring. Also, in Greece, Jamaica (2010) and Seychelles, staff medium-term debt projections have been revised upward substantially within only a few years compared to projections made at the time of the restructurings.

Also of note is the emphasis on the broader guidelines of the IMF programs , supporting countries sustainable return to private capital markets in a specific time-frame , and what that means in terms of the types of restructures that should be used and how, and when, the IMF can support them:

There may be a case for exploring additional ways to limit the risk that Fund resources will simply be used to bail out private creditors.

For example, a presumption could be established that some form of a creditor bail-in measure would be implemented as a condition for Fund lending in cases where, although no clear-cut determination has been made that the debt is unsustainable, the member has lost market access and prospects for regaining market access are uncertain.

In such cases, the primary objective of creditor bail-in would be designed to ensure that creditors would not exit during the period while the Fund is providing financial assistance. This would also give more time for the Fund to determine whether the problem is one of liquidity or solvency. Accordingly, the measures would typically involve a rescheduling of debt, rather than the type of debt stock reduction that is normally required in circumstances where the debt is judged to be unsustainable.

Providing the member with a more comfortable debt profile would also have the additional benefit of enhancing market confidence in the feasibility of the member’s adjustment efforts, thereby reducing the risk that the debt will, in fact, become unsustainable. While bail-in measures would be voluntary (ranging from rescheduling of loans to bond exchanges that result in long maturities), creditors would understand that the success of such measures would be a condition for continued Fund support for the adjustment measures. Such a strategy—debt rescheduling instead of debt reduction—would not be appropriate when it is clear that the problem is one of solvency in which case reducing debt upfront to address debt overhang and restore sustainability would be the preferred course of action.

In light of the ongoing litigation against Argentina the paper also appears to be pushing for two things, firstly the introduction of a standard across-the-board mechanism to support collective action clauses, and resolution, within the sovereign debt markets:

Recent experience indicates that the contractual, market-based approach has worked reasonably well in securing creditor participation and avoiding protracted negotiations. But these episodes have also foreshadowed potential collective action problems that could hamper future restructurings. These problems are most acute when a default has not yet occurred, large haircuts are needed to reestablish sustainability, and sovereign bond contracts do not include CACs. The ongoing Argentina litigation has exacerbated the collective action problem, by increasing leverage of holdout creditors. Assuming there continues to be lack of sufficient support within the membership for the type of statutory framework envisaged under the SDRM, avenues could be considered to strengthen the existing contractual framework.

These aspects of the Greek legislation resemble the aggregation features of the SDRM. The key differences between the framework envisaged under the SDRM and the Greek legislation is that the SDRM would be established through a universal treaty (rather than through domestic law),
apply to all debt instruments (and not just to bonds governed by domestic law), and be subject to the jurisdiction of an international forum (rather than the domestic courts of the member whose debt is being restructured). At this stage, there does not appear to be sufficient support within the membership to amend the Articles of Agreement to establish such a universal treaty.


Complementing efforts to revamp CACs, the Fund may consider conditioning the availability of its financing more tightly to the resolution of collective action problems.

For instance, the use of high minimum participation thresholds could be required in debt exchange operations launched under Fund-supported programs to ensure broad creditor participation. Fund policy encourages members to avoid default to the extent possible, even after restructuring. An expectation of eventually being paid out in full may encourage holdouts. The use of high minimum participation thresholds would help reduce such incentives. The Fund could also routinely issue statements alerting creditors that securing a critical participation mass in the debt exchange would be required for the restoration of external stability—the implication being that failure to meet the
established minimum participation threshold would block future program financing, leaving no other option but default and protracted arrears.

Also, in pre-default restructurings, where collective action problems are most acute, the Fund could consider setting a clearer expectation (already allowed under existing policy) that non-negotiated offers by the debtor—following informal consultations with creditors—rather than negotiated deals, would be the norm, as in these cases speed is of the essence to avoid a default. These ideas could be explored in future staff work.

And the second area, that is also “to be explored in future staff work”, is what to do about the risks caused by asymmetry in the treatment of private and official sector creditors, something that was very apparent in the recent Greek restructure:

… arrears to private and official creditors are currently treated asymmetrically under Fund policy.

Private external arrears are tolerated but arrears to official bilateral lenders are not. This subjects the Fund to the risk that it could not assist a member in need due to one or more holdout official bilateral creditors who seek favorable treatment of their claims. Consideration could be given to extend the LIA policy to official bilateral arrears and in that context clarify the modality through which assurances of debt relief are provided by (non-Paris Club) official lenders. Another possibility would be for the Paris Club to extend its membership to all major lenders, so as to allow the Fund to rely on the Paris Club conventions with respect to financing assurances and arrears.

However, it is uncertain whether the Club could achieve such an expansion.

All up it’s an interesting paper and well worth the read if you are interested in this type of thing. The paper also has some discussion on the European crisis-resolution mechanism ( discussed in more detail here ) , although given recent back-steps from Europe on the banking union this looks to still be something of a distant dream at this point.

It will be interesting to see if this paper has any effect on future programs, but it does appear, if only very slowly, that the IMF is learning from past mistakes and attempting to shift policy in a direction to address that issue. It would appear, at least from this paper, that the IMF will be demanding a more realistic assessment of the debt sustainability of target nations and a greater use of up-front restructuring as a per-requisite for program engagement. We’ll have to watch the next steps in Europe to determine if this is simply a talking point or something the IMF board will action.

Full paper below.


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  1. Zapster

    When/if the IMF comes out with rules requiring a reduction in inequality, I’ll then be impressed.. :\

  2. jake chase

    A few modest suggestions for countries facing ‘unsustainable’ debt levels:

    1. withdraw from the Eurozone;
    2. default on the Eurodebt;
    3. eliminate the private debt by a one time per capita currency distribution;
    4. tax land at its unimproved value, impose franchise taxes based on corporate sales, tax transactions in stocks and other financial instruments;
    5. pay students to obtain education in subjects that matter (i.e., engineering, physics, mathematics, biology, other hard sciences specifically excluding economics)
    6. establish a public bank insuring individual deposits up to a reasonable limit, with a fixed rate of interest payable at 3% to encourage saving.
    7. eliminate all taxes on workers; tax executive compensation at 99% when it exceeds 5 times the minimum wage.

    1. Ignacio

      Instead, this is what has been done:

      1) bail-out private creditors with taxpayer money
      2) squezze public balances as much as is considered feasible without causing bloody revolutions.
      3) rule out the possibility that bondholders (MBSs and the like) take the losses they deserve. Nationalise all bad debt.
      4) (this is a guess) In order to implement such large scale robbing effort, some guys (government guys for instance) should be er… encouraged to participate through… opaque instruments?
      5) (another guess) repeat every year the same mantra “one day we gonna act against fiscal heavens” while at the same time, use them extensively to ensure that key people maintains the “courage” to rob their fellow citizens.

    2. Chris Rogers

      I’d be careful using language like that and suggesting ‘rational solutions’ to our present economic predicament – you could be called a Socialist, or worse a ‘Communist.’

      Indeed, given Obama’s love for his iToy’s (read Drone’s) you could be called a Muslim fundamentalist terrorist and executed by a HellFire missile.

      Apart from that little issue of freedom of speech, great post.

    3. allcoppedout

      I would favour a move from Jukonomics to Jakeonomics. In the UK we have knocked the fees off hard sciences. PEW tells us those who do factual subjects are rarely GOP/Tory supporters. Academe is now almost entirely corrupt. I see little point in education post-14 as we have it now.

      The essential problem is we have very little clue on how to organise work and reward – this clueless state gives us economics instead of politics. We have almost nothing I can regard as data and very little method or literature that can be taken at face value as in science.

      One can put forward tentative argument (Oxfam) that the wealth of only 100 people could solve the worst global poverty 4 times over (years ago Foucauldian economists had this at a penny rise in income tax). I guess there must be enough work in the world on stuff that needs doing like this for full employment. The collection of student scripts I have kept over 20 years hardly suggests much quality in higher education. I may have been a crap teacher, but I did the double marking, moderation and external examiner bit and my classes were full to bursting.

      We seem incapable of trusting ourselves in rational planning. This isn’t a totally bad idea as we are more irrational than rational and tend to criminal cheats. But what kind of barking condition are we in if we are letting 100 people sit on wealth that would cure poverty if redirected?

      Radical Jakesterism could well work – but how can we develop it in practice? Education has been a dire failure and a lot of our thinking on this has ‘deficit theory’ behind it – as though bringing people up to speed on facts will make us all see the case for the dangers of global warming, world peace, fair distribution of wealth and so on. This is not how human brains and communities work – there’s plenty of work from Quine on concerning problems with human world-views and what happens to facts in them.

      Echoing Michael Hudson, one has to wonder how much more productive we are now since the end of WW2. The changes are massive. So how come we are so worried about the sky falling and letting people share wealth? Are any of the givens in economics given at all? My nextdoor neighbour at 90 thinks the world is so bad humans should give up and let the next phase of evolution take place. I’d guess 15% of the workforce could keep us going on the basics and that economics and banking is broadly neurotic and criminal. Yet we panic about demographic time bombs.

      If we gave everyone in the world a basic living I suppose we might all be so content we wouldn’t do anymore work – but doesn’t this say something about “work”? Such a miserable drag we don’t want to do it and have to be forced into it?

      It would be good to see argument based on facts – I suspect even debunked economics is stuck in medieval assumptions and fear of instruments of torture.

  3. The Dork of Cork.

    Its working like a charm for the IMF chief shareholders.

    That is giving global resident banks letters of Marque to wage war in the national interest.
    I am reminded of Big Pauls words during the 1970s crisis when I think of symbiotic Anglo power mechanics.

    He spoke of a policy with “controlled disintegration” in its design.

    Look at it from a small islands perspective on a now massive monster of a global economy.
    In a closed loop world its not so much a question of the size of wealth claims …….its a question of relative wealth claims after the dust has settled.

  4. ArkansasAngie

    Some times you have to apply the micro to the macro.

    This is what you get when capitalism is divorced from moral hazard.

    Debt restructuring has to be accomplished one debt at a time. Not recognizing bad debt does not make it go away.

    BTW … moral hazard applies to policies, corporations and their “leaders”.

    1. Jim Haygood

      Here’s a proposed addendum to address the moral hazard:

      Debt is not only a system of money and financial status, but an attitude of mind. It is also a canker which is gnawing deep into the vitals of society.

      With the monetary system as the source of infection, it has spread through the veins of economic enterprise, penetrating with its poison every organ of production and distribution.

      Indeed, so imbedded has the idea of debt become in the conception and attitudes of people, so coated over with the nacre of terminology —- debt is no longer “debt” but “credit,” “personal finance,” “deferred payments,” “securities,” and the like —- that the nation has insensibly saddled itself with a mountain of monetary obligations that may require a revolution to remove.

      “Hi, we’re from the IMF, and we’re here to overturn the existing order.”

      1. F. Beard

        Common stock is an equity-based money form but I never hear the Austrians recommending it as private money!

  5. Receding Frank

    The world needs an IMF jubilee. They don’t rethink anything, the people on the ground aren’t the ones who are in debt, but this appears to be an attempt at kinder gentler attempt at punishmnet that is otherwise odious. Ma and Pa Papadakis shouldn’t pay. Various militaries, mega landowners and the super-rich are responsible, have them pay.

  6. Code Name D

    I may be wrong on this (and do correct me if I am) but IMF papers such as this still do not mention any MMT cretiques of their current policy. If they were truly reassesing their mistakes, that would be the first place they would go.

    Instead, this whole thing reads like a tinkering around the edges, trying to find a way to rescue the current orthidocey.

  7. Chauncey Gardiner

    “The best laid plans of mice and men”… from a Scots poem written by Robert Burns in 1785:

    The cumulative debts are not repayable within the present monetary, socioeconomic, political and legal framework. This document is further evidence of official recognition of that reality.

    Impaired assets… write ’em down or off… move on… or change the monetary system.

  8. George Phillies

    The IMF proposals and critiques seem designed to destabilize the system, namely they make clear that if you are a private holder of sovereign debt you will suffer misfortune in order to protect the foreign public holders.

    At some point, it will occur to investors that sovereign debt has become intrinsically unsafe.

  9. impermanence

    What total bullshit, and, as well, a perfect example of, “the more complex anything becomes, the further it deviates from the truth.”

    1. diane

      I agree, but the now digitalized, ♫ Musical Chairs Game!!!! ♫ …. has an highly magnetic pull …

      siiiiigh …. ;0(

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