Transcript of a Briefing by Jack Boorman on Involving the Private Sector in Forestalling and Resolving Financial Crises
April 15, 1999
April 15, 1999
MR. ANJARIA: Welcome to this briefing on the subject of involving the private sector in forestalling and resolving financial crises. You have received a paper on this subject, which has been produced by the staff and which includes the Chairman of the Executive Board’s summing up of the Board’s discussion of it last month. This briefing is on the record, and it's being given by Jack Boorman, Director of the Policy Development and Review Department of the International Monetary Fund. We would like to request you to observe a strict transmission embargo until 11:00 a.m. Eastern Daylight Time, 1500 GMT today, and that means no broadcast in any way until then or posting on news wires and Web sites. Thank you very much for your cooperation. I'd like to ask Mr. Boorman to begin by some introductory remarks, and then we'll turn to your questions.
MR. BOORMAN: Thank you, Shail, and thanks for coming to this press conference. We have, I think, begun a tradition here of releasing staff papers along with the summary from the Board discussion of the relevant issue. The document that has been given to you, which follows the tradition we started when we released the study of the Asian papers, has the summing-up of the Board discussion in blue pages in the front, and then the staff paper in the back.
The Board summing-up, as you read through it, is a bit of an art form in the IMF. You will see references to "many Directors" and "some Directors" and "other Directors" and "most Directors" and so forth. That is an attempt to convey the sense of the discussion that took place. Like the staff and management, the Board is not a monolith in this, and you'll see a diversity of views on issues, not just on this topic but on all the topics that the Board addresses.
What you will find, though, if you go through and don't fall over those adjectives, "many" and "some" and "few," is the center of gravity of the Board which reflects the position of the institution.
We're also providing the paper that was prepared by the staff for this discussion. Some of that staff is here, and I would like publicly to thank them for the work that they have put into this effort, not just in my own department but in other departments in the Fund as well. Their names are listed in the preface of the document.
It's a routine practice in the Fund that when the Board has a discussion on a topic, the staff prepares background material for it. It will present various aspects of the issue. It will present analysis of the issue. It may present proposals regarding the way the Board and the institution ought to move forward on an issue. And that is what is in the staff report that you have in this document.
It's important, though, to note that the staff report is input to a discussion of that sort. It is not the position of the Fund. The position of the Fund is the position of the Board that's reflected in the summing-up. The Board may or may not agree with the analysis that's presented by the staff, and it may or may not agree with the proposals that are presented by the staff. And so if you see a difference of any kind or of nuance between a staff paper, this one or other papers, and the Board's summing-up, it is the Board's summing-up that reflects the position of the institution.
The work reflected in the staff report is part of a much bigger effort which you all know is underway under this terrible word of "architecture" of the international financial system. It's not just these issues of involving the private sector, but it's also issues of transparency--transparency by the Fund, transparency by its members, transparency by the private sector. It's standards--standards for accounting, standards for monetary policy, standards for fiscal policy, core principles for banking supervision and the like. It involves the development of facilities within the Fund. As you know, probably, there are discussions of a facility for provision of contingent credit lines under discussion in the Board. It involves work on strengthening the financial sector, especially in emerging markets. And so forth.
All of this is a big agenda. This is one element of it. On the other elements, as we approach the days before the Interim Committee on April 27th, there will be more reporting on the outcome of the discussions in these various other areas as well.
Today's issue, though, involving the private sector in forestalling and resolution of financial crises, I think is probably one of the more complex areas on this agenda. And from that point of view, I would stress that what you have before you is really a progress report. All of this is work in progress. It is work that will continue, clearly, for the foreseeable future.
More and more, though, it's clear that this is an area in which the final product is not going to be a set of rules; rather, it will be a set of principles that will have to guide the activities of all the involved parties, whether the debtors themselves, their private creditors, or the official communities, in working with individual cases.
There is no magic solution, and the deeper we have gotten into this area, I think the clearer it becomes that there is no magic solution.
The practice in this area is going to have to evolve as the markets themselves evolve and as the instruments that are used by markets also evolve.
Another thing that's becoming completely clear is that there will never be a single or a clear-cut way to resolve crises. Crises are probably always going to be messy affairs. This implies at least two things, I think. One is a high premium, a very high premium, needs to be put on prevention and on measures that can be put in place beforehand to avoid that situations of stress in a country's external situation unwind into a crisis. And what you will find in both the staff report and the summing-up is a lot of attention to preventive measures and what we label ex ante measures: things, instruments, policies that can be put in place in normal times, in routine times, that can help involve the private sector--either keep the private sector in the situation or, in fact, even increase their exposure, bring them further into the situation when a country comes under particular stress.
The second thing that becomes more and more clear is that in a crisis everything possible needs to be done to find a cooperative and a voluntary solution, a collaborative way, basically, of resolving a crisis that takes account of the interests of both the debtors and the creditors.
Much of what you see in the paper represents a distillation, if you want, of the lessons from the crises that we have been through in the last few years. Much of it is also motivated by the concern that many in the official sector had that the provision of large official financing to a country in crisis which permitted the private sector to exit the country without loss was not healthy for the operation of markets--not healthy in the sense that it could lead creditors to assume that whatever happened, they were likely to be repaid, i.e., that official money would be provided to permit them to withdraw. Such an assumption is indeed harmful to markets if it weakens the incentives of private players at better risk assessment, if it leads to overlending, which I think it's fair to say has been the case in a number of the crisis countries, or lending on inappropriate terms.
Obviously, what I'm talking about here is simply the risk of bailing out the private sector from poor lending or poor investment decisions. I dislike intensely that word "bailout," but it's the best thing the community has come up with to describe the situation.
But let's be clear, if I can, on one aspect of this. In no case in the recent crises has there been a wholesale bailout of the private sector. The IIF, for example, has estimated that private investors, banks, bond holders, and others have lost something on the order of $350 billion in the three Asia crisis countries and in Russia. But saying this is not to say there is not a problem. There is a problem. And in a number of recent cases, it's been concentrated at the short end of the market, including the inter-bank market, where creditors can and have exited in crisis situations.
It's a fairly simple proposition. If you're a bond holder and you try to get out, unless you happen to face the fortunate circumstance of having an amortization payment due at that moment, if you want to go out, you go out through the secondary market. In the secondary market, the price drops as people try to exit. And so there is a payment on the part of the private creditors that exit at that moment.
If you're in the inter-bank market, if you're a short-term creditor, you simply wait a few days or a few weeks until your short-term line matures, and then you exit at that moment. That's where the bailout occurs. It doesn't typically occur in the bond markets and the equity markets or for private direct investors.
The view that I just expressed is a view that has led us and the staff to concentrate on issues related to short-term debt and debt that can become short term. One of the experiences of the recent crises is clearly that even though we thought and countries thought they were looking at medium- and long-term debt in certain instances, derivatives such as puts that had been put into those instruments effectively made them short term, and in many instances, those puts got activated.
So we're looking at the short-term debt, and we're looking at the vulnerabilities of debt structures that result from that. Much of the material in the staff paper you have goes precisely to these issues. You'll find a list of specific issues on pages 9 and 10 of the foreground paper, and you'll find much more detailed consideration of the analysis of many of these issues in the several chapters in the background paper.
Included in the background paper, for example, is a detailed treatment of issues that lead the staff to call for consideration to be given to modifying bond contracts, why do we think that's a sensible idea, what are the analytical underpinnings of that proposition and so forth. You'll find a review of the experience in encouraging rollovers of short-term debt in recent cases--in the Korean case, for example, Brazil and so forth--and other such issues laid out in some analytical detail.
Now, in summary, you can find the conclusions of the Board on some of these issues in the blue pages, in the summing-up. In particular, let me say just a few words of summary on those views.
The Board reached several conclusions in the area of crisis prevention, and as I indicated earlier, it is prevention that both the staff and the Board are focused on. Among these conclusions:
First, national authorities should intensify their efforts to maintain an appropriate debt structure. Clearly, in the crisis cases, we were faced with, and the authorities in the countries were faced with, inappropriate debt structures that had increased the vulnerability of the economy dramatically. An appropriate debt structure is one not too heavily weighted towards short-term credits, among other things. The Board also conclude in this context that you need to improve early warning systems to detect signs of market and economic instability.
Secondly, measures should be considered to eliminate what many consider to be the market bias in favor of short-term inter-bank credit lines. And the call here by the Board is for the Basle Committee on bank supervision to give early consideration to various proposals that have been made in this area.
Third, the IMF staff should continue to assist countries in establishing systems for frequent monitoring of private sector indebtedness, and the Fund should intensify its surveillance generally of countries' debt structures, of the use of derivatives in those debt structures, of off-the-books liabilities, and of other items that can increase the vulnerability of the country situation.
Fourth, members should maintain effective communication with private capital markets. This is something I noticed the IIF has put a lot of emphasis on in its recent reports. It is also something that we encourage strongly. Two examples where this has been done with great effect recently that have served the countries well, I think, are Argentina and Mexico.
The Fund also has to explore better ways, closer ways of dealing with the private markets. There is also a need to improve the environment for private risk assessment and decisionmaking, especially to ensure efficient and realistic pricing of debt.
That's on prevention.
Among the Executive Board's conclusions in the area of crisis resolution, let me mention a few. First, many Directors--using that phrase--said that governments should seek to modify certain standard provisions in the international bond contracts as they undertake new bond issues. A number of these Directors recommended that there should be an introduction of provisions for the modification of terms by qualified majorities of bond holders and steps intended to reduce the likelihood of litigation by dissident bond holders in the event of a default.
Secondly, governments should consider establishing contingent credit lines with commercial banks--again, as you know, this has been done by Argentina and Mexico with some success.
Third, governments should explore with their creditors the possibility of creating debt instruments that can be designed to shift risk in a moment of crisis. Particularly in the private sector, there's been a lot done in this area, and the sovereigns could learn quite a bit from this. Structured notes is one way to do this.
Fourth, the IMF staff should continue to study various instruments that might be introduced to reduce the threat of destabilizing capital outflows from a member country. One possibility that has been raised but hasn't really gotten legs yet in any of the fora where it has been discussed is to introduce call options in the inter-bank credit lines. That would enable borrowers to ensure stable lines of credit in times of stress. This is a difficult area, though, and no one has come up with a solution that yet looks operational.
Fifth, the Fund should continue to examine its own policies on lending to countries that are in arrears on their private sector debt so that the Fund at moments of extreme distress for a country which have forced it into default can possibly assist the country even in the event of and in the face of that default.
So those are the basic conclusions. You'll see them, again, laid out in the summing-up of the Board discussion. Why don't I stop there and take questions?
MR. PELOFSKY: Jeremy Pelofsky from Bloomberg. A couple days ago, the IIF actually put out a report and a letter to the IMF and the international community calling for the IMF not to push some of these very ideas that are included here, such as bond contract amendments. I'm wondering what kind of response you have to that and how you see overcoming that difficulty or that displeasure from the private sector.
MR. BOORMAN: I think we're all basically searching for the same thing, and that is, how do you find elements for a system that will make it work not just in good times but also make it work better in bad times?
As I said, two things. One is we're not working towards a series of rules. We're working towards a series of principles that you can work from on a case-by-case basis. We're also not of the view that there's a simple solution out there. Bond contract modification, for example, is not a magic bullet that's going to solve the problem.
What we are all seeking, though, is ways to smooth the process when countries get into difficulty. And we believe that one way to do that would be to have clauses in bond contracts that would permit majority voting, for example, as is already the case in British-style bonds, so that if a country gets into distress it has to face the prospect of approaching its creditors and finding a resolution by restructuring its debt in some way. There are mechanisms to allow that to happen.
Now, why do we think that's useful? Primarily because if the bond market of a particular sovereign tanks because of the prospects for the country, one of the things that can happen if every creditor has full right to sue is that vulture companies--companies that basically specialize in distressed debt--can come in, with no particular long-run interest in the country, and could litigate, could sue.
If they do and if they win, you've got two problems. One is that it can tie up the country and the prospects for adjustment and implementation of policy reform in the country simply by the threat of litigation, and it also can result in a situation where that bond holder, if it wins, simply walks off with what that bond holder has won. The rest of the bond holders are still sitting there.
What we're looking for is a collaborative way of getting the debtor and the creditors together in that extreme kind of situation under a system that would allow the bond holders as a group to solve what's called the collective action problem, to come down as a group to look at the situation of the country and to come to conclusions about what's necessary to help see the country through this particular situation. That may involve a stretching-out of maturities, a lengthening of payment periods, and so forth. And if that's the case, our view is that if it can be done in a non-disruptive way, it's better for both the bond holders and for the country.
The bond holders will come out better off if the country isn't forced through an extended period of distress and can get on with adjustment and reform. The country is obviously better off if it can do that rather than facing protracted litigation and disruption in the courts from various bond holders.
But I would stress I think in both instances we're looking for the same thing. We're looking for ways in which collaborative approaches, voluntary approaches, can be used at these moments of stress and extreme situations to try to get the community, both the debtor and the creditor community, through the situation.
MR. FIDLER: Steve Fidler from the Financial Times. Two questions. One relates to the kind of progress report that you have here which suggests the balance between things that have not been done and the things that have been done is rather biased in favor of things that haven't been done. In other words, wouldn't you say that the progress on this, on a lot of these issues, is very slow and the experience since '94 in that some of these things have been around since the Mexico crisis in '94, '95, suggests that perhaps they won't be done?
And the second is a British-style question about British-style bonds and whether the spreads on British-style bonds and their experience when in times of financial crisis what happens to them--relative to U.S.-style bonds, if you like--tells you anything about their behavior and whether investors will indeed regard them as riskier because they have these different types of contracts when they're being launched.
MR. BOORMAN: Has progress been slow? A fair point, I think. If you look back to the G-10 report, Jean-Jacques Rey's report of 1996, there was, for example, extensive treatment there on the issue of modifying bond contracts. And you're right, it hasn't been done.
I think the world has gone through quite a different kind of and more severe shock in the last two years than was the case in the Mexican context. Remember, Mexico created a number of problems: the tequila crisis throughout Latin America, pressure on Argentina, pressure on those other countries.
Investors turned to Asia at the same moment, but the attack, if I can use that word, on Asian currencies lasted literally a few days. At that moment, the investors, the markets looked at Asia, and they were content at that moment in early '95 with what they saw because they backed off.
Similarly, in Mexico itself, the crisis had rather a V shape, and so by the time Rey's report came out, I think the markets to a certain extent had gone back into a period of calm, and perhaps the official community as well wasn't as forceful on some of the reforms that it thought were needed, as is now the case. I think the Asian crisis, its spread to many parts of the rest of the world, what happened in Russia, what's happened in Brazil, has convinced people who were perhaps earlier on the fence about some of these matters that it would be preferable if mechanisms were in place to help smooth the situation when a crisis strikes.
So my conclusion from that is that the international community is far more seized with these issues, and it will have staying power on these issues, in a way that I don't think was necessarily the case after Mexico. So I'd be more optimistic on that.
On the other hand, the reason, as you put it, the staff report is perhaps focused the way it is goes back to what I said in the beginning. I think this is the most complex aspect of the whole architectural discussion. It's turned out to be, frankly, far more complex than I think we expected it to be.
The kind of instrumentation that has been developed by markets in recent years, while all to the good in terms of providing countries and corporations, with new ways of handling risks--appropriate, positive, constructive ways of handling risks--also can create problems.
Puts are a sensible way of dealing with risk in certain circumstances. But if a country, to save a few basis points, allows puts to be put in a large component of its external debt so that it is no longer really medium and long term but can come back for repayment very quickly at a moment of crisis, it's trouble. It's a problem. And I think there has to be a much more careful balancing in the future of the kind of savings that can be accrued by using instruments like that against the risk that they create in the country's debt structure.
But I am not as pessimistic as you imply you might be about progress in this area. I think there's a far better understanding of all of this than there was when the Asia crisis broke, and that's no small feat. It's taken a lot of discussion in a lot of fora to spread that understanding, but I think it is far better now than it was previously.
There has been concrete action in a number of countries, a fairly large number of countries, where they have taken much stronger steps to assess the real vulnerabilities in their external debt structure. We have helped a lot of countries from the Fund by putting in place monitoring systems--the same people, by the way, who have written the staff report on the staff.
We have developed quite a lot of experience in the various cases that have been thrown up in the process of this crisis, whether it's the Korea rollover, the more recent experience in approaching banks by the Brazilian authorities, the Ukraine experience, obviously Russia's traumatic experience last August. We've got quite far, I think, in ourselves and the Bank organizing better to provide technical assistance to countries in the area of strengthening their financial sectors. All this work has been done on standards and so forth. I could go through it, but as I said, that will be coming out over the course of the next few days.
So I think there is a sea change, frankly, in the attitudes in the official community about getting on with this. That's not to say it's going to be easy because there really are different views on many of these issues. Bond contracts is one of them. There are other areas as well where there needs to be more discussion before there's a consensus on how to proceed.
On the second question, the fact of the matter is that there's not much experience with using these different bond styles, whether they're American bonds or British bonds. There's not much experience in defaults and renegotiations on these. So we're on relatively new territory here and one is speculating.
We and a number of others have tried to look at the differential pricing, for example, between issues in British bonds and American bonds, and there are no clear results from this analysis. It is not evident that countries that issue with the clauses in British-style bonds pay more than what is paid by those issuing under American law.
This work is tricky business analytically, and I'm not sure that we have the right conclusions in this. But it's impressive that the number of people who have looked at this, even in specific bond issues--the bond issues in Hong Kong, for example, that had been issued under both kinds of law--don't see differentials there either.
I am of two minds on this, frankly. I think there is a presumption out there that if you put these kinds of clauses into bond contracts which make it "easier," somehow or other, for the debtor to renegotiate, that this will be looked at askance by creditors and, therefore, will lead them to demand a higher spread. I'm not so sure.
When you look at the collapse of bond prices and the spreads that emerge at a time of stress for a country, it clearly shows that people expect there can be problems. It clearly shows that the markets expect there can be defaults. The question then arises: If, in fact, that happens, how will it be handled? And it seems to me that if there is a mechanism in place--bond contracts clause changes being one of them--that can smoothe the process and in the end provide more recovery to the bond holders, the spreads could actually be lower. It's not clear, it seems to me. It's an empirical question. I think we need more experience before we can answer it firmly.
MS. GUTTSMAN: Janet Guttsman from Reuters. You seem to be saying that the G-10 should lead the way in introducing new bond contracts. When do you expect that to happen? And if I may, a question on a different topic. There's a lot of talk that the Interim Committee will finally agree on the sale of some IMF gold. How quickly could that go ahead? And would you tell us that you're going to do it, or will you wait until you've done it and then tell us you've done it to avoid disrupting markets?
MR. BOORMAN: On the G-10, yes, we have two proposals, basically. One is that perhaps some of the major industrial countries could lead by example by inserting these kinds of clauses into their own securitized debt issues, their own bond issue. I don't know what's going to happen on that. There are different views out there about whether that is a feasible start.
There are some G-10 countries who have indicated some sympathy to going this way. There are others who haven't indicated a position, and I take silence in this case perhaps to be an indication that maybe they're not anxious to do it.
I think we may get a little bit further on this in the Interim Committee, and perhaps out of the discussion that takes place there we may be able to judge a little bit better the extent to which there's a willingness to do this. That's one approach.
There are a number of other approaches. One is for the regulatory authorities of the major financial centers to begin to look at the usefulness of insisting that clauses like this be in bond contracts. That, too, is an issue on which we don't have firm indications of willingness. It's being explored, and I think we'll have to see where that discussion goes. Again, possibly the Interim Committee will shed more light on that.
Now, on gold sales, the gold sale proposal has been on the table for some time. As you know, the Managing Director suggested, when we started the discussion about refunding the ESAF and then in the context of the cost of the HIPC initiative, that there should be a mixture of mechanisms to finance it, some through bilateral contributions and some through the sale of gold. And he suggested that up to 5 million ounces of gold could be sold.
That did not find the majority that's needed. We need an 85 percent majority in the Board to take a decision on something like gold sales. That proposal did not find the support that was required. A number of governments, including, as you know, the German Government, had been opposed to it.
The new German Government has provided signals that it is sympathetic. The U.S. Government also, in the announcements that it made recently regarding the HIPC initiative, has suggested that it might be willing to support gold sales of up to 10 million ounces.
So I think we're in a different discussion now. We're in a discussion which I think comes close to a position where we can see approval of gold sales some time in the future. Maybe there will be agreement in principle on this in the near future, maybe even at the Interim Committee. I think the discussion now is going to turn to whether it will be 5 million ounces or something larger than that.
This is related, of course, to the proposals that are on the table for the HIPC initiative itself, not quite the topic of this morning's discussion. But as you know, many of the G-7 countries have put out more or less specific proposals about how to broaden, deepen, make more generous the HIPC initiative. A lot of NGOs, church groups, and so forth have done the same.
We're going to have a discussion in the Board on this on Friday. The Bank Board is discussing the issue today. We have in the staff put background papers to the Board. These review the proposals that have been made. So we'll see on Friday whether or not those proposals can be narrowed.
You asked whether you will find out about a decision to sell gold only after the sale has been made. I suspect not. I suspect it will be known that a decision has been taken. We do have to take care and we are concerned about any market implications that a decision to sell gold may have. So we will approach this cautiously to make sure that that doesn't happen. A number of the countries who could benefit from the HIPC initiative are also gold producers, and a number of other members who are not HIPC eligible are also gold producers. And, needless to say, they are advising us to take care and be cautious on this.
MR. MILVERTON: Damien Milverton from Dow Jones. Just a quick follow-up on that. Congressional approval is needed--isn't it?--for gold sales before the IMF can actually go ahead with that. What's the feeling in terms of the Hill's attitude at this point? It seems a bit thorny.
Second, in terms of discussing the private sector, what sort of involvement does the private sector have in a paper like what we have before us? Are there private sector people like Mr. Rhodes from Citibank who get to have some sort of input at this point? Or does that come afterwards?
MR. BOORMAN: On the first, yes, the U.S. Administration has to go up and consult with Congress on the issue of gold sales. You'll have to ask them what they think the atmosphere up there is.
My own impression is that there is a good deal of support for the HIPC initiative. The NGOs are very strongly supportive of debt relief for the poorest countries. And to the extent that there is a connection between gold sales, which would help fund the IMF's financial costs of participating in the HIPC initiative, my sense is that there will be lobbying on the Hill which is supportive of this effort.
Many of the NGOs, for example, who are active lobbyists on the Hill have been calling for this action for some period of time. So we'll have to see. But I think there is at least the possibility of a sympathetic hearing to this issue.
On the private sector input, there are a lot of different things going on. There have been discussions in many, many fora of these issues, not the least the IIF. And as you know, Bill Rhodes and Charles Dallara at a press conference, I believe either yesterday or the day before, released reports that the IIF has prepared on basically these same issues. We at the staff level are having discussions with these people, and there will be other mechanisms found as well to discuss this.
I am impressed in the reports that the IIF has put out, and the letter that Charles Dallara has sent to the Chairman of the Interim Committee, of the common ground that exists between the private sector and us. I think it's possible to focus on the few perceptions of difference that exist and, indeed, talk them through, because as I said in my opening remarks, I think we are searching for the same thing. We're searching for ways to deal in these crises and stress situations in as collaborative a way as possible.