General Discussion

Richard Cooper emphasized that any new arrangements for dealing with sovereign debt had to include domestically held debt. Although it has not been at the center of the Argentinean crisis, domestic debt was fundamental in the crises of Brazil, Mexico, and Russia. Any arrangement for dealing with debt problems that addressed only foreign debtholders would likely be undermined through arbitrage. Cooper also highlighted some essential differences between bankruptcy in the United States under Chapter 11 and international bankruptcy. In the context of Chapter 11, two essentially business judgments must be made: the value of the firm in liquidation has to be compared with its value if it is restructured and enjoys all the advantages of Chapter 11. By contrast, sovereign debt is not backed by assets or even by ability to pay, but rather by the borrowing country's willingness to repay. Debt relief requires political and ethical judgments. Cooper agreed with Jeffrey Sachs that a country should not be expected to service past debt at the expense of pressing social needs, and he noted that the IMF is not the proper agency to weigh those competing priorities, although it might provide a forum for politically responsible officials to do so.

Benjamin Friedman addressed the issue of using aid in place of loans from international financial institutions or from private sources with the presumption of some backing by those institutions. He questioned the unstated presumption that the amount of resource transfer would be the same whether it came in the form of aid or loans, and that the choice between them could therefore be made on the basis of other criteria such as transparency. He suggested that, historically, advocates of transfers to developing countries have judged that loans are politically more acceptable, precisely because their lack of transparency obscures the grant element in them, and he predicted that switching to outright grants would diminish the volume of transfers the public was willing to support.

Michael Kremer acknowledged Friedman's concerns but noted two important costs in the present, lending-based system that he believed outweighed those concerns. First, many developing-country loans are made to governments that are notoriously inefficient. An important advantage of grants is that they could be made directly to nonprofit entities devoted to particular goals such as education. He cited as an example the much higher costs and lower quality of public schools in India compared with private schools in that country. Second, the World Bank's excessive administrative costs are another important inefficiency of the present system. Administrative costs equal about 10 percent of the roughly $15 billion of loans the World Bank makes each year, a ratio that may seem acceptable. But if the grant element of that lending amounts to just $3 billion, the ratio of overhead to grants is revealed to be about 50 percent. Whatever effect this greater transparency might have on public support, it would presumably push the World Bank toward greater efficiency.

William Nordhaus saw the inherent resistance of existing institutions to innovations as an underlying problem and suggested that countries and markets contemplate new types of financial instruments as a way of circumventing that resistance. A useful analogue is catastrophe bonds, used for hurricanes, for example, because these kinds of instruments have two features that make them desirable for international lending to poor countries. First, catastrophe bonds call for lower payments, suspension of payments, or extended lines of credit during difficult periods, when the marginal utility of consumption is particularly high. Second, these lower payments are triggered by objective indicators of catastrophe or hardship rather than decisions made by interested parties, and they therefore avoid the moral hazard problems that arise with most current arrangements. An example of a financial innovation that would be the equivalent of catastrophe bonds for developing countries is what Nordhaus called "mirror-image bonds," which would carry variable interest rates that move inversely with interest rates in high-income countries. However, Christopher Sims reasoned that, for these or other bonds that automatically eased debt burdens when problems arose, it might be difficult to find buyers at a reasonable interest rate. He observed that bonds denominated in domestic currencies...