Literature on reform proposals for crisis resolution
Since the mid-1990s, a controversial debate has been taking place and many legal or institutional reform proposals have been floated.2 A core issue in these discussions was how to mitigate adverse creditor behavior such as coordination failures, moral hazard, or a “rush to the exit” by investors facing a crisis. The policy debate was accompanied by a large analytical literature.
A series of authors have proposed theoretical models to evaluate the merits of competing policy proposals. Gai et al. (2004) analyze how different official sector interventions affect investors and the efficient prevention and resolution of crises. Their results and those of Morris and Shin (2004) underline the crucial role of proper information on fundamentals for private creditor behavior, that is, through public sector monitoring and surveillance efforts. Haldane et al. (2005) examine the welfare implications of competing policy proposals distinguishing between liquidity and solvency crises. Among other findings, they conclude that coordinated lending by private creditors is only a second-best solution for liquidity crises, while in solvency crises debt write-downs should be preferred to IMF bailouts. They also find that a statutory mechanism and third-party intervention is only necessary in case of serious coordination problems between the debtor and private creditors. For this reason-failed creditor coordination—Ghosal and Miller’s (2004) analytical article argues in favor of a formal sovereign bankruptcy procedure. Related work has also focused on the role of collective action clauses (CACs) in sovereign bond contracts—a legal feature facilitating debt restructurings and limiting creditor coordination problems (Eichengreen and Mody 2004).
Further contributions have explicitly tested for creditor moral hazard during crisis episodes, mainly by examining the reaction of market participants to official bailout announcements. Most of these articles focus on the private sector’s behavior after official bailout announcements. Lane and Phillips (2000) analyze the bond spread effect of news about the potential size of IMF emergency lending, but find little indication for moral hazard, except in the Russian crisis case. Based on a comparably large news sample, Haldane and Scheibe (2003) test the same by employing stock market data of major emerging market creditor banks, which, they conclude, provide some evidence of moral hazard. Zhang (1999) and Kamin (2004) focus on the Mexican crisis bailout in 1995 to test moral hazard, finding only weak evidence. However, an article by Dell’Ariccia et al. (2002) strongly criticizes relying on the Mexican case. In their much perceived event study, they focus on the Russian crisis instead, providing robust evidence for investor moral hazard.