The introductory panel, "Views from the Shadow Committees," is not included in the following transcript.

Proceedings

MR. KAUFMAN: We'll reconvene in five minutes.

[Recess.]

MR. KAUFMAN: [IN PROGRESS] minutes and then we'll have a few minutes if they want to respond to the comments of one of the other panelists. And if everybody is well-behaved, we'll have some time for Q and A from the audience.

So our first speaker is Glenn Hubbard, who is the Chairman of the President Council of Economic Advisers.

Glenn?

MR. HUBBARD: Thank you, George, and thank you for having me. I think this is obviously a very important topic at a very important time.

I have some prepared remarks that I gave the conference organizers, if anyone is interested, but I really wanted to have more of a conversation with you about the administration's views on the subject of sovereign debt restructuring, but also stepping back a moment on policies that affect economic growth.

The President's central concern as a policy message here is the obvious statement that U.S. economic policy has a very strong interest in economic growth around the world and the values that economic growth promotes.

It is easy in political discussions, I think, to forget economics. Because I'm the economist in the White House, it is my job to stop that as often as I can. And I think for this audience it is obvious that trade links with the United States and U.S. foreign direct investment in many emerging markets make this a very central economic policy question.

We also know that economic policy matters. Some of the bright spots we see in emerging markets--Chile, Mexico, prior to the U.S. recession, Costa Rica, El Salvador--are examples of good economic policy being linked to good economic outcomes. Trouble spots, Argentina, and question marks over Brazil raise policy concerns.

Most of the discussion in this context, and I think the subject of the meeting, goes straight to the international financial institutions. And I would argue that that is a little bit like putting the cart before the horse. Again, the really basic issue here is the promotion of economic growth.

Our profession, the economics profession, has to be somewhat humble in its arguments about what promotes growth, but I think we do know that there are at least four pillars that are extremely important in the promotion of growth around the world, in the United States, in industrial economies, in emerging-market economies, and in the poorest economies.

First and foremost is an emphasis on the rule of law, by which I mean not just police actions, but the enforcement of property rights and contracts. And we know from tangible examples of countries that ignored the rule of law paid a tax in terms of reduced financial intermediation and lost GDP.

A second is intelligent fiscal policy, and here I think much as in the discussion in the United States, a bit too much emphasis is placed on budget deficits or surplus targets and not enough on the size of government, which is, of course, the ultimate tax on any people, and on the composition of taxes that are required to sustain that government. Taxes that have very high efficiency costs, for example, as financial transaction taxes, are not consistent with a pro-growth agenda.

Monetary policy is very important. We know from lessons around the world that monetary control and avoiding the proliferation of quasi-monies contributes to low inflation and a positive environment for growth.

And, finally, openness is very important in product and labor markets, and here, of course, the U.S. has a prominent role to play. In emerging markets, for example, in Latin America the Chilean Free Trade Agreement and the FTAA being co-chaired with Brazil are obvious opportunities.

Now, I could go on here, but I won't. I just want to make the point to you that economic growth is the first pilar of thinking about sustainability in a fiscal situation and thinking about sovereign debt restructuring.

Now, as a background to sovereign debt restructuring, it is obvious to this group, of course, that there have been numerous proposals to advance ways to lower the economic costs of sovereign debt restructuring. And as an economist, I think of those on a continuum of going from a sort of status quo, decentralized approach to the far end of the continuum, something quite deregise [ph], say, a full international bankruptcy court along the lines my now-colleague Jeff Sachs [ph] has proposed. In the middle, I think of proposals like we'll have the bulk of our discussion on today from the IMF, from Anne Krueger, and from our Treasury Department.

Working across the spectrum, I think these proposals differ in the way they view the coordination problem between a sovereign debtor and its creditors, and therefore suggests somewhat different solutions. But let me focus, in the interest of time, really on the IMF and Treasury proposals. I think these are both very valuable proposals and, as you know, it is the government's view that these are complementary proposals.

The IMF proposal views, I think, the hold-out problem as the central problem, and hence the issue is protection ex post against hold-out through a sanctions day while restructuring are put together.

The Treasury's starting point, on the other hand, was more an ex ante formalization of how a market-based solution would work through contractual provisions and then some ex-post cleanup.

On the ex ante part, the Treasury had suggested, along with suggestions of many in the marketplace, collective action and sharing clauses to deal with the hold-out problem and collective representation clauses that serve as a way to structure discussion among creditors.

As a way of getting here to there--that is, a transition to such a system--exit consents could be used to encourage participation in exchanging old debt instruments for new. Financial incentives either from governments or from the international financial institutions could facilitate this transition.

Now, as is well known and has been pointed out many times, there is an important issue with the Treasury's emphasis, which is that inclusion of such provisions would really be required for all contracts in order to be effective, and that is a tall order. And hence, to address the coordination problem, discussions of a sovereign debt dispute forum, in any of a number of names, has emerged.

Now, a key such proposal here obviously is the IMF's proposal, which would have statutory changes to create a sovereign debt dispute resolution forum. The U.S. government, of course, has talked about a two-track approach centered on the private markets, but also a discussion and encouragement of the IMF for further details of its proposals.

But I would actually like to pose a few questions that I think both of these proposals need to answer as the debate goes forward. And the first question is whether hold-outs are really such a big deal.

There have been more than 70 cases of default since 1975, with litigation in only 15, and the disputed amounts were a small fraction of the debt and default. And I'm not a lawyer, but I would like to at least advance and would argue questions if anybody would like, about how meaningful the Elliot [ph] Associates case itself is.

The second question, since we know we have this two-track approach, is could a forum, could a sovereign debt dispute resolution forum be voluntary at first. The forum's role, for example, could be acknowledged by inserting a clause in every debt instrument naming the forum as the venue for negotiation. It could operate much in the way you think of a domestic bankruptcy court pulling people together.

The borrower would approach the forum, request the initiation of proceedings for restructuring, and the forum would notify the creditors and convene a committee that monitors voting processes. We know, for example, this kind of voluntary approach did work with some success in Korea in late 1997.

A third question is whether the contractual approach that has been suggested and the sovereign debt restructuring mechanism from the IMF can be discussed until access incentives and IMF lending policy more generally are thoroughly discussed. The G-7 and the Group of 10 communique, of course, raised this issue of the need for clarity. There are many ways to do this, but I think more transparency would definitely help the process.

Now, let me go back to where I started. I think these discussions, particularly the leadership that Anne displayed at the IMF and the proposals from the U.S. Treasury, among others, are constructive. But I think there is a fear in the marketplace, for example, that a well-oiled restructuring machine might throw the baby out with the bath water.

Now, I don't think this is the case and I think with this concern in mind, it is important to return to the broader context of improving creditworthiness in emerging-market economies. Ultimately, the borrowing capacity of a country depends on the ability of the economy--and let's be clear, it depends on the ability of the private sector of that economy to generate returns for savings.

I would submit to you this comes back to the basic pillars for growth that I led off with, and while I think this discussion is a meaningful one, I think it needs to be couched very much in the context of promoting economic growth.

MR. KAUFMAN: Thank you, Glenn.

Our second speaker is Anne Krueger, who is the First Deputy Managing Director of the IMF.

MS. KRUEGER: Thank you, George.

I'll start by saying I agree with almost everything Glenn said. Very little disagreement.

MR. KAUFMAN: You don't say "agree with Glenn."

MS. KRUEGER: That is my shorthand. I'll come back to the few exceptions as we go, but certainly economic growth, improved living standards, and all that are the objective of whatever proposals are coming forward. And they go down a ways that way and I'll come back to that point.

The world used to be a place in which private capital flows were small. Capital flows were dominant and when countries found themselves in difficulty, it wasn't that hard, although it was hard, for the international financial institutions, the IFIs, to come to the assistance of countries and work with them.

On the other hand, it has taken such efforts, and I call to your attention the Brady bonds, the incidence of which are very often regarded as the beginning of the resolution of the 1980s debt crisis. So we have been there before, but it was official and official debt was a very large chunk of the total at that time.

With the tremendous growth of private capital markets, obviously the nature of the problem has changed. It is the countries that are able to attract private capital flows that are the ones that have the good macroeconomic structure and structural policies that are able to manage their debt well.

There are occasional changes and slips and when those slips happen, there can be a problem. And I would argue that there is no really well-developed mechanism for handling such cases. And in that process, if nothing more, time is lost as the country's authorities are reluctant to go into a restructuring. And delays of even several months can cause a great loss of value, and there is money on the table for both sides if, when it is essential, which is infrequent, it can happen sooner and more predictable in an orderly process.

There are tremendous costs in delays, as is shown in many cases. But more than that, I think I'm prepared to argue that if there were a more predictable process, probably the private capital markets would be a little bit more reluctant to lend late in the game, so to speak, which might speed it up even more and might make the debt burdens less unsustainable when indeed the chickens come home to roost in those cases.

The world has changed. The IMF and the international community must change, too. And in response to one of the few places where I disagree with Glenn, quite clearly the SDRM is not something that we are proposing in isolation. We fully share the view that there have to be a better understanding and more clearly defined access limits and some other things than there now are.

And the SDRM proposal is part of a package of how to deal with this new and changed world where, whether we like it or not, official capital flows simply cannot manage the problem on their own. The most they can do is present a framework.

Right now, the IMF and its political masters, I should importantly add, are faced with two unpalatable options. Either they let the country sink further or they try to assist it with a program when the odds of the program's success aren't very great, and where indeed delays in facing this may even make the entire economic situation with which one is confronted worse. It is not a wise use of anybody's money.

Now, both of the proposals on the table are really intended to address the problem. The common aim is to find mechanisms that allow countries with clearly unsustainable debt burdens to restructure in a fashion that preserves economic activity and asset values, while protecting creditor rights.

We need to ensure that debtors and their creditors face incentives to move more rapidly than they now are confronted with--the incentives, that is--on restructurings that allow sustainability to be restored. The aim is not to make default the preferred option. The aim instead, if anything, is to get markets working more efficiently so that indeed, if things are becoming unsustainable, it would be anticipated sooner both by the private markets and the official sector, and in that sense that there would be less of these problems and not more.

We want to make the cost of restructuring lower for unsustainable debts of sovereigns. We want to make it more predictable and make the legal rules for the process more uniform without inducing countries with sustainable debts to restructure. I think that is very important and has been one part of the misunderstanding on all of this, is the argument that countries would leap into restructurings at first opportunity rather than waiting.

This, I think, is really a non-issue. There is no responsible official in any developing country that I know of that is concerned about doing that. And, indeed, the two countries where the officials have spoken out to some extent worrying about SDRM, Mexico and Brazil, have both done so out of concern that they might be forced into a restructuring that they did not want, which is an interesting twist on the creditors' concerns. Both, I don't believe, can be right.

In any event, what we want to do is look and see if we can't find the international counterpart of something akin to bankruptcy domestically, where obviously it isn't exactly the same because you can't attach property in quite the same way and a number of other things. But you can have a legal framework which provides incentives to both parties to come together before they ever get to the law in order to resolve and to restructure where it is necessary.

Clearly, such a mechanism will work only if we get incentives balanced so that debtors don't go there too soon and the creditors have the assurance they need so that they won't think that everybody will run for the door too soon.

Now, as we see it, collective action clauses and SDRM are genuinely complements; they are not substitutes. CACs would, as Glenn already said, do a great deal in the sense that if you had a trustee mechanism or something within each issue, that would do something to simplify the process. And if you then have something going beyond that, so much the better. It would simplify, and so on.

Glenn mentioned the problem that they would be still only in the individual bond issuances. One kind of question is what about other sovereign debt to banks, export credits, and so on? There is an issue there, not to mention the outstanding stock or debt which could cause problems, too.

But the Fund is supporting efforts on collective action. The European Union, as we know, has now said that it will insist on them in its sovereign bond clauses, and so on. We are going to try and work with our member countries and when they do come to us for a Fund program, we will try and persuade them to try and include CACs in their future bond issues. So I don't see any conflict between the two, and CACs can obviously begin to be put in as soon as people want to do it, whereas, of course, SDRM, because it is a statutory framework, will take more time.

Now, the statutory approach, of course, is designed to create a legal framework for all of this. It would allow the debtor and a super-majority of its external creditors to reach a restructuring agreement binding on all holders of debt instruments that are subject to the mechanism. It would also allow a super-majority of creditors to provide temporary limitations on the enforcement of creditor claims and to agree to the provision of new money on a senior basis.

To some extent, this sounds as if it is an answer only to the hold-out problem, which is my second small disagreement with Glenn, whereas, in fact, we think it goes further in the sense that the ease of identifying the creditor, the ease of bringing people together, the mechanism that was there, would provide incentives for people to get there privately perhaps because they get together with CACs.

Is the hold-out problem a big deal? So far, it has not been, although indeed some people are getting exercised because there are hold-outs even among those lending to some of the highly-indebted poor countries that are getting in the way of some of the restructurings there. To everybody's amazement, there was a case recently where the poor Democratic Republic of the Congo was found to have to pay off some debts in full before it could go about its business.

I suspect that this is one of those things where even though I agree with Elliot Peru [ph], who has got the definitive case, or so I'm told, once creditors have been successful with hold-outs, the incentives for others to try it may increase. And the fact that it is not now a major problem does not prove that it will never be, but if that were the only disadvantage, I would think it would be there, but it wouldn't perhaps be overwhelming. I would put more emphasis on the ease and the framework for restructuring when it is necessary.

Now, the basic features of the SDRM approach are modeled on the provisions found in existing sovereign debt contracts governed by English law that allow for collective action. The key decisions would be made by the debtor and a super-majority of the creditors, not by a third party and certainly not by the Fund. The Fund does not, and knows better than to try to get in the midst of a restructuring between creditors and debtors. This is not something we're in the business of.

And only a consent of a super-majority of the creditors would make this restructuring agreement binding on a minority of hold-out creditors. In addition, the creditors--and this is important in terms of creditor rights--would have to certify that negotiations on restructuring were going forward in good faith in order for any mechanism to continue. Otherwise, we would be back to the status quo ante; i.e., the circumstances right now. And in that sense, it is the creditors who have the upper hand in the mechanism.

It differs from the contractual approach in two key ways. It does deal immediately with the existing stock of debt, including instruments that don't provide for collective action. And the votes of the creditors holding participating debt instruments would be aggregated, so that indeed you could get representative classes or something coming together quite quickly in terms of an agreement so you have the banks and the others in the same creditor pool and that problem could be substantially simplified.

These features would make reaching agreement on a restructuring easier, we think, while still ensuring that any agreement had the support of the vast majority of the country's creditors.

Given the diversity of legal and other interests of creditors, there does need to be a system that allows the creditors to be put into different classes for voting purposes, and there could be some variability for that class and we are working somewhat more in terms of asking what kind of aggregation rules would be used.

Now, there are many details still to be worked out. This is a work in progress. The IMF Board last month raised several of these; let me just go over them briefly.

The scope of debt to be covered by the SDRM, where indeed there are questions as to whether this should cover sovereign debt that is issued under foreign law. What we are now thinking is that that would be the first cut. But if something were done legally to make this an approach, what would have to happen would be doing only the sovereign debt under foreign law initially, but allowing at some future date if it were warranted a change by, let's say, a super-majority of the Fund's votes or shares or something so it did not have to go through the entire process again if that were deemed preferable at a later date.

The design of the SDRM, we believe, needs to retain flexibility, given the potential complexity and diversity of instruments and the creditors involved in individual restructuring and the ability of markets to think up new instruments once we have these that we would want to have included. So there are issues, I think, coming up there.

The features of the dispute resolution forum would provide for legal uniformity in all jurisdictions and ensure uniform interpretation. Its role, we believe, would be limited to the administration of claims and the resolution of disputes.

That much said, one of the disadvantages of CACs, we believe, is that any one country that permits sovereign debt to be issued under its legal jurisdiction that was not a member could undermine much of it, much as we have some kind of offshore banking centers at the present time. SDRM, by virtue of being an amendment to the Articles, would, I believe, get around that problem.

We are trying to maintain a dialogue with the private sector, emerging-market sovereign borrowers, and the public. There are a number of issues on which the Fund staff are still working and we hope to have a fully-blown or a close to fully-blown proposal by the time of the Spring Meetings in April.

Notice, and I stress this, that we do not envision new legal powers for the IMF. Sometimes, they said this would give the IMF too much power. What intrigues me about this is the IMF has more than all the power it needs right now.

Insofar as going forward, what is happening at the time of any debt restructuring is the Fund staff are working with the country to find out what is a sustainable macroeconomic program going forward. That, in turn, is going inevitably to require judgments about what is the feasible size of the primary surplus. Working that backward, one can tell immediately what the size of the haircut is going to be. So this is an issue where I think there is no question but that indeed we don't need any more power.

In fact, one of the interesting questions is if you did have this mechanism, how and at what point would consultations come between the creditors, if indeed they were thinking that a 10-percent haircut would do it, when those primary surpluses on any realistic assumptions going forward would only be reasonable if, for example, you had a 30-percent haircut. How does this get resolved? It is an issue to which I don't think we as yet have any better an answer than we have right now. We are working, of course, to improve our debt sustainability analysis and other things, but in the meantime there are real issues there.

Now, as I said at the beginning, the work on the SDRM is part of a broader agenda to improve the Fund's capacity to assist its member countries in strengthening their underlying macroeconomic framework for purposes of growth.

We're working hard on increasing the analysis of debt sustainability, although I want to just call attention to one thing that always worries me a bit when I read about it in the papers. Debt sustainability is quite clearly a function of what the member government is going to decide to do by way of its own fiscal policies, and what may be sustainable in one country may not be in another country or it may not be sustainable in the same country later on, just depending on what the policy framework is in the decision of the authorities.

Indeed, if you were to decide today what you think has gone wrong in Brazil, it is basically that a number of people in private markets believe that the underlying fiscal stance of the government will change. And therefore a debt that was deemed to be sustainable six months ago there are now more questions about, not because Brazilian fundamentals in some private market sense have changed, but because there are questions as to what this coming-in government will do.

This is an issue of debt sustainability and I don't think anybody can answer that until they know what the authorities will do and why. We're doing our best on this issue, but I think nasty surprises do happen. Things like that do come along and that makes that one difficult.

We are going to define much better the policy for exceptional access to Fund resources, and that, of course, goes to this question of access limits. And I think that is absolutely necessary and could, along with SDRM, form the basis where there is more predictability in what will happen which could strengthen the efficiency and the functioning of private markets, as well as strengthening economic policymaking in the developing countries.

It seems to me the two go hand in hand. I don't see getting access limits that will be meaningful until we have something like an SDRM, and I don't see having an SDRM without access limits. So I think they are complementary, and if you let me go another 15 minutes I could even tell you what some of the issues are on access limits, but I don't think you will.

We also need to clarify Fund policy lending into sovereign arrears to private creditors so that it supports sound adjustment policies and does encourage collaborative agreement with creditors.

I have probably gone on too long, but as you can imagine, we are deeply enmeshed in this. We think it is important and we think its time is coming and it is worth working on.

Thank you.

MR. KAUFMAN: Thank you, Anne, and our final speaker is Allan Meltzer, of Carnegie Mellon and the American Enterprise Institute.

Allan?

MR. MELTZER: Thank you. I want to begin first by pointing out some important changes that have occurred. There is much less discussion these days of large rescue packages. I think that is a step forward. There is much less discussion about bailing in the private sector. If there are no bail-outs, then you can only get out at a price. And it took a long time apparently for people who discuss these issues and governments to get around to recognizing that we didn't need bail-in clauses, that you just don't do anything and they are bailed in.

The discussion is, I think, on a very good track where--and a lot of this credit belongs to Anne for recognizing that what needed to be discussed was a series of questions about institutional reform that were going to be made, reforms both in the way in which the IMF deals with these problems, and I would say missing from the discussion are some of the things that Liliana raised earlier. What are the countries going to do to make them able to deal with issues of this kind?

For me, there is still much too much about architecture--I think "institutional structure" is a better word--and too little about incentives and general equilibrium effects, and I'll come back to that. Here, I think the question of incentives, what is going to happen after these changes occur--I mean, I think Anne already began to describe for us some of the things that--if you put the bankruptcy proposal in place, what are you going to do about private debts? There are a whole series of other issues here that need to be worked out and it would be good to see those spelled out.

It would also be good to see--the general equilibrium effect, of course, is what is going to happen to the relation between creditors and debtors and is there going to be an emerging market. Are people going to have to borrow? Would it be a good thing, in fact, if the emerging-market debt for some of these countries were to dry up? That might be a very good side effect of some of these proposals.

If, in fact, they got into lending or providing capital through foreign direct investment to a much greater extent, that would be a big step forward as far as I can tell because many of these problems arise because of too much debt, not too little. So that is the first set of issues.

The second is one of the benefits of today's discussion with this group of lawyers and economists is that there are a lot of legal and economic issues. There are many countries. They have different laws, they have different contracts, and the issue about a standard contract tries to address these issues directly using the International Monetary Fund to enact a standard set of rules and that is Anne's proposal. So those are, in my mind, good things that we are now onto those subjects. Unlike corporate bankruptcy, where here we have sovereign immunity, major restrictions on creditors' rights become quite paramount.

The bankruptcy proposal seeks to provide a way for creditors and debtors to have a bankruptcy proceeding that allows the debt to be restructured without having to confront the question of sovereign immunity directly. And it is also a way around the hold-out problem, as you already heard, where one of a small number of borrowers can get control of a small debt issue and insist on full payment.

An important side issue here is whether this problem is as big as it appears, and there seems to be agreement at least on this panel that it isn't as big as it has appeared. And I will come back to that in a different way in just a little while.

Third, let me set out what I see as the principal pros and cons of Anne's bankruptcy proposal. The pros are it gets around--maybe the word is "resolves"--many of the legal issues, adopting uniform standards and dealing with hold-outs.

Second, it is comprehensive; that is, it is going to apply to all debts. It can be made comprehensive in the sense that it can be made to apply not only to bond-holders, but to bank loans, to trade credit, to all kinds of borrowing and lending arrangements. And that is really, I think, one of its major advantages. It would provide a uniform way for settling defaults more rapidly, and that is certainly a plus.

And it often is said, especially with bond issues, that there are many small bond-holders and that they have a difficult way of organizing themselves to press their claims. And I will come back to that in just a little bit.

On the con side, at least from my standpoint, one is we don't know much about the general equilibrium effects. What are the kinds of contracts you are going to have to change? What is the market going to look like? What do we think the markets are going to look like after this? Is there going to be emerging-market debt for small countries? Is it going to change the creditor-debtor relationships in ways that we have not yet figured out?

So what would happen to the debt market if this major change in position of debtors and creditors is passed? That certainly is the worry of the Institute for International Finance that is, as I understand it, very much opposed to proposals of this kind.

Second, there is the role of the IMF. Even though Anne has addressed this issue from her original proposal to where we are now, originally there was a lot of concern about conflict of interest between the IMF as a creditor and the other creditors and its role on the other creditors, what it would do to change the relations between debtors and creditors.

I think Anne has been very responsive to those kinds of issues and has really modified her proposal so that the IMF role is certainly much less--its hand is not directly on the negotiations, although whether in the future that would remain is a question that I think would probably scare some of the creditors.

Third, in the U.S. and perhaps elsewhere, there is a political problem. Any change in the IMF charter would require approval of the U.S. Congress, and that is going to be time-consuming and somewhat questionable. That problem may arise in other countries as well, but the Bretton Woods enabling Act, as I understand it, requires that Congress has to approve any major change in the standard, and at least at this point there is some question as to whether that would happen.

Let me say finally where I come out. I think that this is a very valuable discussion, as I've said. I believe that trying to find a solution is premature and possibly unnecessary. I have two main reasons for that.

First, I think it would be very valuable to give the markets some time to find market solutions to these problems and we're only at the beginning of finding those solutions. And, second, we need to get countries--as Liliana said before earlier, we need to get countries to make reforms. We really need to think about this problem in a different way. So let me develop those two points.

First, we come with a history that has two very, very bad, from my perspective, elements. The first is that everybody was bailed out for decades, and certainly in the '80s and '90s in one way or another, and especially in the '90s, everybody was bailed out. So there was no reason--in fact, there was every reason not to develop market institutions to deal with these problems because the way in which you dealt with them was it was both in the interest of the creditor and the debtor to have the G-7 taxpayers provide the money to settle whatever issues that arose.

Now that we are out of that and we have had a few defaults, we have found that in countries like Ecuador it has been possible to settle these issues without a great deal of difficulty, and I want to come back to that.

Second, the incentive is to help everyone, and I believe that we won't get proper incentives into the debt market until we move from that position to a position in which we say that there are going to be classes of countries. Let's put aside the geopolitical questions, like countries like Turkey and Korea and Mexico where the U.S. and G-7 perhaps have a special interest, and talk about the other countries in two groups: those countries which have problems, maybe have a debt problem and a financial crisis, despite the good policies that the country has put in place and tried to keep, and other group of countries where they have not put those policies in place and where the markets have not yet begun to thoroughly distinguish between these two countries because the IMF has treated them all alike. Whether you had good policies or bad policies, you got different medicine, but you got the money, all right, and so the incentive for the country to get its policies right is not there.

I believe, and the commission that I headed urged and has had damn little success in seeing it happen--urged that we help countries that deserve to be helped--and I shouldn't say we had no success because Argentina is a good case in point--and we don't help countries that simply don't have good policies in place. And then the markets would begin to distinguish between those countries which are going to get a lot of private capital at low interest rates and those countries which are going to get much less capital at higher interest rates.

And now the second set of countries is going to be able to say not "the IMF has told us that we have to make these reforms," but said "if we want to get more capital at low interest rates, we have to make these reforms, and that is going to give us a lot more incentive."

And until the IMF or others begin to take seriously the idea that we have to distinguish between the kind of country we're dealing with and that we ought to help countries that help themselves by having sustainable, good policies and don't help countries that don't do that, then I don't believe that we're going to find happy solutions to these problems.

So I think we need to do two things. We need to see, one, time for the market to develop some institutional frameworks, and, second, time for efforts by the G-7 countries and the IMF and the World Bank to really make distinctions between countries that deserve help and countries that don't.

And then there is a third group of countries and that is the group of countries which is hurt by behavior in one of the first two kinds of countries. In those countries, I believe that is a part of the responsibility.

The basic problem here is that the IMF has moved from its original conception, which was the idea of using--the countries got into trouble because they had some kind of shock. With their fixed exchange rates, they couldn't deal with that shock without borrowing heavily. They were going to be the lender that would provide--that is, the surplus countries would lend to the deficit countries and that would be the way in which we would smooth it, just the way that we described in Economic 1 or 100 about the consumption/loan model. If you have a bad draw on the consumption, you can borrow. That was the idea.

The IMF has moved from that partly because of the movement to capital, partly because of the ambitions of people who were there. It has moved to that to where it thinks that every problem is a problem that it has to deal with. And I think we have to step back from that and say the original conception was we're going to help those countries which have a problem which is soluble, which occurs because of credit market problems, not because of real problems, because we can't do much about that, and sort that out--a much more structured, focused IMF. And until we get there, institutional reforms of this kind should not be the main point on our agenda.

Next, let me say that Ecuador is an example of a country which defaulted and which was able within a reasonable time to solve its problem. Another example where the collective part of this problem is a major part of the problem--the Argentine debt is held by thousands of individuals in Italy, Germany, Austria, and Japan.

What has happened is very interesting. During the period in which these discussions have been going on both in Germany and in Italy, we've seen mutual fund type structures emerge where they collect the bonds of individual holders and are willing to act as agent for them. In Germany, there is a group called the DSW which already has 10 percent of the outstanding bonds held by small holders. In Italy, the banks are organizing to get these bonds and therefore to act as a collective to negotiate for the benefit of small holders.

So the point of all this is that the market is finding creative solutions to come along, and the institutional changes that we want to have that are going to be durable and important should reflect the new set of arrangements that are in markets, reflecting the kinds of actions which markets have taken, and then finding if there is some gap in the problem that still has to be resolved. That is the role of someone like the International Monetary Fund.

It is premature for the International Monetary Fund to come first and say "we're going to structure this problem and you structure around us." I don't think that that is the right way to go. So I believe that while this has been a very useful discussion and Anne deserves a lot of credit for raising these questions--I believe that it is good to discuss them--we ought to be very slow about adopting them.

One of the things which hasn't been mentioned here--Anne talked about how slow it is for some of these problems to get resolved, but it will speed up. One of the reasons it will speed up once we know that the IMF is not going to come in with bail-outs is that people have big incentives.

Default means that the creditors are losing money everyday. Present value goes down, right? They have a big incentive to want to come and settle. They have all gone to MBA classes or better and they have learned about present value. That is a big difference from the 1930s. They understand about present value and they know that every day that they are there they lose some money, and that gives them a lot of incentive to try to find ways to solve the problem.

I believe the IMF could help the market by adopting something like the Larick [ph]-Meltzer proposal that creates an active market in default to debt and thereby makes it easier to do some of these restructurings. But even that may be premature.

Thank you.

MR. KAUFMAN: Thank you, Allan, for those non-controversial statements.

[Laughter.]

MR. MELTZER: You expected something else?

MR. KAUFMAN: Nothing else.

Glenn, do you want to take a few minutes?

MR. HUBBARD: Yes, just a few things actually stitching together Anne's comments and Allan's.

I think the theme that surfaced in all three sets of remarks was this idea of general equilibrium effects and not know where we're going. And as I indicated in my remarks, and I think I picked up a great deal in Allan's as well, I think this is something where letting the market proceed gingerly may have some advantages.

I suggested, for example, a voluntary version of a forum along the way, letting markets figure out how to get creditors together, putting in contractual provisions. All that seems to make a great deal of sense to me.

One of the reasons we're on a two-track in terms of our government support is again to let markets come to grips with the situation. So I guess I would quit, though, with Allan Meltzer in the category that I wouldn't want to jump there either. I would much rather have markets figure out.

What I picked up, as well, I think, in both other sets of comments from my colleagues here is the importance of access incentives. Now, I said access incentives deliberately. I think there has been too much discussion of access limits, which has in people's minds curves that look like this, and rarely in public policy do curves ever look like this and shut things off.

But access incentives, I think, are very important. It is very hard, I think, as Anne correctly said, to imagine having SDRM or any of these reforms absent a very serious discussion of access incentives because unlike the corporate bankruptcy analogy, we do not know exactly what the corpus is in a transaction until we have those incentives.

Those incentives, of course, I think, marry also with what Allan had suggested of the need to link to good policy. From the administration's perspective, again, we think good policy must be a pre-condition for U.S. support.

MR. KAUFMAN: Anne?

MS. KRUEGER: Well, we think that good policy is a pre-condition for IMF support, so there is certainly no disagreement on that. And, in fact, the real problem, I think, is not whether good policy is a pre-condition. The real problem that you go into a country where, in fact, you can run into ? towards the United States. No policy is ever perfect.

And given that, the real question is a judgment call as to how much do you ask, how quickly in any country in order to get that good policy, and that is a troublesome issue to some extent.

I want to take issue with one small thing Allan said, although I'm sure he didn't quite mean it. He talked about the IMF helping countries, and so on. In fact, the IMF is almost always repaid. It lends at very close to market rates. So in a sense, there has almost been--and a test of that--and much as I agree that there are times when--Mexico, '94, there was indeed a series, what you might call a sovereign equivalent to a liquidity problem. The evidence shows it was not a solvency problem.

For the IMF to lend into those kinds of situations may make sense, at least in some instances. I don't want to defend any particular one, but to say that this is helping the country--it is true, but in lending and getting repaid, I'm not really sure it is help in the form of something that people tend to think of like foreign aid.

And I just want to stress this that at least in the emerging markets, lending is on commercial terms or very, very close to it when the private sector will not lend precisely because it is deemed to have become too risky.

The incentive to countries is they get the money anyway, while again if they are going to have to repay it, if it is commercial terms and if they must do some policy reform in order to get it, my big question would be how do we know what is the right amount of policy improvement to make them eligible. And, there, I would agree with Glenn. We've got to sort that out better than we have and there is more work to be done, but I think it needs doing.

As to Allan's point, my last point would be that there is, of course, a time factor in developing SDRM. If we get it, it then has to be approved. That will take time. More important, nobody is ever forced into it. It would never happen without the debt asking for it. It could never continue without the creditors agreeing to it.

In that sense, it is not that different from the voluntary mechanism that Glenn has in mind, the only difference being that if you get a super-majority of creditors, it is binding on the rest of them and therefore makes the process simpler.

I would go on, but I'll stop here.

MR. KAUFMAN: Allan?

MR. MELTZER: I have only a few comments. I think we agree on a lot of things here. We agree that growth is a major issue. We agree that these proposals are useful to be thinking about.

Where we perhaps disagree, maybe not too much, is on the shift at the IMF which I believe is necessary from a command and control operation--it may be in the process of doing that, where it comes in and tells countries these are the things that you have to do, raise tax rates or cut spending, to a system of incentives that will work, I believe, much better. We're out of the age of command and control and into the age where incentives are going to be the important thing.

There is no mystery about the broad aspects of what countries have to do to grow. There are maybe details about these things that are different from place to place, but there is no mystery about what countries need to do. They have to have the rule of law, they have to have contracts, and so on.

The fact is that we've gone through all this long period and we don't have that. So we ought to ask ourselves why is it that these countries haven't done it, and the answer is, I think, because they haven't been pushed into it. They haven't been given enough incentive to do it, and that is what we need to do. Telling them that you should do these things is not a substitute for giving them an incentive to do it; that is, making them want to do it because they see it as being in their interest.

And I think Paul O'Neill and the U.S. Treasury have taken a great step forward by emphasizing all the time the importance--rather, the administration generally emphasizing the importance of productivity, the importance of the right institutions, the importance of how including things like putting into the millennium challenge account things like how long does it take to organize a business in this country. Can we reduce the time that it takes to organize a business in the country? There are a lot of steps forward of that kind where people will have incentives and the incentives will improve, and I think that that is a major difference between me and the IMF.

Finally, Anne repeated what is a standard IMF statement that always sends the hair on the back of my neck rising, and that is that the lending is always repaid. Well, repaid by renewing the loan? What are all these things that we've been discussing about debt forgiveness now for the last couple of years? I mean, is that money that is going to be repaid?

I mean, it is going to be repaid by the G-7 governments, not by these--that is where the money is coming. It is not coming out of the IMF. I mean, we would have had the debt forgiveness if the IMF had to take it out of its own coffers. The reason it is taking so long is because you are trying to get the G-7 governments to come up with the money to do it.

So if you have debt forgiveness, it reminds me of the trustees of my university who, after the president has assured them for about 15 years that he always ran a balanced budget, one of them finally said when they got the next president, "Gee, if we always ran a balanced budget, how did we get all this debt?"

MR. KAUFMAN: It is time for questions from the audience. Notice, the word is "questions." The panelists give speeches. You ask questions. We do have a roving microphone and if you state your name and direct your question to somebody, then we'll attempt to answer it.

Right over there.

MR. BILLINGTON: Thank you. Mike Billington [ph], from Executive Intelligence Review. I'd like to ask Ms. Krueger, the Italian Senate has just passed a resolution inspired by Lyndon LaRouche's proposals for a new Bretton Woods system. And this proposal comes partially dealing with Argentina, but mainly arguing that you cannot deal with this global debt structure on a country-by-country basis when it is actually a global financial crisis, and in particular that the U.S. itself is one of the most indebted and most endangered countries. As the Bundesbank chief just said yesterday, it is not a double-dip, it is a crash.

In that context, the proposal in Italy is for a new Bretton Woods, returning to global fixed exchange rates dealing with the bankruptcy of the banking system and long-term credits for great infrastructure projects.

How would you respond to that?

MS. KRUEGER: I thought we were getting more questions and then answer all at once.

Well, the first part of my response is been there, done that. We tried the fixed exchange rate system until 1971 and discovered there were huge cracks in it. I think that economists might disagree as to their solutions, but they would all agree that there are three policies that you can't choose all of. If you are going to have capital mobility and if you are going to have a fixed exchange rate, that pins down your fiscal policy. You don't have choices there, and so on down the line.

I think the whole lesson of the post-war era certainly until now has been that at least until this time, almost all countries have been unwilling to subordinate their domestic economies entirely to the international system, and they will not run the fiscal and monetary policies that are necessary for a fixed exchange rate in a world with capital mobility.

We have seen that over and over again, and I think most observers would say that the lesson of the 1997-98 Asian financial crisis, not to mention Mexico in '94 and a few others, is exactly the same, namely fixed exchange rates are something that you can possibly adopt when you've done almost everything else right, but they are not something that--putting the cart before the horse doesn't work.

I think I would also, of course, object to the notion that we have a global financial crisis. I find it hard to believe that there is any great problem with American indebtedness. While it is true we have some debt, we also have an awful lot of assets and a very productive economy. So there are a whole variety of reasons here why--

MR. KAUFMAN: [INAUDIBLE.]

MS. KRUEGER: There are a whole variety of reasons why it seems to me that the premises on which that proposal are based may have some dubious value, but then the solution offered may be worse than whatever the disease is alleged to be.

MR. KAUFMAN: Can we go to that side over there, please?

MR. DOBROVIRS: Whitney Dobrovirs [ph] from Arnold and Porter. My question is for Anne Krueger.

What are your thoughts at this point about ranking of debts? in particular, at the moment IMF facilities seem to be de facto senior but not de jure senior. With SDRM, should we be considering making that explicit, and what are the consequences for other categories of debt?

One of the first things you do when you restructure the debts of a country is you figure out what is in and what is out, what is included, what is excluded. For example, trade debt is frequently out, but not always, and if you are the bank making the trade loan, what should you be putting in your contract, whether you are senior or junior, and so forth? What is your thinking about these issues at the moment?

MS. KRUEGER: Well, the first part of the answer is that this is an issue which I think is very difficult on which we are still thinking. I think that we made some progress with the issue, but that there are questions going forward. And I think I hinted in my remarks that I thought it would be that whatever we did by way of getting the statutory approach into the books, we would want some flexibility so that we could bring more things in later.

You asked the senior issue with regard to the IMF. I'll come back to that in a second. There are seniority issues with regard to Paris Club reschedulings and all that. There are a whole variety of issues there.

In our proposal for the forum where there would be, if you like, the registration of claims, we have assumed that there would in that process be the appropriate net present value aggregation. We have right now on the table put in sovereign debt issued under foreign jurisdictions as the class of debt to be restructured.

One of the big problems, and I think one of the reasons I'm at least having trouble thinking this out in terms of the sovereign debt domestically, is that the sad fact of life is that in many countries right now, in these bad policies that we all deplore, there is a lot of debt issued by the sovereign that is stuffed into banking systems.

The difficulty with that is if you pull that into the same basket, as you may have to--I agree to that, but if you do it, then you get into Allan's general equilibrium effects big time because any restructuring may bring down the banking system. And our thought is, again, start modest with the debt issued under foreign law and continue with that later, if need be.

Now, IMF preferred creditor status. The IMF lends into situations where the private sector will not, or else there would be no need for IMF resources. Given that, it seems to me there is a perfectly valid case for some kind of preferred creditor status which the IMF now has.

In our proposal, we have also talked about the possibility, although I agree we haven't spelled out the rules or the understanding, that it might be possible with such a mechanism to create a class of preferred private foreign debt which would enable the private sector to get preferred creditor status upon the restructuring so it wouldn't have to be IMF money. So that is part of our general thinking, but this is one of the issues where we think we need to work quite a bit over the next couple of months, at least, thinking harder about this, where I think there is going to be a proposal for here is what we would do initially, here are--or we will leave open the flexibility to go further at a later date if that were called for, which it may very well be.

MR. KAUFMAN: We'll stay on this side over here.

MR. KAUFMAN: ? from Carnegie Mellon, and I have a simple question, which is I understand very clearly that if all the private debtors, the debtors and the creditors, started on a new mechanism to sort out their problems, that would be fine.

But I guess my question is what is the argument--if you got all the debtors and all the creditors in a room and they said "we don't want a bankruptcy court," what is the argument for the public sector to put one in place?

MS. KRUEGER: Well, I mean the first part of the argument is if they are in a room and say they don't want it, then it doesn't happen. So it is there as something that they can opt to use.

MR. KAUFMAN: [INAUDIBLE.]

MS. KRUEGER: The proposal as it now stands is that nothing could ever be initiated without the debtor's request and nothing could ever continue without the creditor's assent.

MR. KAUFMAN: Back there.

MR. SCHRADER: I'm Robert Schrader [ph], an international investor.

The other day, George Soros made a proposal in front of a bunch of us. I don't know if you are familiar with it, but basically it was to set up some sort of quasi-guarantee agency to accept sovereign debt of nations. It could also include private debt as well. It sounded similar to what you were suggesting, Ms. Krueger.

MS. KRUEGER: I don't think so. I think it is a little closer to what Allan has in mind in the sense that it is something to buy up debt. We have certainly proposed nothing like that at all. We have proposed instead that the sovereign debt be worked out between the debtor and the creditor.

We are and continue to be--I don't think the word is "reluctant"--I think we refuse to get between the private creditors and the sovereign in terms of the debt restructuring mechanism. But there can't be a restructuring until somebody has got some idea what the sustainable situation is going forward in terms of ability to finance the debt, and that is where we are now and have been and will continue to be involved.

MR. KAUFMAN: Allan?

MR. MELTZER: No. I think George Soros' proposal is really quite different from ours, mine, and it is certainly different from Anne's because what he wants to do is just simply say, "Well, you know, we've had this game and it turned out to have these losses. Now, let's find an agency. We'll buy up the debt, we'll sink it into something else, and then we'll start the game over again." I think the incentives in that system are just so perverse as to seem to me to be a non-starter. I mean, George Soros has one great virtue and that is he puts his own money where his mind is, but many of his ideas are unappealing.

MR. KAUFMAN: Bert?

MR. ELY: Bert Ely. A question for Dr. Krueger. This is just kind of a simple little technical question. How do you define sovereign debt? And specifically when we take a large country like Brazil or the United States, does this include the debt of political subdivisions--states, provinces, localities? Does it include the debt of government-owned banks? Does it include the debt of government-owned enterprises like utilities and hospitals? Would it, in the U.S. context, include the debt issued by government-sponsored enterprises like Fannie Mae and Freddie Mac? And, also, who defines what sovereign debt is and who adapts that definition to each of the 180-or-so countries in the world?

MS. KRUEGER: Well, in practice, the forum would be the one that adjudicated whatever the claims that were brought forward to it were, but that is a superficial answer. Sovereign debt is debt that is either issued or guaranteed by the sovereign at the federal level.

MR. KAUFMAN: [INAUDIBLE.]

MS. KRUEGER: As of right now, explicitly, and as we are defining it, that is issued under a foreign law. In other words, Argentine debt issued in Argentina under Argentine law, at least initially, would not be covered in our proposal. Argentine issued in New York or in London would be covered under the proposal.

So the distinction that we're basing it on is not as you are looking at, you know, sort of what is the degree of coverage. It is the question of whether it is issued under foreign jurisdiction. Now, when indeed it is Argentine debt that is guaranteed by the government, the federal government, even though it is state debt, that counts as part of federal debt if it is issued under foreign law.

By the way, most of the enterprise debt is not issued under foreign law.

MR. KAUFMAN: Not yet.

MS. KRUEGER: Not yet.

MR. HERRING: I'm Dick Herring from the Wharton School. I'd like to pose a question to Anne about--it is a hypothetical. If we had had the SDRM in place, say, in January of 2001, could you speculate about how Argentina may have played out differently if we had had that mechanism available? Would it have made a difference in the dynamic of interaction between the creditors and Argentina?

MS. KRUEGER: That is a hard question because so much was going on there and you do have there the strange issue on the fiscal side with the provinces able to issue debt which comes out as payment ? . So it is a huge problem there. If it was going to help, I think there would have been several points at which it might have. It is counterfactual, so that is the best I can do.

One, I think last August or July 2001, there would have been a third option on the table in terms of what everybody was thinking about in terms of what to do about Argentina, and that might at that time have changed the relative bargaining power, on the one hand, of the different parties. And in that sense, it might even, for all I know, change the outcome. I was not at the Fund at that time, so I can't speculate as to all the events.

Secondly, it could have changed the calculation among the alternatives to the economics ministers then and in the fall when they recognized that their hope for a zero fiscal deficit didn't happen, when they recognized that they could not finance all of their outstanding debt and they decided to restructure the domestic debt recall first without the international, which is still part of the problem that they are facing. It very well might have changed that.

If it had changed that, I can even, if I want to speculate wildly, imagine that that might have changed behavior enough so that things could have been very different, let's say, by December. But that is horribly hypothetical.

MR. KAUFMAN: [INAUDIBLE.]

MS. KRUEGER: It certainly would have given a third option in August, because in August of 2001 the choices were lend or be blamed for whatever happens next. And being blamed for whatever happens next was not only unpleasant to contemplate from the viewpoint of the Fund. It was also unpleasant to contemplate from the viewpoint of some of the Fund's political masters.

MR. HUBBARD: If I could just add as one of the shareholders, a representative of one of the shareholders--

MS. KRUEGER: And not the smallest.

MR. HUBBARD: I think your question actually puts a finger on a really general point. I don't think--this is my own speculation--that SDRM, per se, would have been----[END OF TAPE RECORDING]

[END OF PANEL DISCUSSION, BEGINNING OF PRESS BRIEFING]  

MR. KAUFMAN : We had at the meeting, as I might have mentioned earlier, 30 folks from 15 countries or so.

Do you want to stand up? Introduce yourself to the crowd.

MR. KAUFMAN: So it was a really unique and--oh, Peter, you're hiding back there. Now, everybody is looking at you and you're blushing.

Any other shadows in the shadow back there someplace? No, okay.

MR. KAUFMAN: It's at the front desk. When you leave, there will be a list of people who were at the meeting. The members of all the committees, I think they are on the website, the AEI. If not, they will be there shortly.

So there are four committees. Each one averages about 10 people, so it's about 30 members of the committee. We're 30 here, which is quite a successful thing.

Charlie Calomiris will summarize the statement that you have in front of you which, of course, relates a great deal to the discussion we had earlier in the day.

If you haven't met the chairmen of the committees, Liliana you've met already. She is the Chairman of the Latin American group; Harold Benink, who is the Chairman of the European group. The Chairman of the Japanese group is not with us, but standing in for him is Takatoshi.

So, Charlie, would you like to summarize the statement?

MR. CALOMIRIS: Thank you. I want to again welcome everyone, especially those who weren't here for the earlier panels.

As you know, we had, it was about 28 people from--how many--15 countries converged on Washington for two days and we produced this statement. The statement is entitled "Reforms in the Process of Structuring International Sovereign Debt," and the statement is a discussion of, or is motivated by two proposals--you heard about them this morning again--the collective actions clause proposal. There is a set of proposals about adopting or strengthening the use of collective action clauses, and then, of course, the IMF's sovereign debt restructuring mechanism, the so-called SDRM proposal, which is also sometimes referred to as the statutory approach to reform in this area.

To summarize, the shadow committees believe that the IMF proposals both in a sense go too far and not far enough. They go too far in the sense that we would favor a more gradual approach that begins by strengthening the existing contractual means for resolving debt problems.

We think that the IMF approach doesn't go far enough in the sense that there is a need to recognize that alongside, and maybe even prior to any success being achieved with an SDRM mechanism that there has to be fundamental change in what is sometimes called access limits or access incentives, meaning the way the IMF approaches assistance to countries who are near or at an unsustainable debt point.

A central objective of the recent reforms is to alleviate conflicts among creditors, and these conflicts can be very costly because of the delays that they create for the resolution of debt which is costly both to the sovereigns and to the creditors.

Now, we believe that this problem can be addressed adequately with a general adoption of CACs, and furthermore we believe that the general adoption of CACs can be achieved by voluntary actions and probably does not require mandates through some sort of coordinated legal means, like a revision of the IMF's Articles.

So at this time--and I emphasize at this time--the committees do not endorse the adoption of the statutory approach to debt resolution; that is, the SDRM. However, part of the reason for that is because we think that it's not clear yet that one really needs to go that far.

And we can conceive that in the event that the existing contractual approach, especially after been strengthening by the widespread adoption of CACS--if at some point in the future that doesn't appear to be sufficient, then we could certainly see a need for moving beyond that with some sort of statutory approach.

Let me briefly review the guiding principles that we established. We think that an ideal debt restructuring reform would have five key features.

First, it would discourage countries from over-borrowing and creditors from over-lending. Similarly, it would--our second goal is that it would reduce moral hazard by making sure that once you have lent and are earning returns commensurate with the presumption of risk that you also have to share in those risks on the downside. You don't just get to have the high interest; you have to also bear the risk of loss.

A third principle is that a good reform would reduce the recognition lag of sovereign debt unsustainability. A lot of the emphasis, of course, in the SDRM proposal or the CAC proposal is on the later phase; that is, after there has been recognition, after there has been a default, how fast can you get resolution of the problem and restructuring of the debt. But we think that a key part that is often neglected in the current technical discussions is how do you get early recognition.

Fourth, obviously once you do get recognition, prompt resolution is very desirable. And, fifth, we'd like to see a resolution mechanism that doesn't create some sort of permanent victimization of the country that is going through the debt process. A successful debt restructuring would result in an ability for the country to return to capital markets insofar as the country was creditworthy going forward.

Now, the SDRM proposal and various proposals about CACs mainly address the fourth of those five criteria; that is, trying to ensure prompt resolution after the recognition lag. And so we think that while it's important to address the prompt resolution after the recognition lag that that shouldn't distract attention from the importance of the other goals, and in particular of modifying current IMF policies to make that recognition occur faster.

I want to talk a little bit now about creditor coordination problems and make a comparison among the three approaches to resolving these problems: one, leave things as they are; two, add CACs--that is, collection action clauses--to the process to try to resolve creditor hold-out problems; or, three, a full-fledged SDRM.

Now, the way that the collection action clauses work to resolve hold-out problems is very directly by binding all bond-holders to the will of a super-majority. So there is not much point in holding out if you are bound by what the super-majority is going to say; that is, you don't have any real leverage as a hold-out.

Now, the existing mechanism to which CACs would serve as an alternative is what is sometimes called exit consents. Exit consents are amendments to contracts that are signed by exiting debt-holders which work to the disadvantage of the remaining old debt-holders, and therefore try to inspire those preexisting debt-holders to be on the side of the majority because they don't want to get stuck with the bad contracts left behind with these sort of poison amendments that are left by the exiting bond-holder.

There has been some success in solving collective action problems using this mechanism and in several of the cases, as Glenn Hubbard mentioned this morning, we've seen, if not absolutely universal participation, nearly universal participation in some of the debt restructurings.

But one of the advantages that CACs has over the existing system is that there are some legal uncertainties involved in exit consents. And so, going forward, it might just be a cleaner system to try to get collective action built into the contracts in the first place.

Secondly, and perhaps even more importantly--and, in fact, Anne Krueger this morning said this--having CACs in place as a formal, predictable device would go a long way toward making it easier for the IMF to have the choice, the political choice, not to have to do bail-outs and prolonging the recognition of unsustainable situations. And we see that as a major advantage of CACs. We agree with her in that respect, although she sees that, of course, as applying that logic to the SDRM. We would apply that logic also to the CACs.

Furthermore, the shadow committees believe that the impact on the cost of issuing debt from including CACs in bonds is unlikely to be significant. I should also mention to you that Anne Krueger, after the session this morning, pointed out to me that in an offering that the Mexicans were considering that would have included CACs, they actually were offered a higher price than the non-CAC debt.

And she said that Hill-Diaz [ph] did admit that this fact was true. So there's even some evidence and there are some people out there who believe that it is conceivable that because CACs would resolve collective action problems without creating very great incentives for the abuse of default that somehow CACs might actually not be very costly. But people disagree about this.

Whatever the answer is, we don't think that the answer is that the cost of issuing is going to go up by a significant amount as a result of CACs. So we don't think the cost of this change would be very high.

Another good thing about the CACs proposal, as opposed to the SDRM proposal, is that if you listened to Allan Meltzer this morning, he said that, well, we really are still experimenting, the system is evolving, we don't want to pass an SDRM proposal that forecloses evolutionary development in the contractual approach.

The nice thing about CACs is they don't foreclose anything. All they do is help facilitate the coordination of the creditor's will within the contractual approach. So we think that again from a sort of unpredictability of the future and not wanting to foreclose good evolution of the market mechanism, they have that advantage.

Okay, so now the question--having argued that CACs are a good idea, the obvious question is why does the government or the G-7 or the IMF or somebody have to do something to make it happen, why aren't CACs already in existence.

Well, of course, they are to some extent in existence, but only to a small extent, and they are already used in international bond issues under the laws of the United Kingdom, Luxembourg, and Japan.

So if we already have the ability to do CACs through these countries--and by the way, we also have the ability to do them statutorily within the United States. While it is often incorrectly viewed that the U.S. law somehow prevents the use of collective action clauses in sovereign debt contracts, that is not true. It is simply a matter of customary practice that has led to CACs not being used in sovereign debt offerings.

So if CACs are a good idea, you can do it in all of these markets, it is being done occasionally in some of these markets, in Luxembourg, London and Japan, why do we need to encourage their use through public action?

The answers that we would give are three. First of all, if, as Anne Krueger argued this morning and as we believe, the presence of some kind of orderly resolution device makes it easier for the IMF not to do bail-outs, then it may be that neither sovereigns nor creditors find that it is in their interest to include CACs because doing so, while it might make debt resolution less costly, might also make bail-outs less likely.

And so maybe people aren't doing CACs because they already agree with Anne Krueger that the presence of CACs would reduce bail-outs. Of course, that is a good reason to require CACs or to encourage them.

Secondly, if you believe that CACs would actually increase the debt service costs--again, a case that we're not sure about, but if you made that argument, there might be two other reasons why beneficial CACs are currently not being done.

First, if the benefits of CACs extend beyond the countries that actually offer the debt through some sort of reduction of cross-country contagion effects during default, then countries that might see a small increase in their debt cost as a result of including CACs, even though there would be big cross-country benefits to doing so, might not be willing to include the CACs because of these externalities not being internalized in the debt service costs of the issuer, or internalized more broadly and more correctly, say, in the benefits accruing to the creditors of that country and the country itself. So there is that externality problem.

Third, it is possible again--if CACs do increase debt services a little, it is possible to argue that sovereigns who are facing strong short-term political pressure might want not to do something, might avoid including CACs even though CACs have a long-run advantage. Maybe political events keep us from thinking about that long run.

So having suggested that there is a benefit from official encouragement in this direction, the question is should they be made mandatory. Well, we prefer a more moderate approach than the mandatory approach that would occur through potentially treaties or the IMF Articles or something.

The more moderate approach would require that countries would be encouraged perhaps through lower interest rates and multilateral loans for countries that adopt CACs or perhaps through a variety of other official encouragements.

And at the same time, following what Professor Ito said this morning before he left, it makes sense to focus on the issuing locations, not just the issuing countries. And to the extent that there are some sort of customary barriers in the United States rather than legal barriers to including CACs in U.S.-enforced contracts, that is a U.S. problem and the U.S. Treasury should consider ways to overcome that customary resistance.

So having argued that collective action clauses would be a good idea and that there are moderate ways to encourage their use and good reasons to encourage their use, we then turn to the question do we need to go farther--at least let me pose the question more narrowly: Do we need to go farther right now with an SDRM proposal, as Anne Krueger suggested? And we don't think so for the moment.

Let's look at the arguments that are made about why you would need to go farther and let's see why we don't think that they are convincing arguments.

One argument has to do with so-called transitional issues; that is, there is a lot of debt outstanding right now that doesn't have CACs. So what do we do if a country gets into an unsustainable position and its new debts under these new rules would CACs, but its old debts wouldn't?

Well, the IMF would solve that problem through the SDRM by having a mechanism that brings all the debts together, irrespective of whether they were issued before this implementation of our proposal or afterwards.

What would we do? Well, one mechanism would be simply to try to encourage countries to use debt swaps to swap out of the preexisting non-CAC debt, and we think that that is a very viable option and that there would be ways to try to share some of the costs for those swaps if those transition problems were really deemed as very important.

A second rationale that is used for the SDRM--going beyond the CACs again, a second one is that we want to insulate sovereigns from adverse court judgments during the renegotiation process. The committees believe that that concern is overstated.

Now, there is some remaining concern about transactions in the clearing and settlement process where sovereign resources might be attached, and we think that there might be some very clear rule changes that should be made to try to prevent that problem. But for the most part, sovereigns before they default have already protected themselves from judgments in courts and we don't think that this was a very big issue, certainly not in the recent Argentine case.

A third argument--and you heard Anne Krueger emphasize it this morning--for using SDRM is that statutory rules allow you to coordinate on a rules-based approach all the different debts at once in the same resolution.

Now, how do they do that? Well, the rules haven't been specified very specifically, but let's talk about certainly part of how they do it which the IMF has mentioned. The way they would do it is they would define creditor classes, they would place all debts in one of these creditor classes, and then they would set up a voting system for voting on a restructuring plan. And each creditor class would basically be able to veto the plan and the voting rules would define how votes would take place within each creditor class.

Now, the question, of course, is, is that going to necessarily be a faster restructuring process than the alternative? Is a system that sets up formal voting with veto power, which is what they are proposing, necessarily going to be faster than a system that just has the sovereign thrown into a situation of raw bargaining power with these various classes of creditors where what we would expect is the sovereign would basically come up with a plan upon informal consultation with these creditors that says, well, here is what we want to do, sign on or don't, and hope that through the use of various pressures that the sovereign would get agreement?

We don't think it is obvious--especially in the presence of collective action clauses and bonds, it is not obvious that the first method that I mentioned, the SDRM, would actually produce a faster resolution than the other method, particularly since we think that this contractual approach is still evolving and that sovereigns may have other tricks up their sleeves before too long.

So we don't want to pre-judge, or as Allan Meltzer said, preclude the development of those beneficial options. And for those reasons, we think it is too early to be sure that we want to go with an SDRM.

So, on balance, we think it is best to keep the statutory approach on hold for the time being, preserving it as an option to consider if the strengthening of the contractual approach that we're proposing proves inadequate.

What other reforms make sense? Well, we don't stop there. We think again, to reemphasize, just focusing on that interval of time between the recognition and the resolution is not good enough. You have to also try to get the recognition to happen earlier and, even better, try to to get the crisis to be less likely.

So the first reform that we have in mind relates to the so-called issue of access incentives or access limits, and that would, of course, entail the IMF finding ways to change its lending rules so that it doesn't prolong unsustainable debt burdens.

But that is not the only set of reforms that need to be addressed. Also, the Basel capital rules are another area that unfortunately makes this problem of capital flow volatility worse than it needs to be. The proposed reforms to the Basel Accords that are currently being considered would actually aggravate the existing distortion in international capital regulation that currently encourages shorter maturity lending to emerging-market countries.

What the Basel Committee should be doing is moving in the other direction, getting rid of capital charges that discriminate in favor of short-term lending, and therefore discriminate unfortunately in favor of more volatile capital flows.

So to conclude, we think that there are reforms that are worth doing. We think that CACs would be highly beneficial, at little or not cost. We think that they should be encouraged and we think that that could be a very successful initiative in overcoming hold-out problems.

Furthermore, there are other reforms particularly in IMF lending policies, but also in Basel policies and to some extent in securing sovereigns from the attachment of assets during the settlement and clearing process which we think would be beneficial. But we want to stop there for now. We think that premature adoption of the SDRM might be counterproductive and might foreclose other beneficial options and adaptations.

Thank you very much.

MR. KAUFAMN: Okay, we'll open the floor to questions. Again, state your name, except for Bert Ely [ph]. Everybody knows Bert. Stand up, Bert.

Do we have a floating microphone around? You're going to have to speak loudly, I guess.

MR. ELY: [INAUDIBLE.]

MR. KAUFMAN: You're perfectly right. We didn't say anything in the statement, so we really don't have anybody from the statement, but we have people who may want to give their individual views.

Charlie, you were saying something.

MR. CALOMIRIS: It's interesting you say that because over this weekend while we were meeting, I was thinking about that issue. And one of the things that Ken Scott taught me, who is here today, is that one of the great advantages or provisions that--I don't know if you were the one who snuck it in, Ken, or someone snuck it in--was this provision that the government could bail out uninsured creditors under FIDESEA [ph]. But if it did, then there had to be special assessments on surviving banks commensurate with their size.

MR. ELY: [INAUDIBLE.]

MR. CALOMIRIS: Right, but the one I want to talk about is this one because that is the one that I'd love to find a way to mimic in IMF lending. I think that's the one, not these little rules which--look, if the IMF doesn't lend, then the G-7 maybe gets around it or combines it with the World Bank.

What we really want to figure out here is a way to bind the governments like the way that we bound the large banks in the United States, because we knew that what was really important was not the Fed or the FDIC, but the large banks and their lobbying efforts.

So what we did was designed FIDESEA to overcome the incentives of the large banks to push for bail-outs because now a bail-out was something that would cost them as a group directly of uninsured depositors. That is the kind of thinking that I think we need to get back to, and we need to remember that we're not just trying to bind the IMF, but that we're trying to bind the way the governments are thinking.

And so I was thinking about this this weekend, but never came up with a good, concrete way to get at it. But I think that is the part of FIDESEA that I admire the most. Maybe Ken can comment on its history.

MR. SCOTT: The problem is how do you get a sovereign to commit to a course of action when any rules that it adopts it can change. And what you are doing is trying to set up procedural impediments to their doing so, and also to create a substantive impediment by trying to change the political economy, the lobbying force, the working of political forces within the country in response to the kind of action which you are trying to obtain pre-commitment. And since we didn't talk about and in this context I haven't thought about it, I can't give you thoughts that are worth taking up time.

MR. KAUFMAN: Let's go back to the statement if anybody has got questions. Otherwise, we can go into this other area.

Yes, sir, just a second. We do have the microphone working now.

MR. COWAN: Thank you. I'm Edward Cowan and I'm here at AEI.

Charlie Calomiris in opening his summary listed five elements of the proposal and the first one, if I caught it correctly, Charlie, was to discourage over-lending or excessive lending. And as I listened to that, I said to myself, well, I guess he means ex ante.

But if you think about it and listen to Bert's question, how does one identify--how would anybody here identify excessive lending ex ante, and what would the mechanism of discouragement that you're talking about be?

MR. CALOMIRIS: Well, my answer to that is the reason that we have markets is because we don't want to have to be sitting around in the Politburo deciding, every time someone makes a loan, whether it is excessive or not. So we presume typically that when banks make loans, let's say, that they are making a decision that is balancing risk and return, and so we presume that that is not excessive in some sense.

And we also presume that the borrower knows that the borrower will be in trouble if he or she can't repay, and so we assume that that is not excessive borrowing and not excessive lending.

The problem, of course, is that then if we start altering those incentives with various other things, government interventions, then we actually can make people decide to change their decisions, whether that is deposit insurance or the IMF or whatever you want to substitute.

And so the goal of getting back to a system where we can be reasonably confident in our presumption of the absence of over-lending and over-borrowing ultimately is--the goal is to try to remove distortions that we think are creating over-lending or over-borrowing, not to be able to sit there on a case-by-case basis and make a judgment on any one loan.

MR. KAUFMAN: Does anybody else--Liliana, do you want to add to that?

MS. ROJAS-SUAREZ: Well, I guess when the question was asked, I thought that Charles was the perfect person to answer the question because he himself is a banker and that's exactly--

MR. CALOMIRIS: I never over-lend.

MS. ROJAS-SUAREZ: In the case of the sovereigns, of course, for the reasons that he said, it is much more difficult. But, however, this morning the discussion was--the message we were trying to say is that precisely a country cannot be, or is not ready to borrow--and we can define what is over-borrowing, but to borrow until it has actually proven capacity to repay, to service its debt. And that is the whole action and the whole idea of this report. I mean, the emphasis for us is not only on crisis resolution, but on how to actually prevent that you actually have to get into that situation.

MR. CALOMIRIS: Does any member of the committee want to talk to that?

George, the microphone is here.

MR. (inaudible): Well, I think if one puts it in the context, as Charlie did, of ordinary bank lending, it is very useful because a banker normally, of course, would lend and take the risk and take the loss, should it not occur.

The problem with governments is that one government can indebt people of the country that they later have to put up. And, in fact, the lender might be very willing to lend to a government in the realization that either, one, they will be bailed out, or, two, the people of the country will be forced to pay even if the funds were very badly used and the country, in fact, couldn't sustain the debt.

And the question is we can certainly deal with the business of not having them bailed out; that is, the private lender should be fully liable for any losses that might be taken. In fact, I'd say there is even a very good case now for saying that any government can default if it wishes to and it doesn't take away from lending, if it weren't for the fact that there would be other governments that would not default that will now be tarred with that brush; that there is an externality that everyone will say, well, you can't lend to this type of country because they default.

So it is the balance between not cutting off the credit to the countries that, in fact, would repay or would use the funds sensibly as against those where the leaders are taking it for their own benefit and then hurting their own people. And if the lender wants to lend to them, well, that is their problem and they can try to get it back if they can.

And I think the position that we've taken here is a good one, in that we certainly don't want these governments and mostly the lenders to be bailed out in those situations. And yet we don't also want to make it terribly easy for someone to default; otherwise, send in the gun boats kind of thing.

MR. KAUFMAN: Other questions? Bert again.

MR. ELY: Yes. I want to follow up on Ed's comment about the over-lending. How do you know that over-lending has occurred ex ante? And I would like to suggest--I'd be interested in your reaction to this--that the presence of the IMF and its history of providing substantial amounts of credit in crisis situations alters people's assessment of whether or not a country--alters people's assessment ex ante as to whether or not a country has been over-lent to because there are going to be at least some borrowers, particularly those who are lending of a very short-term nature, who have in the back of their mind that the IMF is there and likely will ride to the rescue, not has happened in Argentina, but they would hope as happened in Brazil.

And so again I would suggest--and I'd be interested in your reaction to this--that the presence of the IMF as an international lender, an emergency lender, accentuates the ex ante over-lending that occurs.

MR. KAUFMAN: [INAUDIBLE] the architecture of the financial institutions, and that is a study that many people have looked at--Alan Nelson and his proposal, the IMF and its proposal. That is a topic that we, of course, recognize in our statement, and we mention these two have to be done simultaneously.

And as Charlie said, if you had this bankruptcy proposal or similar ones that it may be easier to cut back on the access to the IMF. It works the other way, too. If you cut back on access, then it would be easier to introduce these.

We couldn't do everything in a weekend, Bert. I know that you can, but it takes us a little bit longer.

Anybody else want to respond?

MR. CALOMIRIS: Yes, that should be our next year's project--

MR. THYGESEN: --that in contrast to the early years of the multilateral institutions, no European country in the European Union has borrowed from the Fund for 10 years. There were small amounts by Italy and Greece. Then we copied IMF conditionality. There may be more members in the European Union soon who have been having programs with the IMF, hence have had also in some cases important foreign debt.

But the presumption is that Europe will take care of these problems inside regional arrangements from now on. So we have a slightly more distant view, probably, than at least the Latin American region and the Asian region of the issues that we are currently discussing.

But it would be fair to say that there has been growing unease in both official and academic circles in Europe about the scope of IMF lending. This came already to a head in the Mexican package of 1995 which several European countries did not support at the time. And there has been, I think, criticism subsequently.

You probably hear the words "moral hazard" at least as frequently among European governments as you hear it in this building because Germany and the Netherlands, for example, have taken a strong view on that. Other countries have been apparently a bit more relaxed about the concept, recalling that, in all fairness, I think we have to say the element of moral hazard is inherent in the very functioning of the International Monetary Fund.

The intention was that potential borrowers should feel a little bit--they should derive some comfort from knowing that there is an official institution that can help them through temporary problems of external imbalances and there is conditionality attached.

The worry is, of course, that the scope of this lending has extended enormously in terms of the amounts, and not least in terms of the length of the lending has taken over functions both vis-a-vis emerging-market economies and developing countries that were not seen as the original mission of the IMF.

So there is generally, I think, a European view that there has to be more emphasis on shorter-term liquidity support and much less on lending, although the tight conditionality that is often imposed makes it, I think, a risky element for countries to envisage IMF lending with too much eagerness.

Now, I think there is an awareness certainly also in Europe that some of the causes of this is the interaction of also the creditors in this process. This was perfectly evident in the Asian crisis, where European creditors, European banks came late into the game, European investment funds. And with the keenness of those who get into a booming market, they did lend very freely and certainly were keen to have substantial IMF programs subsequently. Recently, we've had some repetition of that through the environment of one or two European countries, in particular, in banking in Latin America.

But on the whole, the main criticism has been on the proliferation of the longer-term mechanisms and the massive transgressions of the earlier lending limits. I remind you that they were originally 300 percent of country quotas, but have been exceeded in a number of cases.

I'd like to return in this context to what Charles Calomiris said about the role of the IMF. The crucial problem, as he said, I think, is indeed to recognize problems early and to have, in the shape of the IMF, an institution that can put relevant information out early.

There are, of course, limits to what the IMF can do, as we have seen in recent years. The IMF does conduct surveillance and does offer advice to governments in private. We don't quite know what it is always and to the full extent, even though IMF reports are now published to a much greater degree than at any time before.

But the real issue is, of course, if there is some conflict of evaluation about the sustainability of a country's debt position, whether the IMF can indeed threaten to go public with the kind of critical assessment that Charles Calomiris is asking for.

Most of our own governments wouldn't like really critical assessments. We see that when they discuss their own IMF reports. They are worried not only, of course, about market-sensitive information, as is the case with major international borrowers, but also simply about the political embarrassment at home from being criticized or doubted by an international institution.

There has been much discussion, for example, in the case of the Asian crisis whether the IMF could have gone probably a bit earlier than it did. There is no doubt that in some of these cases they did have the right view of the sustainability of the position, but they didn't feel that they could risk triggering a crisis which they didn't still regard as inevitable.

And I suspect that is, of course, the very problem that has been faced by the Fund in determining the sustainability of the Brazilian situation, and for that matter the Turkish case, where crises were triggered by short-term political developments that were not easy to, let's say, include in a regular analysis of debt sustainability.

So the task of the Fund is indeed not an easy one and the best hope we can have is that countries in the regions that are represented here will tend to push for more transparency and openness and for, of course, exploring as fully as possible the scope for letting private markets also solve a greater part of the issues that we are facing through positive incentives to do so.

We do not quite know how the private markets would rise to that challenge in the absence of the possibility of large Fund packages. This is one of the issues we've been discussing here and we'll no doubt come back to that when we present our statement. It's an open question.

So let me point out also that one other area that we have not discussed here today but which has a close interaction with the sustainability of sovereign debt is, of course, the stability of short-term flows, the renewal of trade credits and other short-term forms of support. In several cases, this has been the triggering fact of crisis in Korea earlier, in Brazil in 1999.

And here again, I think there is scope for exploring maybe sometime in another discussion the role of contractual arrangements that could make it more robust to have a limitation on the volatility of short-term capital flows.

So there are many other issues that are closely linked to this. As I said before, there is no clear European view on the virtues of the sovereign debt restructuring mechanism. If I may return still to the official document that I searched for, they said cautiously sitting there and waiting for the U.S. to make up its mind, I think, well, it is too early to discuss these details.

Yesterday, we discussed that the devil is in the detail in these proposals. You cannot really take a stand, a priori, completely without looking at the details. Let's wait until there is a political clarification of whether this kind of statutory approach wins favor.

So this is, I think, the characteristic attitude of Europe. Sit back a little bit and wait, deplore maybe that the United States is deciding too much in the IMF and other international institutions, and then criticize subsequently.

[Laughter.]

MR. THYGESEN: So I hope the European academics have a bit of a better record here. I note that there have been several articles and contributions to the subject we have looked at, but I think this proves the value of the kind of meeting we've been having here over the weekend.

So thank you very much.

MR. KAUFMAN: Thank you, Niels. I could feel the tension rising, waiting for our statement to be released at noon.

We do have time for one or two short questions, but not statements.

So, Bert, there is a microphone.

MR. ELY: Bert Ely, a banking consultant here in the Washington area. It seems to me you've touched on two issues. Number one is the whole problem of short-term liquidity problems, and then the other is the larger-scale IMF-type broad-based creditor bail-outs.

Doesn't this suggest that there are two underlying problems, number one, particularly with regard to short-term capital flows? Oftentimes, these are associated with fixed exchange rates that have gotten out of sync.

Therefore, might not one of the solutions be a longstanding piece of advice, which is to get rid of fixed exchange rates and for countries to not try and maintain them?

And then looking at the longer-term, larger-scale problem of the IMF, might not the solution there be to simply get the IMF out of the lending business? I'm sure there are other things they can do, but isn't this really the moral hazard problem that the IMF is there and without the IMF we might not have the moral hazard problem that everybody is concerned about?

MR. KAUFMAN