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posted on 24 May 2016

Chapter 11 For Countries?

from the Philadelphia Fed

-- this post authored by Satyajit Chatterjee

Sovereign default risk has been growing, yet the world lacks an adequate mechanism for averting debt crises. It might be time to resurrect a plan modeled on the U.S. Bankruptcy Code.

For the past 40 years or so, every decade seems to have brought its own brand of international debt problems. In the 1980s, emerging market economies, led by Mexico, defaulted on their debt to private banks. In the 1990s, the fast-growing economies of Thailand, Indonesia, and South Korea teetered on the brink of default. The new millennium brought the 2007 - 2008 financial crisis, the worst the U.S. had experienced since the Great Depression. And this decade has brought the ongoing Greek debt crisis, which for about six months in 2011 had engulfed Italy, Spain, Portugal, and Ireland and threatened to destroy the euro.

Although outright default on foreign borrowing is relatively rare - Argentina, Russia, Ecuador, and Greece have been the only countries to default on their foreign obligations in the past 25 years - even the threat of sovereign default can be very disruptive for countries that experience it.1 Greece, sadly, is a poster child for the chaos that can befall a country when investors begin to doubt its ability to pay its bondholders. Greece was already suffering a recession in 2010 when it became clear to investors that its government was under severe budgetary pressure. Greece's debt was eventually restructured to avoid outright default, but the process was lengthy and extracted a heavy toll on the Greek economy: By the end of 2013, Greece's gross domestic product had fallen 25 percent below its GDP in 2010, and its unemployment rate had climbed to 27 percent. Then, the recovery that had begun in 2014 collapsed amid the political fallout from five years of harsh economic policies, and in 2015 Greece defaulted on its interest payments to the International Monetary Fund (IMF). Although an exit from the euro was averted, Greece's economic situation remains dire.

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Source: publications/ economic-insights/2016/ q2/eiq216_chapter_11.pdf?la=en

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