Date of Original Version
Abstract or Description
This paper proposes a low cost alternative to the large bailout packages that the International Monetary Fund (IMF) has organized to address financial crises. The IMF would act as a lender of last resort. Faced with an unsustainable debt burden, a government would declare default. It would announce negotiations to restructure its debt at a sustainable level and a minimum restructured value of the debt. During the restructuring period, the IMF would provide a cash support bid at a discount to the government's minimum offer. The IMF floor would guarantee liquidity and create a functioning market in the defaulted debt. The proposal would remedy market failure, preclude panic and contagion, and facilitate an orderly debt restructuring. This would be achieved without substantial official funds. Lenders would be forced to bear the risks they undertake thereby reducing moral hazard and future instability.
Journal of Monetary Economics , 50, 1, 289-303.