Bail out or work out? Theoretical considerations

Working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 14 May 2004

Working Paper No. 219 
By Andrew G Haldane, Gregor Irwin and Victoria Saporta

This paper assesses various crisis resolution proposals using a theoretical model of (liquidity and solvency) crisis. The model suggests that payments standstills and last-resort lending are equally efficient means of dealing with liquidity crises, while coordinated lending through creditor committees is second best. Debt write-downs are preferred to subsidised IMF financing when dealing with solvency crises, because of the negative moral hazard implications of the latter tool. Finally, the model suggests that international bankruptcy court proposals may be superior to existing contractual approaches in securing such write-downs.

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