Research
Recovery Before Redemption? A Theory of Delay in Sovereign Default, with Mark L.J Wright [Revise and
Resubmit, Econometrica]
Negotiations
to restructure sovereign debts are protracted, taking on average more than 7
years to complete. In this paper we construct a new database and use it to
document that these negotiations are also ineffective in both repaying
creditors who lose on average 50 per-cent of the value of their claim and
reducing the debt burden of the defaulting country which typically exits
default as or more highly indebted, scaled by the size of their economy, as
when they entered default. To explain this apparent inefficiency in
negotiations, we present a theory of sovereign debt renegotiation in which
delay arises from the same commitment problems that lead to default in the
first place. A debt restructuring generates surplus for the parties at both the
time of settlement and in the future. However, a creditor's ability to share in
the future surplus is limited by the risk that the debtor will default on the
settlement agreement. Hence, the debtor and creditor find it privately optimal
to delay restructuring until future default risk is low, even though delay
means some gains from trade remain unexploited. We show that a quantitative
version of our theory can account for a number of stylized facts about
sovereign default, as well as the new facts about debt restructurings that we
document in this paper. Finally, we argue that our findings shed light on the
existence of delays in bargaining in a wider range of contexts.
Detrended Total
Factor Productivity (TFP), net of changes in
capital
utilization, fell 2.6% after the Korean 1997 financial
crisis.
Detrended real GDP per working age person fell by 10.1%.
We construct a
two-sector small open economy model that can
account for 40%
of the fall in TFP in response to a sudden stop
of capital
inflows and an increase in international interest
rates. The model
also accounts for 55% of the fall in GDP.
Empirically, the
fall in TFP follows a reallocation of labor from
the more
productive manufacturing sector to the less productive
service sectors
and to agriculture. The model has a consumption
sector and an
investment sector. The reallocation of labor in the
data corresponds
to a movement from the investment sector to the
consumption
sector in the model. The sudden stop raises the cost of working capital needed
to employ labor
and use materials. We show that working
capital requirements fall disproportionally
on the
investment sector.
Published as:
Benjamin,
David and Meza, Felipe (2009) "Total Factor
Productivity and Labor Reallocation: The Case of the Korean
1997 Crisis," The B.E. Journal of Macroeconomics: Vol. 9
:
Iss. 1 (Advances), Article 31.
Winner: Arrow Prize
Formal versus Informal Default in
Consumer Credit, with Xavier Mateos-Planas[Revise
and Resubmit, Economic Journal]
This paper
studies informal default (or delinquency) in consumer credit as a process of
negotiation over unpaid debts. We consider an economy with uninsurable
individual risk where, as an alternative to informal default, households can
also declare formal bankruptcy. Negotiated settlements, which can be reached
quickly or with some delay, involve limited recovery, are often followed by
further defaults, and may end in bankruptcy as households reduce their assets
in the process. When calibrated to aggregate measures of default, debt and wealth,
the model yields differences in the financial positions of formal and informal
defaulters which are quantitatively consistent with observed data. Informal
defaulters have higher debts, assets, and net worth, but lower incomes. The
opportunity to bargain provides substantial insurance opportunities. It
considerably mitigates the known adverse consequences of formal bankruptcy.
Bargaining also enhances the welfare gains following from a tighter asset
exemption. Attempts at limiting debt collection outside bankruptcy lower
generally, but not uniformly, welfare.
Health
Insurance Mandates in a Model with Consumer Bankruptcy with Gilad Sorek
[Published in Journal of Regulatory Economics
(2016)]
We study insurance take-up choices by
consumers who face medical expense risk and who know they can default on
medical bills by filing for bankruptcy. For a given bankruptcy system, we
explore the total and distributional welfare effects of health insurance
mandates compared with the pre-mandate market equilibrium. We consider
different combinations of premium subsidies and out-of-insurance penalties,
confining attention to budget-neutral policies. We show that when insurance
mandates are enforced only through penalties, the efficient take-up level may
be incomplete. However, if mandates are also supported with premium subsidies,
full insurance coverage is efficient and can also be Pareto improving. Such
policies are consistent with the incentive structure for insurance take-up set
in the ACA. Pareto improvement is possible because the legal requirement that
medical providers dispense acute care on credit, together with the bankruptcy
option, yields effective subsidies for medical care utilized by the uninsured.
Those subsidy funds, however, can serve the initially uninsured better when
they are given as ex ante subsidies on insurance premiums.
Deconstructing
Delays in Sovereign Debt Renegotiations, with Mark Wright [Published in Oxford
Economic Papers (2019)]
Negotiations to restructure sovereign debt
are time consuming, taking almost a decade on average to resolve. In this
paper, we analyse a class of widely used complete
information models of delays in sovereign debt restructuring and show that,
despite superficial similarities, there are major differences across models in
the driving force for equilibrium delay, the circumstances in which delay
occurs and the efficiency of the debt restructuring process. We focus on three
key assumptions. First, if delay has a permanent effect on economic activity in
the defaulting country, equilibrium delay often occurs; this delay can
sometimes be socially efficient. Second, prohibiting debt issuance as part of a
settlement makes delay less likely to occur in equilibrium. Third, when debt issuance
is not fully state contingent, delay can arise because of the risk that the
sovereign will default on any debt issued as part of the settlement.
I combine two previously
separate strands of the bargaining literature to present a bargaining model
with both one-sided private information and a majority vote for proposals to go
into effect. I use this model to show
that the
I consider the
bargaining that occurs in bankruptcy between an informed firm and a set of
uninformed creditors over a set of new debt contracts. The agents have an infinite horizon to
bargain and cannot commit to a schedule of future offers. If individual creditors can be treated
differently and a majority vote is required for the acceptance of new debt
contracts, adding creditors increases the probability of reaching agreement by
the end of any given period. The
The
Productivity
in Economies with Financial Frictions: Facts and a Theory, with Felipe Meza
We document and account for two facts regarding the relation between
international interest rates and total factor productivity (TFP) in a sample of
developing countries. First, there is a negative correlation between both
variables at quarterly frequency. Second, the share of agricultural labor and interest rates are positively correlated, whereas
the share of agricultural labor and TFP are
negatively correlated. Manufacturing labor shows
opposite correlations. These relationships are particularly strong in the
aftermath of financial crises. We then construct a model in which the presence
of costly intermediation can produce such relationships. We show that, after
increases in interest rates, a requirement to intermediate factors of
production in high productivity sectors, like manufacturing, causes resources
to leave these sectors. Resources end up in low productivity sectors, like
agriculture, where intermediation is cheaper. This lowers aggregate
productivity. We show that the channel we identify is quantitatively important
in the case of
Ongoing projects
not ready to circulate:
Austerity
and Bailouts in Sovereign Debt Restructuring, with
Mark Wright and Yun Pei
In this paper we consider the interaction between international lending
and bargaining incentives. We show that
the optimal international bailout policy requires international lenders to be
willing to supply lending to countries in default if they have the ability to
insure that their debt is repaid before the debt of private lenders. However we show that this lending should not
be unconditional. In particular there
should be limits on international lending beyond those dictated by repayment considerations
and that to gain bargaining leverage, international lenders should place
requirements on government spending so that debtor governments have resources
to offer their lenders in bargaining and so that countries with intermediate
income levels are discouraged from default.
We show that the patterns of public and private lending over the default
cycle correspond to those in the data which we also document.
A Quantitative
model of HAMP, with Xavier Mateos-Planas
In this paper we
quantitatively analyze the influence of the HAMP program on the mortgage market
in a model where agents renegotiate over mortgages subject to default
risk. The HAMP program contained
measures designed to facilitate the renegotiation of mortgages where previously
it was structurally unlikely to occur.
The HAMP program also contained rewards to creditors and debtors for
successfully concluded renegotiations.
In our model the
value of housing assets is closely related to changes in income but is also
determined in the market by the amount of housing that is currently
occupied. Housing assets can be seized
and declared unoccupied if foreclosure procedures have begun. Thus housing prices and foreclosure rates
determine homeowner’s ability to commit to repay mortgages and thus the likely
success of negotiations for new mortgages.
In turn the ability of negotiations to terminate without agreement
affects housing prices which creates a vicious cycle. We show that even without any externality there
is room for a policy to subsidize agreements to avoid the excessive amount of
foreclosures that occur in equilibrium.
With the feedback through asset prices we show that this argument is
strengthened. On the other hand
excessive negotiations due to overly generous subsidies can limit borrowing
which depresses housing prices. We
create a quantitative measure of the effect of HAMP on foreclosures and asset
prices.
[Coming Soon]
Medical Debt, Health Insurance and Medical Costs, with Gilad Sorek
In this paper we
look at the trade-offs between health insurance and bankruptcy as a means of
insuring against
income and
costly medical shocks. Our motivation
comes from the large number of individuals who discharge medical bills in
bankruptcy. We show that with the
presence of a bankruptcy institution and actuarially fair insurance,
individuals with a high probability of bankruptcy will not buy insurance. We show that insurance take up actually
decreases as income risk over their lifetime increases, thus increases in
inequality are an important driver of changes in the insurance rate. We show from an optimal policy point of
view, that as long as there is some aspect of future income which remains
hidden or costly for the government to detect the optimal policy will leave
some consumers uninsured. Nonetheless we
show that the optimal policy involves some subsidization of premiums. In a model where we allow policy makers to set
the amount of care available through insurance and allow the level of care to
adjust to the bankruptcy exemption level, we show that a greater the welfare
weight on lower income levels leads to the average level of care for both
insured and non-insured individuals to increase as well as the exemption level
under bankruptcy. Thus insurance
subsidies are correlated with more expensive medical care. However the percentage of individuals buying
insurance is not.
[Coming Soon]
Bankruptcy,
Industrial Policy and Development in a Model of Limited Commitment