THE DEBATE over the International Monetary Fund’s role in rescuing Asia’s troubled economies has obscured a much more fundamental problem: Many firms and banks in the region are bankrupt. Because the countries’ currency exchange rates are so low, the local value of these companies’ debt now exceeds any reasonable value of their assets.
If these firms were American, they would be subject to Chapter 11 of our bankruptcy laws, which enable creditors either to liquidate a company, accept a writedown of their debt, or convert a portion of their debt into equity so that the restructured firm can survive. The same thing needs to be done – but on an even larger scale than America’s savings and loans bailout and as rapidly as possible – in Southeast Asia, as well as in Japan, where the banking system is in dire straits.
But there are at least two obstacles. For one thing, these countries have imperfect or nonexistent bankruptcy laws. Equally important, allowing outside investors to pick up the assets of insolvent firms and banks at fire-sale prices risks triggering an anti-American backlash. Consider, for example, the implications of liquidating the roughly 90 percent of the companies listed on the Indonesian stock exchange that are bankrupt given the current value of the rupiah.
Fortunately, there is a way out, but it must be pursued quickly to help restore the confidence of investors. Although the countries themselves must take the necessary actions, the IMF could accelerate the process. Each of the countries should pass simple bankruptcy legislation, if it doesn’t exist already. They should give limited emergency powers to relevant government authorities or newly created entities managed by individuals highly respected for their financial acumen. The IMF and the World Bank could help.
Each country should establish a mechanism for quickly performing triage on all firms above a certain size and banks facing bankruptcy. The applied exchange rate should be set below the rate before the crisis began, but above today’s excessively depressed market levels.
In principle, the rates should reflect the region’s long-run potential for economic growth.
Firms and banks that are insolvent even under this applied exchange rate should be subject to a presumption of liquidation or forced merger, unless creditors quickly accept an equity-for-debt swap. Liquidation or merger would be accomplished by the surviving banks or creditors themselves in the case of private borrowers, or in the case of deeply insolvent banks, by the equivalent of the Resolution Trust Corp. that was set up in this country to clean up the savings and loan mess. Not all insolvent firms and banks should face the ax. But deeply insolvent entities (or the assets themselves) should be moved quickly into hands unburdened by crushing debt.
All insolvent firms and banks not subject to liquidation, as well as banks with capital below regulatory standards, should be eligible for Chapter 11 resolution, with lenders required to exchange some portion of debt for equity. This will give the restructured firms a reasonable chance of survival. Banks and other lenders would do this themselves for their borrowers.
If that doesn’t work, then an appropriate ministry or new government entity could function as the equivalent of a bankruptcy court to quickly impose restructuring plans. The finance ministry (or its equivalent) presumably would carry out this function for potentially viable banks. This would mean that foreign banks would automatically take losses. An alternative approach for insolvent banks would be for the governments to extend guarantees on the loans once they’ve been partly forgiven. To soothe ruffled feathers abroad, the restructuring plans could provide local firms with options later to repurchase at least some of the equity after creditors have earned some decent return.
Significantly, this plan does not envision local governments infusing equity into troubled concerns, as the Japanese government has proposed for its banks, and as the Reconstruction Finance Corporation did in the United States during the Depression. Putting government money on the line – other than to pay off depositors, which is necessary to prevent a bank run – would only perpetuate the kind of excessive government micromanaging of the economy that helped get these countries into trouble in the first place.
More importantly, there is no need for a grand new international bankruptcy agency, as some have suggested. These countries’ debt problems are internal and, unlike Mexico’s crisis four years ago, they plague firms and not the government. Of course, applying a common approach to insolvent Asian entities would set important international precedents.
An active liquidation program would restructure entire economies, while achieving many important goals. It would help stop the growing cascade of failures, which is driving down both the economies and their currencies. It would help restore confidence in the economies by assuring a role for new foreign investment, helping to better assure payback of at least some existing debts, providing stronger incentives for fresh investment to return to the country, and offering the prospect of gains to the former creditors who exchange their debt for equity. It would associate the IMF with quick, flexible help to troubled firms, rather than with unpopular austerity measures.
And the program would send a message to all creditors that the days of “too big to fail” are over, and that if all creditors are to feel comfortable with the outcome, the pain must be shared.