- The Washington Times - Monday, May 12, 2003

Latin American countries are successfully adopting a strategy promoted by the Treasury department for averting economic crises. The concept has long been embraced by Deputy Treasury Secretary John Taylor, and is now favored by developing countries.

Mr. Taylor’s prescription for helping avoid the serial crises and subsequent bailouts that have been global problems in the past is a simple one. Under his plan, when countries emit bonds, they would include a clause stating that most bondholders can approve a renegotiation of debt payments should the government develop financial troubles. Traditionally, these kinds of debt restructurings could only be done with unanimous bond-holder approval, which makes a messy default more likely. In wake of such defaults, the IMF usually comes in to clean up the mess.

But by including Mr. Taylor’s rommendations, which have been dubbed collective-action clauses, governments can more easily negotiate new terms with bondholders, who would be forced to take a hit on their investments, reducing the likelihood of a full-blown economic crisis and an IMF bailout.

On Tuesday, Brazil, with rousing success, emitted debt with these collective-action clauses. After suffering an investor exodus last year, Brazil last week emitted a $1 billion global bond, which matures in January 2007 and carries a spread of 8 percentage points over U.S. Treasuries. Many governments have been concerned that such a move would temper demand, but investor demand for the Brazilian bond stood at about $6 billion. The new government only sold $1 billion, which was $250 million more originally planned.

In late February, Mexico became the first Latin American country to issue bonds with the collective-action clause. Demand for the 12-year bond, at about twice the interest rate on U.S. Treasuries, outpaced the $1 billion the Mexican government wanted to sell. And last month, Uruguay, as part of a debt swap, offered investors new bonds with the clause. Argentina has said it will do the same in future debt swaps or bond offerings.

These changes, if they are widely adopted, could help prevent the crisis-bailout cycle. The international community has been long seeking innovative ways of preventing a serial economic meltdown in the emerging world. The elegance of Mr. Taylor’s market-based proposal is that it allows governments and bond-holders to voluntarily agree to more flexible terms. After so much economic hardship the world over, it is surely surprising that such a simple idea could avert catastrophic collapse, such as Argentina’s. Collective-action clauses put a greater onus on bond-holders — who have reaped the benefits of risky investments — to face the consequences of their bets. This is a welcome change.

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