Facing the Debt Challenge of Countries that are Too Big to Fail
The recent financial woes of Greece and other nations are reinvigorating the debate over whether to bail out defaulting countries or, instead, restructure their debt. Bailouts are expensive, in the case of Greece costing potentially hundreds of billions of euros. But a bailout was virtually inevitable because a default on Greek debt was believed to have the potential to bring down the world financial system. This is a growing problem: as finance becomes more intertwined, the potential for a countrys debt default to trigger a larger systemic collapse becomes even more tightly linked. This reveals a phenomenon viewed until recently as limited to banks and other large financial institutionsthe problem of too big to fail. Bailouts are not, however, the only way to prevent defaults. Just as policymakers have been proposing orderly resolution procedures for troubled financial institutions, an orderly resolution procedure for troubled countries can bypass the need for a bailout. This short and accessible paper, written as a chapter for the forthcoming book Sovereign Debt: From Safety to Default (Robert W. Kolb ed., 2010-11), explains how simple such a resolution procedure would be and why, without it, we will all end up subsidizing nations that lack the political will or ability to be fiscally responsible.