Voluntary choices in concerted deals : mechanics and attributes of the menu approach

When sovereign debt trades at a discount on secondary markets, a market buyback increases the secondary market price. The wealth of private creditors increases because part of the funds used in the repurchase is a transfer payment to them. This transfer of resources can be mitigated by imposing a capital gains tax on the remaining debt. The authors show how this can be achieved by including exit and new money options in a menu of options from which creditors can freely choose. The menu approach imposes an implicit tax on the capital gains on the remaining debt by requiring lenders that do not exit to extend new loans in proportion to the debt they retain. The menu approach does not require that particular choices from the menu be assigned to each lender. Instead, it implements debt reduction through a price system, allowing different creditors to select different portfolios in equilibrium from a common set of options. The authors illustrate some of their results by analyzing the recent Mexican debt agreement. They show how to read through the complex financial acrobatics to estimate the net debt reduction. Funds provided by international financial institutions benefited both Mexico and its creditors. Mexico directly retained 62 percent of these resources and the banks 34 percent.