Mark L. J. Wright

Senior Vice President and Research Director

mark.wright@mpls.frb.org
Google Scholar Profile

Interests:
Sovereign default
International financial crises

Mark L. J. Wright is senior vice president and director of research at the Federal Reserve Bank of Minneapolis. In this role, he oversees key research efforts at the Minneapolis Fed and advises the Bank’s president on monetary policy and related matters. Prior to coming to Minneapolis, Wright was a senior economist and research advisor in the Economic Research Department at the Federal Reserve Bank of Chicago.

Wright has been an associate professor at the University of California, Los Angeles, and an assistant professor at Stanford University. He has been an economist and advisor to the Reserve Bank of Australia and the Federal Reserve Banks of San Francisco and Minneapolis, as well as an instructor at the IMF Institute. He is currently a faculty research fellow of the National Bureau of Economic Research and serves on the editorial boards of the Journal of International Economics, Economics Letters, and the Journal of Monetary Economics.

Wright received a B.A. in economics from the University of Sydney, Australia, and an M.A. and a Ph.D. in economics from the University of Chicago. His research examines the macroeconomics of developing countries, with a specific focus on their tendency to be prone to international financial crises. Much of his recent work has been devoted to sovereign default and the process by which sovereign debts are restructured.

Under-insurance in Human Capital Models with Limited Enforcement

This paper uses a macroeconomic model calibrated to U.S. data to show that limited contract enforcement leads to substantial under-insurance against human capital risk. The model economy is populated by a large number of risk-averse households who can invest in risk-free physical capital and risky human capital. Expected human capital returns are age-dependent and calibrated to match the observed life-cycle profile of median labor income. Households have access to a complete set of credit and insurance contracts, but their ability to use the available financial instruments is limited by the possibility of default (limited contract enforcement). According to the baseline calibration, young households are severely under-insured against human capital (labor income) risk and the welfare losses due to the lack of insurance are substantial. These results are robust to realistic variations in parameter values.

Settlement Games with Rank-Order Payoffs and Applications to Sovereign Debt Restructuring

Consider a sovereign who must obtain agreement with all creditors in order to realize a gain from re-entering world capital markets. A simple game of settlement is developed to reflect strategic interaction between creditors in this environment. Payoffs to creditors depend only on the rank-order in which they settle and the solution concept is Markov-perfect equilibrium. This generates an extremely simple and tractable solution under which delay depends a comparison between the immediate payoff and the average over payoffs going forward. The solution can generate sequences of cascade and delay observed in practice. Comparative dynamics, the effect of increasing the number of creditors and the impact on delay of secondary markets are analyzed. We derive the empirical distribution of delay implied by the model for comparison to the observed distribution of delays in the data. Finally, we derive predictions for the time path of settlements within a given sovereign debt restructuring as a function of the motives for creditors to holdout, and compare these predictions with data on the ongoing negotiations to restructure Argentina’s debts.

Human Capital Risk, Contract Enforcement, and the Macroeconomy

We use microdata to show that young households with children are underinsured against the risk that an adult member of the household dies. This empirical finding can be explained by a macroeconomic model with human capital risk, age-dependent returns to human capital investment, and endogenous borrowing constraints due to limited contract enforcement. When calibrated, the model quantitatively accounts for the observed life-cycle variation in life insurance holdings, financial wealth, earnings, and consumption inequality. The model also predicts that reforms making consumer bankruptcy more costly will substantially increase the volume of both credit and insurance.

The Stock of External Sovereign Debt: Can We Take the Data at ‘Face Value’?

The stock of sovereign debt is typically measured at face value. Defined as the undiscounted sum of future principal repayments, face values are misleading when debts are issued with different contractual forms or maturities. In this paper, we construct alternative measures of the stock of external sovereign debt for 100 developing countries from 1979 through 2006 that correct for differences in contractual form and maturity. We show that our alternative measures: (1) paint a very different quantitative, and in some cases also qualitative, picture of the stock of developing country external sovereign debt; (2) often invert rankings of indebtedness across countries, which historically defined eligibility for debt forgiveness; (3) indicate that the empirical performance of the benchmark quantitative model of sovereign debt deteriorates by roughly 50% once model-consistent measures of debt are used; (4) show how the spread of aggregation clauses in debt contracts that award creditors voting power in proportion to the contractual face value may introduce inefficiencies into the process of restructuring sovereign debts; and (5) illustrate how countries have manipulated their debt issuance to meet fiscal targets written in terms of face values.

Interpreting the Pari Passu Clause in Sovereign Bond Contracts: It is All Hebrew (and Aramaic) to Me

Notions of ‘inter-creditor equity’, ‘equality’ and ‘justice’ in the treatment of creditors in sovereign debt restructuring, and in the resolution of competing claims to property more generally, have existed for millennia. This article briefly summarizes some of this history, drawing examples from bankruptcy cases in the Talmud to sovereign bond contracts over the last two centuries.

GDP-Indexed Bonds: A Tool to Reduce Macroeconomic Risk?

In this paper, we review the case for the introduction of GDP-indexed government securities. After discussing different types of debt indexation, we review the experience of sovereigns with the issuance of indexed debt, including indexation to inflation, commodity prices and real variables like Gross Domestic Product (GDP). We then provide an assessment of the potential gains from the introduction of real GDP indexed debt. Finally, we discuss possible barriers to the more widespread introduction of indexed debts including issues of liquidity of the new instruments, the incentive for governments to misrepresent economic data such as inflation or real GDP, and the political costs associated with state-contingent liabilities.

Comment on “Sovereign Debt Markets in Turbulent Times: Creditor Discrimination and Crowding-Out Effects” by Broner, Erce, Martin and Ventura

Strategic Behavior in Sovereign Debt Restructuring: Impact and Policy Responses

The restructuring of sovereign debt is time consuming. For the period since 1970, the time between an initial default on a debt and the final restructuring of that debt has averaged roughly seven years (Pitchford and Wright 2007). These delays show little sign of abating. Argentina’s default of 2000 remains unresolved at the time of writing, and US courts have recently affirmed the use of pari passu clauses to prevent the servicing of new debts while previously issued debt remains in default and hence limits a country’s ability to borrow again.1 Likewise, although Greece used the domestic legislation to promptly restructure privately held bonds issued under Greek law in 2012, a future restructuring involving offcial creditors and foreign law bondholders appears inevitable.

The Costs of Financial Crises: Resource Misallocation, Productivity, and Welfare in the 2001 Argentine Crisis

Financial crises in emerging market countries appear to be very costly: both output and a host of partial welfare indicators decline dramatically. The magnitude of these costs is puzzling both from an accounting perspective – factor usage does not decline as much as output, resulting in large falls in measured productivity – and from a theoretical perspective. With the aim of resolving this puzzle, we present a framework that allows us to do the following. First, we account for changes in a country’s measured productivity during a financial crisis as the result of changes in the underlying technology of the economy, the efficiency with which resources are allocated across sectors, and the efficiency of the resource allocation within sectors, driven both by reallocation amongst existing plants and by entry and exit. Second, we measure the change in the country’s welfare resulting from changes in productivity, government spending, the terms of trade, and a country’s international investment position. We apply this framework to the Argentine crisis of 2001 using a unique establishment level dataset and we find that more than half of the, roughly, 10 percent decline in measured total factor productivity can be accounted for by deteriorations in the allocation of resources both across and within sectors. We measure the decline in welfare to be of the order of one-quarter of one year’s gross domestic product.

On the Contribution of Game Theory to the Study of Sovereign Debt and Default

This paper reviews the lessons learned from the application of the tools of game theory to the theoretical study of sovereign debt and default. We focus on two main questions. First, we review answers to the most fundamental question in the theory of sovereign debt: given that there is no supranational institution for enforcing the repayment of debts, why do countries ever repay their debts? Second, we review theories of the process by which sovereign debts are restructured with a view to answering the following question: why does the process of sovereign debt restructuring appear so inefficient? The first question raises issues in the design of self-enforcing contracts and on the credibility of threats to punish a country in default. The second question involves applications of the theory of bargaining in environments where the parties to a bargain cannot commit to honour the terms of the bargain or even commit to enter into negotiations in the first place.

Empirical Research on Sovereign Debt and Default

In this article, we review the empirical literature about sovereign debt and default. As we survey the work of economists, historians, and political scientists, we also emphasize parallel developments by theorists and recommend steps to improve the correspondence between theory and data.

Sovereign Debt Restructuring: Problems and Prospects

This Article reviews the history of sovereign debt restructuring operations with private sector creditors with a view toward diagnosing the factors that lead to inferior outcomes. The Article also attempts to forecast potential problems that may arise in sovereign debt restructuring negotiations in the future and reviews possible modifications of existing institutions. The future potential problems range from the role of credit default swaps in discouraging creditor participation in voluntary exchange offers to the potential for manipulation of aggregation clauses. Other potential issues include the possibility of de facto sovereign default on state contingent debts through statistical manipulation, more widespread use of appeals to the notion of odious or illegitimate debts, and the extent to which recent regulatory changes aimed at restricting litigation against sovereigns in default might reduce the incentive for sovereigns to repay their debts in the future.

Holdouts in Sovereign Debt Restructuring: A Theory of Negotiation in a Weak Contractual Environment

Why is it difficult to restructure sovereign debt in a timely manner? In this paper, we present a theory of the sovereign debt-restructuring process in which delay arises as individual creditors hold up a settlement in order to extract greater payments from the sovereign. We then use the theory to analyse recent policy proposals aimed at ensuring equal repayment of creditor claims. Strikingly, we show that such collective action policies may increase delay by encouraging free riding on negotiation costs, even while preventing hold-up and reducing total negotiation costs. A calibrated version of the model can account for observed delays and finds that free riding is quantitatively relevant: whereas in simple low-cost debt-restructuring operations, collective mechanisms will reduce delay by more than 60%, in high-cost complicated restructurings, the adoption of such mechanisms results in a doubling of delay.

The Pari Passu Clause in Sovereign Bond Contracts: Evolution or Intelligent Design?

Restructuring Sovereign Debts with Private Sector Creditors: Theory and Practice

Presents new empirical results on the differences in private sovereign debt-restructuring outcomes across debtor countries in different regions and at different levels of development. Restructuring sovereign debt is very time consuming, and ineffective at preserving the value of private creditors’ claims or reducing the level of indebtedness to private creditors of defaulting countries. Data on 90 defaults and 73 renegotiations between 1989 and 2004 indicate that the time taken to complete a private debt restructuring and the size of creditor losses are greater for low-income countries, in particular in Sub-Saharan Africa, than for middle-income countries. Despite private creditor “haircuts” averaging about 38 percent, poor countries tend to exit from defaults more indebted to private creditors than when they entered. Although recent theory can explain the magnitude of delays observed in the data, it has less to say about which aspects of the debt-restructuring process lead to large increases in indebtedness to private creditors in low-income countries.

Capital Flows and Macroeconomic Performance: Lessons from the Golden Era of International Finance

Sovereign Theft: Theory and Evidence about Sovereign Default and Expropriation

This paper examines two major risks to foreign investors: default on sovereign debt and expropriation of foreign direct investment, which we refer to collectively as “sovereign theft.” Using a series of formal models, we analyze how the incentives to engage in sovereign theft vary with the state of the economy, the risk aversion of political leaders, and the nature of punishments for default and expropriation. We then document patterns of sovereign theft and foreign investment across much of the twentieth century. Our research, based on a new data set, reveals a striking asynchronicity: defaults and expropriations have occurred in alternating, rather than coincident, waves. Our findings shed new light on the possibility of reputation spillovers across issues, and on cooperation and conflict in the international economy.

Solutions Manual for Recursive Methods in Economic Dynamics

Establishment Size Dynamics in the Aggregate Economy

This paper presents a theory of establishment size dynamics based on the accumulation of industry-specific human capital that simultaneously rationalizes the economy- wide facts on establishment growth rates, exit rates, and size distributions. The theory predicts that establishment growth and net exit rates should decline faster with size, and that the establishment size distribution should have thinner tails, in sectors that use specific human capital less intensively. We establish that there is substantial cross-sector heterogeneity in US establishment size dynamics and distributions, which is well explained by relative factor intensities.

Do Countries Default in “Bad Times”?

This paper uses a new dataset to study the relationship between economic output and sovereign default for the period 1820–2004. We find a negative but surprisingly weak relationship between economic output in the borrowing country and default on loans from private foreign creditors. Throughout history, countries have indeed defaulted during bad times (when output was relatively low), but they have also suspended payments when the domestic economy was favorable, and they have maintained debt service in the face of adverse shocks. This constitutes a puzzle for standard theories of international debt, which predict a much tighter negative relationship as default provides partial insurance against declines in output.

Urban Structure and Growth

Most economic activity occurs in cities. This creates a tension between local increasing returns, implied by the existence of cities, and aggregate constant returns, implied by balanced growth. To address this tension, we develop a general equilibrium theory of economic growth in an urban environment. In our theory, variation in the urban structure through the growth, birth, and death of cities is the margin that eliminates local increasing returns to yield constant returns to scale in the aggregate. We show that, consistent with the data, the theory produces a city size distribution that is well approximated by Zipf’s law, but that also displays the observed systematic underrepresentation of both very small and very large cities. Using our model, we show that the dispersion of city sizes is consistent with the dispersion of productivity shocks found in the data.

Private Capital Flows, Capital Controls, and Default Risk

What has been the effect of the shift in emerging market capital flows toward private sector borrowers? Are emerging market capital flows more efficient? If not, can controls on capital flows improve welfare? This paper shows that the answers depend on the form of default risk. When private loans are enforceable, but there is the risk that the government will default on behalf of all residents, private lending is inefficient and capital controls are potentially Pareto-improving. However, when private agents may individually default, capital flow subsidies are potentially Pareto-improving.

On the Gains from International Financial Integration

Are there large unexploited gains from international financial integration? Why do they remain unexploited? This paper shows that when market incompleteness leads foreigners and residents to value firms differently, multiple equilibria arise where domestic residents purchase very inefficient domestic firms.

Coordinating Creditors

New Empirical Results on Default: A Discussion of “A Gravity Model of Sovereign Lending: Trade, Default and Credit”

William T. Thornton on the Economics of Trade Unions: An Early Contribution to Efficient Bargaining Theory

This paper examines the writings of William T. Thornton on the economics of trade unions as exemplified in his treatise, On Labour. In contrast to many recent commentators, the paper takes the title of On Labour seriously by moving beyond discussion of the “exceptional cases” in Chapter 1 Book II to the relatively little studied material on trade union wage determination that comprises the bulk of the volume. The authors argue that Thornton articulated a theory of trade union bargaining that was both sophisticated and well developed. In addition to presenting a careful and well-researched discussion of the aims and methods of contemporary trade unions, he outlined an analytical structure in which successful union wage claims can be viewed as the redistribution of firm revenues from employers to workers. He also emphasised that unions bargains over both wages and employment levels, so that his model may lay claim to being the precursor to modem theories of efficient bargaining.

Insurance in Human Capital Models with Limited Enforcement

This paper develops a tractable human capital model with limited enforceability of contracts. The model economy is populated by a large number of long-lived, risk-averse households with homothetic preferences who can invest in risk-free physical capital and risky human capital. Households have access to a complete set of credit and insurance contracts, but their ability to use the available financial instruments is limited by the possibility of default (limited contract enforcement). We provide a convenient equilibrium characterization that facilitates the computation of recursive equilibria substantially. We use a calibrated version of the model with stochastically aging households divided into nine age groups. Younger households have higher expected human capital returns than older households. According to the baseline calibration, for young households less than half of human capital risk is insured and the welfare losses due to the lack of insurance range from 3 percent of lifetime consumption (age 40) to 7 percent of lifetime consumption (age 23). Realistic variations in the model parameters have non-negligible effects on equilibrium insurance and welfare, but the result that young households are severely underinsured is robust to such variations.

The Direction of Capital Flows

Debt Statistics a la Carte: Alternative Recipes for Measuring Governement Indebtedness

According to Eurostat, the Greek government owed €317 billion in debt at the end of 2014. This is equivalent to more than 177% of gross domestic product (GDP) or 387% of tax revenue, and amounts to almost €30,000 per person. This seems like a very large sum. For comparison, of the other highly indebted European countries that received financial assistance, Portuguese government debt amounted to 130% of GDP, while Irish government debt amounted to 110% of GDP.

How Much Debt Does the U.S. Government Owe?

The U.S. government is often referred to as the world’s biggest debtor. But how much debt does it owe? A visit to the website of the U.S. Department of the Treasury yields a bewildering array of different measures of U.S. federal government debt. Although the gross debt of the U.S. federal government is approaching $18 trillion, the debt that is subject to the debt limit is a few billion dollars smaller, while debt in the hands of the public is less than $13 trillion.

External and Public Debt Crises

The recent debt crises in Europe and the U.S. states feature similar sharp increases in spreads on government debt but also show important differences. In Europe, the crisis occurred at high government indebtedness levels and had spillovers to the private sector. In the United States, state government indebtedness was low, and the crisis had no spillovers to the private sector. We show theoretically and empirically that these different debt experiences result from the interplay between differences in the ability of governments to interfere in private external debt contracts and differences in the flexibility of state fiscal institutions.

Bad Investments and Missed Opportunities? Postwar Capital Flows to Asia and Latin America

Since 1950, the economies of East Asia grew rapidly but received little international capital, while Latin America received considerable international capital even as their economies stagnated. The literature typically explains the failure of capital to flow to high growth regions as resulting from international capital market imperfections. This paper proposes a broader thesis that country-specific distortions, such as domestic labor and capital market distortions, also impact capital flows. We develop a DSGE model of Asia, Latin America, and the Rest of the World that features an open-economy business cycle accounting framework to measure these domestic and international distortions, and to quantify their contributions to international capital flows. We find that domestic distortions have been the predominant drivers of international capital flows, and that the general equilibrium effects of these distortions are very large. International capital market distortions also matter, but less so.

Human Capital Risk, Contract Enforcement, and the Macroeconomy

We use data from the Survey of Consumer Finance and Survey of Income Program Participation to show that young households with children are under-insured against the risk that an adult member of the household dies. We develop a tractable macroeconomic model with human capital risk, age-dependent returns to human capital investment, and endogenous borrowing constraints due to the limited pledgeability of human capital (limited contract enforcement). We show analytically that, consistent with the life insurance data, in equilibrium young households are borrowing constrained and under-insured against human capital risk. A calibrated version of the model can quantitatively account for the life-cycle variation of life-insurance holdings, financial wealth, earnings, and consumption inequality observed in the US data. Our analysis implies that a reform that makes consumer bankruptcy more costly, like the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, leads to a substantial increase in the volume of both credit and insurance.

The Stock of External Sovereign Debt: Can We Take the Data at ‘Face Value’?

The stock of sovereign debt is typically measured at face value. Defined as the undiscounted sum of future principal repayments, face values are misleading when debts are issued with different contractual forms or maturities. In this paper, we construct alternative measures of the stock of external sovereign debt for 100 developing countries from 1979 through 2006 that correct for differences in contractual form and maturity. We show that our alternative measures: (1) paint a very different quantitative, and in some cases also qualitative, picture of the stock of developing country external sovereign debt; (2) often invert rankings of indebtedness across countries, which historically defined eligibility for debt forgiveness; (3) indicate that the empirical performance of the benchmark quantitative model of sovereign debt deteriorates by roughly 50% once model-consistent measures of debt are used; (4) show how the spread of aggregation clauses in debt contracts that award creditors voting power in proportion to the contractual face value may introduce inefficiencies into the process of restructuring sovereign debts; and (5) illustrate how countries have manipulated their debt issuance to meet fiscal targets written in terms of face values.

Interpreting the Pari Passu Clause in Sovereign Bond Contracts: It’s All Hebrew (and Aramaic) to Me

In this comment, we take a helicopter tour of the history of notions of “equality” and “justice” in sovereign debt restructuring in particular, and in the division of property more generally, and show that these concerns have existed for centuries, if not millennia. We argue that the issue at stake in the interpretation of the pari passu clause is not so much the treatment of holders of identical claims—it is now customary to treat them identically—but whether the holders of different claims should be treated differently. We show that exists a customary “principle of differentiation” that allows creditors with claims that differ in specific ways to be treated preferentially. One of these specific differences concerns debts that have been reduced in value during a previous debt restructuring or default, and based on this principle we conclude that the New York court has, if not completely misinterpreted the meaning of the pari passu clause, then at least misapplied it.

Empirical Research on Sovereign Debt and Default

The long history of sovereign debt and the associated enforcement problem have attracted researchers in many fields. In this paper, we survey empirical work by economists, historians, and political scientists. As we review the empirical literature, we emphasize parallel developments in the theory of sovereign debt. One major theme emerges. Although recent research has sought to balance theoretical and empirical considerations, there remains a gap between theories of sovereign debt and the data used to test them. We recommend a number of steps that researchers can take to improve the correspondence between theory and data.

Where Has All the Productivity Gone?

The productivity of an economy is a measure of the efficiency with which that economy uses its resources—such as its labor and investments in capital—to produce valuable goods and services. Productivity is important because growth in the amount of goods and services produced for a given amount of labor and capital is the ultimate determinant of growth in living standards in an economy over time.

Recovery Before Redemption: A Theory of Delays in Sovereign Debt Renegotiations

Negotiations to restructure sovereign debts are protracted, taking on average almost 8 years to complete. In this paper we construct a new database (the most extensive of its kind covering ninety recent sovereign defaults) and use it to document that these negotiations are also ineffective in both repaying creditors and reducing the debt burden countries face. Specifically, we find that creditor losses average roughly 40 per-cent, and that the average debtor exits default more highly indebted than when they entered default. To explain this apparent large 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.