The International Monetary Fund is rethinking bailouts in the wake of the eurozone crisis, with an eye to giving governments near default better options to stabilize their finances.
To date the world's crisis lender has had two choices to help out a country struggling to pay its debts: offer funds to keep it afloat while it adjusts policy, or, if the crisis is too deep, first require its creditors to write off some of the debt.
But the eurozone crisis showed that that was too inflexible, given the difficulty of assessing what is needed to ensure debt "sustainability" -- when a country can continue to service its debt while making necessary governance adjustments and reforms.
Taking the harsher approach of writeoffs to ensure sustainability, the IMF concluded, risks not only the country perhaps unnecessarily losing access for a long time to capital markets, but also contagion, causing further damage to the broader financial system.
That was the case with the bailouts of eurozone countries. The restructuring of Greek debt especially damaged holders of its bonds around the eurozone, including banks, and sparked selloffs of the bonds of other at-risk countries, pushing them toward crisis.
"No matter how orderly a debt restructuring operation is, it will impose costs... (which) may include any spillover effects to other sovereign bonds or asset classes," said the IMF study.
"From the perspective of global financial stability, there is also the risk of contagion."
The IMF study suggests a third way: if the country can still pay its debts but faces the possibility of default because it has lost access to markets, the IMF will push the bondholders to stretch out the payment terms of their bonds, rather than take writeoffs, to help stabilize the government.
The IMF would then provide funds to the government, along with a required program of reforms, aimed at helping it restore access to capital markets more easily.
It could also avoid going through the lengthy process of negotiating a debt restructuring, which allows creditors time to dump their bonds, complicating the broader rescue program.
Such a "reprofiling", rather than a full debt restructuring with writedowns, "will generally be less costly to the debtor and creditors -- and thus to the system overall," it said.
"Relative to a bailout, the financing that will be provided through the reprofiling could allow for more gradual adjustment paths, which would help growth, reduce economic dislocation and facilitate successful program implementation."
The third way still hinges on the challenge of knowing how sustainable or near-unsustainable a country's debt is.
But it would also confront a problem that arose with the Greek bailout, and subsequently, Portugal and Ireland. Then rules were bent to promise the countries financing without first forcing creditors to take a writedown, out of fear of a threat to the entire eurozone.
That use of "systemic exemption" created new problems and drew criticism from IMF members.
The new approach was cautiously welcomed by the IMF executive board. The idea remains a proposal, "neither final nor approved," said IMF Managing Director Christine Lagarde.