Bankruptcy Protection against Macroeconomic Shocks: the Case for a 'super Chapter 11'

East Asian economies caught in the recent crisis have seen their output contract fiercely despite enormous real exchange rate depreciation. Why are relative prices not maintaining demand and output at pre-crisis levels? We investigate the idea that there are negative supply-side shifts due to balance sheet effects. Specifically, we use the framework of Kiyotaki and Moore (1997) to explore the impact of an unexpected devaluation on highly-leveraged, fully-collaterised firms who have borrowed in foreign currency. A fall in the currency triggers margin calls and a consequent fire-sale of collateral assets: and it can easily cause collapse to a low level equilibrium. Using the same framework, we show how crisis management can, in principle, avert collapse in two ways: by forced debt rollovers in the short run; and ultimately by debt write downs under Chapter 11 bankruptcy procedures. But normal bankruptcy procedures are not designed to handle macro shocks hitting the whole economy : specifically they fail to internalise the price effects of asset ‘fire-sales’ required to satisfy margin calls. We investigate the idea of a “super Chapter 11” where firms can write off debt increases due to devaluations in excess of a given limit; and show how it may avert economic collapse. JEL Classification: E32, G21, G32, G33, and O54