The ‘Bad-Asset Problem’

The bad-asset problem of transition economies had its origin in the system change. Though moral hazard problems were a concern when credible rules and structures had yet to be established, a strong case can be made for a thorough debt cancellation and balance sheet repair in the transition. This chapter reviews different strategies of how to distribute the burden and their impact on investment activity and growth, price stability, the future tax burden, and social security, respectively. It briefly describes how the bad-asset problem has been tackled in Europe, highlighting the role of the banks. Finally, an outlook is given on the recent financial crisis which led to an excessive inter-government lending. This new European ‘bad-asset problem’ calls for shared responsibility in fiscal policy.