Sovereign bankruptcy is hardly a hot topic right now. Its fifteen minutes of fame are long gone.
But it briefly occupied the attention of top policy makers. And some of you may be interested in my take on the politics of sovereign bankruptcy.
I don’t think it is much of a surprise that the IMF’s proposal for a new sovereign bankruptcy regime (the so called SDRM) failed. The difficulty successfully collecting on a lawsuit on a sovereign government provides the governments of countries that cannot pay their debts de facto protection from litigation while they develop their restructuring proposal even without a bankruptcy regime. They lack formal protection from litigation, but litigation still is not much of a threat immediately after default. And multi-instrument exchange offers have proved to be a practical way of restructuring most types of debt. Muddling through using existing institutions for debt restructuring always offered a viable (if somewhat messy) alternative to a new international treaty …
And it was hard to ever envision the US agreeing to allow international law to supersede US contracts and US law without an overwhelming case that US contracts and US law could not be made to work. For the record, the relevant contracts are overwhelmingly governed by the law of New York state, as interpreted by the US courts. To me the surprise was not that the IMF’s proposal for international bankruptcy failed, but rather that the IMF ever was given political space to develop a serious proposal. For that the world really can thank one man – Paul O’Neill.
But O’Neill, as we now know, was not exactly well positioned to bring the rest of the Bush Administration with him. For that matter, he never really seemed to bring the rest of the Treasury with him. Support from a maverick US treasury secretary did not cut it.
That is a big part of the story. It is not, though, the entire story.
The IMF’s proposal ran into a second problem. Supporters of “sovereign bankruptcy” were drawn to different aspects of domestic bankruptcy law, and in practice, wanted very different things. Some liked the aspects of bankruptcy law that provide debtors – particularly municipalities and individuals – with a “fresh start,” a chance to clear away their debts and move on. They believed that the absence of a formal bankruptcy regime for sovereigns tilted the playing field toward creditors. Others liked aspects of bankruptcy law that allow creditors to assume operation control of the assets of a failed firm. They believed the absence of a formal bankruptcy regime (or tighter contracts) titled the playing field against creditors. Some liked the provisions in domestic bankruptcy that allow for “senior” new financing to help support the operation of firms going through a reorganization; they saw such senior private financing as an alternative to IMF financing. And others (like the IMF) like those aspects of bankruptcy law that allowed creditors to take decisions on the debtor’s restructuring proposal by a majority vote.
Supporters of a new sovereign bankruptcy regime never really agreed on what kind of new sovereign bankruptcy regime was needed, or on what precisely a bankruptcy regime should aim to do.
One sign of that absence of consensus: the IMF’s difficulty deciding whether or not its proposal should include provisions providing the debtor with formal protection from litigation after a default, or just provisions allowing super-majority voting. For more on the IMF’s proposal, see Sean Hagan’s article in the Georgetown Journal of International Law. Or this IMF paper.
Finally, of course, the debate over sovereign bankruptcy was never truly separate from the debate over big bailout loans. Some supporters – I think incorrectly – thought sovereign bankruptcy would allow the IMF to get out of the business of lending big sums to troubled countries. And others – also incorrectly in my view — worried that the presence of a sovereign bankruptcy regime lead the IMF to say no to all calls for help, so deserving countries would no longer get a financial lifeline.
I could say more – far more. But this hardly seems the right time or place.