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.
No Responses to “Sovereign bankruptcy”
amazed no comments here
seems to me
all formal models fail
as much as anuthing
no one has actually dissected
in timeless algebra
the CBer’s game
just as the ” fisc state ”
isn’t either a household or a firm
a CB ISN’T A bank
just how obviously
states acting externally
are not household
or firm like either
and as a side light
who could be surprised
a hyper power
like our uncle
avenues of response
no open air
for these boyz
a dark mews
What was that, a haiku?
A new genre, like it! But needs a title…well the book’s title is presumably “A dark muse will suffice”
Recent developments in crisis resolution have been as quite positive and have undercut the arguments for an SDRM. Market practice has evolved toward bonds which can lead to more efficient crisis resolution. Experience shows that existing market practice need not constitute an insurmountable barrier to innovation and that financial markets are flexible enough to respond to new situations.
The sharp increase in the stock of bonds that includes CACs is very encouraging as is the lack of observable impact on pricing.
Moreover, a number of countries have issued bonds with aggregation clauses. CACs are issue-specific and, in instances where there are a large number of issues outstanding, it is possible that a “holdout class” could undermine a restructuring. By allowing voting across instruments, aggregation clauses are potentially quite beneficial in promoting an orderly debt restructuring. However, the flip-side of the benefits of aggregated voting is a loss of bondholders’ rights, since a bondholder in a specific issue can be affected by the decisions of bondholders in other issues. However, the market seems to have accepted aggregated voting.
The most interesting development is that a number of countries have issued bonds in New York under trust structures rather than fiscal agency structures. Trust structures contain effective majority enforcement provisions, which confer the right to initiate legal proceedings upon the trustee and dictate that any amount recovered by the trustee must be distributed pro rata among the bondholders. While trustee structures are effective, they have not been standard practice in New York. This seems to be changing.
didn’t it take a pretty big official push to get the market to overcome its inertia? and in the first instance, the change was not even very big, and was market tested — since english law bonds were accepted in the dollar market and they had clauses? if i had to point to an instance of market flexibility, i would point to the development of exchange offers as a vehicle for coordination more than the introduction of clauses. clauses took a big official push, and only really took off when a key issuer mexico decided to force the issue — it was a change that could have and should have happened earlier.
am also not sure aggregation = any real loss of creditor rights. most aggregating clauses (a real innovation by the way — no english law precendent) have a provision that allows the holders of an individual bond to override the aggregation with a big enough vote. and if the bond is overly discriminated against, i woudl assume that no holders of the bond would accept the deal, and that overwhelming vote against would override the aggregation. basically, i think of aggregation as lowering the threshhold to amend to say 51% or 67% from say 75% provided 85% (pick you number) of the holders of all bonds in the series vote to accept the deal. but to amend, you still need the support of a majority of the holders of a single bond.