A Step Forward For Sovereign Debt
Jospeh Stiglitz
Every advanced
country has a bankruptcy law, but there is no equivalent framework for
sovereign borrowers. That legal vacuum matters, because, as we now see
in Greece and Puerto Rico, it can suck the life out of economies.
In September, the United Nations took a big step toward filling the void, approving a set of principles for sovereign-debt restructuring.
The nine precepts – namely, a sovereign’s right to initiate a debt
restructuring, sovereign immunity, equitable treatment of creditors,
(super) majority restructuring, transparency, impartiality, legitimacy,
sustainability, and good faith in negotiations – form the rudiments of
an effective international rule of law.
The overwhelming
support for these principles, with 136 UN members voting in favor and
only six against (led by the United States), shows the extent of global
consensus on the need to resolve debt crises in a timely manner. But the
next step – an international treaty establishing a global bankruptcy
regime to which all countries are bound – may prove more difficult.
Martin Guzman
Recent events
underscore the enormous risks posed by the lack of a framework for
sovereign debt restructuring. Puerto Rico’s debt crisis cannot be
resolved. Notably, US courts invalidated the domestic bankruptcy law,
ruling that because the island is, in effect, a US colony, its
government had no authority to enact its own legislation.
In the case of Argentina,
another US court allowed a small minority of so-called vulture funds to
jeopardize a restructuring process to which 92.4% of the country’s
creditors had agreed. Similarly, in Greece,
the absence of an international legal framework was an important reason
why its creditors – the troika of the European Commission, the European
Central Bank, and the International Monetary Fund – could impose
policies that inflicted enormous harm.
But some powerful
actors would stop well short of establishing an international legal
framework. The International Capital Market Association (ICMA),
supported by the IMF and the US Treasury, suggests changing the language of debt contracts.
The cornerstone of such proposals is the implementation of better
collective action clauses (CACs), which would make restructuring
proposals approved by a supermajority of creditors binding on all others.
But while better CACs
certainly would complicate life for vulture funds, they are not a
comprehensive solution. In fact, the focus on fine-tuning debt contracts
leaves many critical issues unresolved, and in some ways bakes in the
current system’s deficiencies – or even makes matters worse.
For example, one
serious question that remains unaddressed by the ICMA proposal is how to
settle conflicts that arise when bonds are issued in different
jurisdictions with different legal frameworks. Contract law might work
well when there is only one class of bondholders; but when it comes to
bonds issued in different jurisdictions and currencies, the ICMA
proposal fails to solve the difficult “aggregation” problem (how does
one weight the votes of different claimants?).
Moreover, the ICMA’s
proposal promotes collusive behavior among the major financial centers:
The only creditors whose votes would count for the activation of CACs
would be those who owned bonds issued under a restricted set of
jurisdictions. And it does nothing to address the severe inequity
between formal creditors and implicit ones (namely, the pensioners and
workers to whom sovereign debtors also have obligations) who would have no say in a restructuring proposal.
All six countries
that voted against the UN resolution (the US, Canada, Germany, Israel,
Japan, and the United Kingdom) have domestic bankruptcy legislation,
because they recognize that CACs are not enough. Yet all refuse to
accept that the rationale for a domestic rule of law – including
provisions to protect weak borrowers from powerful and abusive creditors
– applies at the international level as well. Perhaps that is because
all are leading creditor countries, with no desire to embrace
restrictions on their powers.
Respect for the nine
principles approved by the UN is precisely what’s been missing in recent
decades. The 2012 Greek debt restructuring, for example, did not
restore sustainability, as the desperate need for a new
restructuring only three years later demonstrated. And it has become
almost the norm to violate the principles of sovereign immunity and equitable treatment of creditors, evidenced so clearly in the New York court’s decision on Argentine debt. The market for credit default swaps has led to non-transparent processes of debt restructuring that create no incentive for parties to bargain in good faith.
The irony is that
countries like the US object to an international legal framework because
it interferes with their national sovereignty. Yet the most important
principle to which the international community has given its assent is
respect for sovereign immunity: There are limits beyond which markets – and governments – cannot go.
Incumbent governments
may be tempted to exchange sovereign immunity for better financing
conditions in the short run, at the expense of larger costs that will be
paid by their successors. No government should have the right to give
up sovereign immunity, just as no person can sell himself into slavery.
Debt restructuring is
not a zero-sum game. The frameworks that govern it determine not just
how the pie is divided among formal creditors and between formal and
informal claimants, but also the size of the pie. Domestic bankruptcy
frameworks evolved because punishing insolvent debtors with prison was
counterproductive – a prisoner cannot repay his debts. Likewise, kicking
debtor countries when they’re down only makes their problems worse:
Countries in economic free-fall can’t repay their debts, either.
A system that
actually resolves sovereign-debt crises must be based on principles that
maximize the size of the pie and ensure that it is distributed fairly.
We now have the international community’s commitment to the principles;
we just have to build the system.
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