A Rule Of Law For Sovereign Debt
Joseph Stiglitz
Governments
sometimes need to restructure their debts. Otherwise, a country’s
economic and political stability may be threatened. But, in the absence
of an international rule of law for resolving sovereign defaults, the
world pays a higher price than it should for such restructurings. The
result is a poorly functioning sovereign-debt market, marked by
unnecessary strife and costly delays in addressing problems when they
arise.
We are reminded of this time and again. In Argentina, the authorities’ battles with a small number of “investors” (so-called vulture funds)
jeopardized an entire debt restructuring agreed to – voluntarily – by
an overwhelming majority of the country’s creditors. In Greece, most of
the “rescue” funds in the temporary “assistance” programs are allocated for payments to existing creditors,
while the country is forced into austerity policies that have
contributed mightily to a 25% decline in GDP and have left its
population worse off. In Ukraine, the potential political ramifications
of sovereign-debt distress are enormous.
Martin Guzman
So
the question of how to manage sovereign-debt restructuring – to reduce
debt to levels that are sustainable – is more pressing than ever. The
current system puts excessive faith in the “virtues” of markets.
Disputes are generally resolved not on the basis of rules that ensure
fair resolution, but by bargaining among unequals, with the rich and
powerful usually imposing their will on others. The resulting outcomes
are generally not only inequitable, but also inefficient.
Those
who claim that the system works well frame cases like Argentina as
exceptions. Most of the time, they claim, the system does a good job.
What they mean, of course, is that weak countries usually knuckle under.
But at what cost to their citizens? How well do the restructurings
work? Has the country been put on a sustainable debt path? Too often,
because the defenders of the status quo do not ask these questions, one
debt crisis is followed by another.
Greece’s
debt restructuring in 2012 is a case in point. The country played
according to the “rules” of financial markets and managed to finalize
the restructuring rapidly; but the agreement was a bad one and did not
help the economy recover. Three years later, Greece is in desperate need
of a new restructuring.
Distressed debtors need a fresh start. Excessive penalties lead to negative-sum
games, in which the debtor cannot recover and creditors do not benefit
from the larger repayment capacity that recovery would entail.
The absence of a rule of law for debt restructuring delays fresh starts and can lead to chaos. That is why no government leaves it to market forces to restructure domestic debts.
All have concluded that “contractual remedies” simply do not suffice.
Instead, they enact bankruptcy laws to provide the ground rules for
creditor-debtor bargaining, thereby promoting efficiency and fairness.
Sovereign-debt
restructurings are even more complicated than domestic bankruptcy,
plagued as they are by problems of multiple jurisdictions, implicit as
well as explicit claimants, and ill-defined assets upon which claimants
can draw. That is why we find the claim by some – including the US Treasury – that there is no need for an international rule of law so incredible.
To be sure, it may not be possible to establish a full international
bankruptcy code; but a consensus could be reached on many issues. For
example, a new framework should include clauses providing for stays of
litigation while the restructuring is being carried out, thus limiting
the scope for disruptive behavior by vulture funds.
It
should also contain provisions for lending into arrears: lenders
willing to provide credit to a country going through a restructuring
would receive priority treatment. Such lenders would thus have an
incentive to provide fresh resources to countries when they need them
the most.
There
should be agreement, too, that no country can sign away its basic
rights. There can be no voluntary renunciation of sovereign immunity,
just as no person can sell himself into slavery. There also should be
limits on the extent to which one democratic government can bind its
successors.
This
is particularly important because of the tendency of financial markets
to induce short-sighted politicians to loosen today’s budget
constraints, or to lend to flagrantly corrupt governments such as the
fallen Yanukovych regime in Ukraine, at the expense of future
generations. Such a constraint would improve the functioning of
sovereign-debt markets by inducing greater due diligence in lending.
A
“soft law” framework containing these features, implemented through an
oversight commission that acted as a mediator and supervisor of the
restructuring process, could resolve some of today’s inefficiencies and
inequities. But, if the framework is to be consensual, its
implementation should not be based at an institution that is too closely
associated with one side of the market or the other.
This
means that regulation of sovereign-debt restructuring cannot be based
at the International Monetary Fund, which is too closely affiliated with
creditors (and is a creditor itself). To minimize the potential for
conflicts of interest, the framework could be implemented by the United
Nations, a more representative institution that is taking the lead on
the matter, or by a new global institution, as already suggested in the
2009 Stiglitz Report on reforming the international monetary and financial system.
The
crisis in Europe is just the latest example of the high costs – for
creditors and debtors alike – entailed by the absence of an
international rule of law for resolving sovereign-debt crises. Such
crises will continue to occur. If globalization is to work for all countries, the rules of sovereign lending must change. The modest reforms we propose are the right place to start.
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