A Rule of Law for Sovereign Debt
NEW
YORK – 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.
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.
Joseph E. Stiglitz, a Nobel laureate in economics.
Martin Guzman, a postdoctoral research fellow at the Department of Economics and Finance at Columbia University Business School.
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