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E-MailAnna Gelpern is a Professor at Georgetown University Law Center. This post is based on a recent article by Professor Gelpern, forthcoming in Current History.
A casual observer of recent policy debates might reasonably conclude that sovereign debt crises of the sort that have ravaged Argentina, Greece, Ukraine, and Venezuela would be less frequent and less damaging if only debtors and creditors could tweak a few words in their bond contracts. Contract reform got a boost from successful enforcement litigation against Argentina in the United States. The government’s 2001 default helped make coordinated change in standardized bond terms the consensus alternative to controversial sovereign bankruptcy proposals: it was elegant, pragmatic, and inoffensive by comparison. More than a decade later, enforcement against Argentina hinged on a single clause, blocked payments to cooperating creditors, and netted some holdouts more than ten times their original investment by 2016. The message could not be clearer: change the clause, fix the problem.
Argentina notwithstanding, the logic of public debt policy investing so heavily in private contract design is shaky. First, sovereign debt contracts are hard to enforce. No court can make a sovereign do as it is told, since national borders and sovereign immunity shield its assets and keep its officials out of jail. Argentina’s case dragged on for fifteen years, after all. Why spend scarce policy resources finessing unenforceable boilerplate?
Second, bond contracts are notoriously hard to change. Academic studies and market reports suggest that standardized contracts are “sticky,” slow to assimilate new terms even if they would improve on the status quo. Sovereign bond contracts might be stickier than most, because their role in the financial system generally requires them to be actively traded. Forcing investors to pause and analyze new words can scare off buyers. It took years and several rounds of concerted intervention by world leaders to make so-called Collective Action Clauses (CACs) [1] the norm across foreign sovereign bond markets. Yet their impact may be small or uncertain, depending on the precise wording and other factors. Meanwhile, it will take more than a decade to exorcise the clause that got Argentina into trouble with holdouts from most sovereign bonds.
Third, private contracts are private. Unlike statutes and treaties, contracts are made behind closed doors between debtors and creditors, some of whom happen to be sovereign governments. International officials have no comparative advantage in drafting the terms, and no sure way to enforce compliance. Standardization is incomplete, while disclosure of financial and legal terms is limited and inconsistent. This is a problem both for market integrity and democratic accountability. Decentralization, lack of information, and coordination problems among governments and market participants make contracts an awkward policy vehicle on balance.
Contracts remain popular nonetheless because they can deliver some of the creditor collective action benefits of bankruptcy without arousing the same level of political hostility. For technocrats and politicians, contract reform has become a go-to deliverable that does no apparent harm. Missing from this calculus is the idea that sovereign debt is a complex political institution, which cannot be reduced to creditor coordination or any other contract problem. The biggest risk of putting so much energy into contract reform lies not in contracts per se, but rather in what falls by the wayside.
Pressing policy challenges beyond the four corners of the contract include, among others, public sector creditors—governments, central banks, and sovereign wealth funds—that may be driven by noncommercial motives and have non-contractual means of influencing the debtor. It is not an accident that the biggest holdouts in the Greek and Ukrainian bond restructurings were the European Central Bank (ECB) and Russia, respectively—not predatory hedge funds. The ECB simply swapped its contracts for new ones with identical terms but different serial numbers, while other bondholders had to write off more than half of their claims. Russia also refused to go along with a general restructuring; however, unlike Greece, Ukraine defaulted and Russia sued. The debt dispute became a chip in the broader political-military conflict between the two countries.
Single-minded focus on private contract design also tends to sideline questions of public accountability and debt legitimacy, which have surfaced prominently in Venezuela. The government of President Nicolas Maduro has long failed to meet the basic human needs of the population—people are starving, hospitals are out of medicine—but, until recently, had continued to borrow and to service its bonds. The elected legislature was disbanded, replaced by a captive assembly allied with the government. U.S. sanctions have sought to cut off the regime’s funding options, but have also served as a foil to deflect domestic criticism, divide and repress the opposition. Meanwhile, Russia and China have kept the regime afloat in exchange for cheap oil and strategic assets. Defining a consensus legitimacy standard would be hard, but the current alternative of ad hoc intervention by individual foreign powers looks worse by the day.
Moreover, contract reform can never be a complete response to sovereign debt problems, where the debtors have vast numbers of domestic and foreign constituents who are not parties to the contracts, and have no means of affecting or even knowing their terms. Bankruptcy can bring together diverse stakeholders in a comprehensive process, and allocate losses equitably among them. Yet it is risky to fetishize the idea of bankruptcy in the abstract, since any given statute or treaty under the bankruptcy rubric could be broad or narrow in scope, and could reflect wildly different ideas about legitimacy and distribution. Bankruptcy advocacy in general is especially uninformative in complex and politically fraught cases—or most sovereign debt crises.
Durable reform requires constituents invested in the project. This requires, among other things, making vast improvements in public disclosure of sovereign debt terms and restructuring outcomes, developing coordination mechanisms among the growing number of regional and international safety nets, and elaborating the standards for debt legitimacy and equitable loss sharing that sovereigns can buy into alongside their public and private creditors.
Public debt cannot be left entirely or even mostly to private ordering. It is bigger than any one contract dispute. It has too many core constituents outside the four corners of the contract, including taxpayers, pensioners, government workers, bank depositors, and other governments, to name just a few. This is not a complex or controversial insight, but turning it into tractable policies is technically daunting and politically risky.
Modern sovereign debt history is littered with stalled and abandoned treaties and institutions, from the League of Nations to the United Nations and the IMF. The temptation to tinker with private contracts an alternative is irresistible. It is time to recognize this as a false alternative: even if it makes good sense as a matter of contract design and helps buy time for political compromise, it can never be that compromise, for the simple reason that public debt is irreducibly public.
The complete article is available here.
Endnotes
1CACs let a super-majority of bondholders amend bond terms over the objections of a minority. Depending on the precise formulation, they can eliminate or reduce the number of holdouts in a debt restructuring.(go back)
