5/5/20

Session 9: Sovereign Debt

International Economic Law

Spring 2020
Ukri Soirila &Kangle Zhang
Faculty of Law, University of Helsinki

Credit to: Anna Gelpern (Georgetown and PIIE)

Overview
I. Why borrow?
II. Is Sovereign Debt Different?
– Public Liability, Public Asset - Functions
– Enforcement, Immunity, Bankruptcy - Features
III. Sovereign Debt Management
– Who Borrows, Who Lends?
IV. Sovereign Debt Restructuring
– Overhang, Jubilee, Odious Debt
– International Coordination
– Meltdown?
V. Now What? Policy Implications

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I. Why Borrow?
What alternatives? Is government borrowing
different from individual/corporate borrowing?

• “Exigencies” – War, State Succession, Shocks

(economic, natural disasters)
– Explicit and implicit guarantees, “bailouts” -
”assumption of the debts of the particular states by the
union”
• Investment
• Consumption Smoothing
• Refinancing
• Foreign Trade (fx) 3

Overview
I. Why borrow?
II. Is Sovereign Debt Different?
– Public Liability, Public Asset - Functions
– Enforcement, Immunity, Bankruptcy - Features
III. Sovereign Debt Management
– Who Borrows, Who Lends?
IV. Sovereign Debt Restructuring
– Overhang, Jubilee, Odious Debt
– International Coordination
– Meltdown?
V. Now What? Policy Implications

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II. Is Sovereign Debt Different? - Functions

ASSET LIABILITY

It is a well-known fact, that, in countries in which the

national debt is properly funded, and an object of
established confidence, it answers most of the purposes of
money.
…
[Those who sold the debt at a discount] knew that, by the
terms of the contract with themselves, the public were
bound to pay … and that, as citizens of the United States,
they were to bear their proportion of the contribution for
that purpose.
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Alexander Hamilton, First Report on Public Credit, January 9, 1790
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II. Is Sovereign Debt Different? -Functions

Source: Gorton, Metrick, Llewellyn (2012)

• Sovereign Debt is a public liability – a claim

on future citizens
• Sovereign debt is a public asset – store of
value, benchmark, core of domestic and
international financial systems

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II. Is Sovereign Debt Different? - Features

NO NO
ENFORCEMENT BANKRUPTCY

Everyone dealing with a sovereign knows he is dealing with a

creature who can welch if he wants to welch. To trick up a lot of
international stuff as if it were law frankly makes me puke, as
dear old Holmes used to say.

c, Letter to Justice Harlan Fiske Stone (1935)

II. Is Sovereign Debt Different? - Features

• Sovereign debt is hard to enforce (immunity)

• Sovereign debt is forever (no bankruptcy
discharge)

IMPLICATIONS:
• Indirect enforcement, externalities
• Negotiated restructuring, consent
• Contracts matter, but not always literally
• Creditor coordination is a major challenge
• Free-rider problem (delay, “vulture” litigation)
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Overview
I. Why borrow?
II. Is Sovereign Debt Different?
– Public Liability, Public Asset - Functions
– Enforcement, Immunity, Bankruptcy - Features
III. Sovereign Debt Management
– Who Borrows, Who Lends, Who Knows?
IV. Sovereign Debt Restructuring
– Overhang, Jubilee, Odious Debt
– International Coordination
– Meltdown?
V. Now What? Policy Implications

III. Sovereign Debt Management:

Who Borrows?
(Source: BIS Securities Statistics)

Domestic Developed

Domestic Developing

International Developed
and Offshore
International Developing

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III. Sovereign Debt Management:

Who Borrows?
(Source: OECD 2018)

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III. Sovereign Debt Management:

Who Borrows?
(Source: The Financial Times)

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III. Sovereign Debt Management:

Who Lends?
• Foreign, Domestic
• Individuals (“retail”), Institutions,
Governments
• Primary, Secondary Market
– Buy-and-Hold, Speculators

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III. Sovereign Debt Management:

Who Lends (High Income Countries)?
(Source: Arslanalp & Tsuda 2016)

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III. Debt Management Implications:

Doom Loop
(Graphic: Bloomberg)

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III. Who Borrows? Who Lends? Who

Knows?
• Domestic Reporting and Approval
– Debt Management Guidelines
• IMF Debtor Reporting
– Creditor Residence Problem*
• World Bank Debtor Reporting
– Foreign debt, WB borrowers only
• BIS Creditor Reporting
– Banks
– Securities
• Paris Club Creditor Reporting

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III. Debt Mangement: Contracts Matter

NML et al. v. Argentina
U.S. Court of Appeals for the 2d Cir. (Oct. 2012)

[W]e conclude that in pairing the two sentences of

its Pari Passu Clause … manifested an intention to
protect bondholders from more than just formal
subordination. … The second sentence (“[t]he
payment obligations . . . shall at all times rank at
least equally with all its other present and future
unsecured and unsubordinated External
Indebtedness.”) prohibits Argentina, as bond payor,
from paying on other bonds without paying on the
FAA Bonds.
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NML v. Argentina (2011-2016)

Breach: Paying Exchange Bonds

but not NML
Remedy: Global Injunction
(2012)
Result: Default on $29b (2014)
Settlement and return to market
(2016); some holdouts get 1200%
return

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Overview
I. Why borrow?
II. Is Sovereign Debt Different?
– Public Liability, Public Asset - Functions
– Enforcement, Immunity, Bankruptcy - Features
III. Sovereign Debt Management
– Who Borrows, Who Lends?
IV. Sovereign Debt Restructuring
– Overhang, Jubilee, Odious Debt
– International Coordination
– Meltdown?
V. Now What? Policy Implications

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IV. Sovereign Debt Restructuring

• What is Overhang
– Country cannot attract voluntary credit
– Creditors continue to lend to preserve option value
– Debtor has no incentive to “adjust” (all gains go to
the creditor)
– Individual creditors have incentive to free ride
– Fragmented debt stock/cooperation architecture

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IV. Sovereign debt restructuring

Theories of Sovereign Debt Relief 1: Debt Overhang
(“Sustainability”)

This paper examines the tradeoffs facing creditors of a country whose

debt is large enough that the country cannot attract voluntary new
lending. If the country is unable to meet its debt service
requirements out of current income, the creditors have two choices.
They can finance the country, lending at an expected loss in the hope
that the country will eventually be able to repay its debt after all; or
they can forgive, reducing the debt level to one that the country can
repay. … Financing gives the creditors an option value: if the
country turns out to do relatively well, creditors will not have
written down their claims unnecessarily. However, the burden of
debt distorts the country`s incentives, since the benefits of good
performance go largely to creditors rather than itself.
(Paul Krugman 1988, 1989)

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IV. Sovereign Debt Restructuring

Theories of Debt Relief 2: Jubilee
The human race is facing forms of slavery which are new and more
subtle than those of the past; and for too many people freedom
remains a word without meaning. Some nations, especially the
poorer ones, are oppressed by a debt so huge that repayment is
practically impossible. … The abuses of power which result in
some dominating others must stop: such abuses are sinful and
unjust. … There is also a need to create a new culture of international
solidarity and cooperation, where all – particularly the wealthy
nations and the private sector – accept responsibility for an economic
model which serves everyone. ... Extreme poverty is a source of
violence, bitterness and scandal; and to eradicate it is to do the work
of justice and therefore the work of peace.
(Pope John Paul II, Incarnationis Mysterium:
Bill of Indiction of the Great Jubilee of the Year 2000, §12, 1998)

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IV. Sovereign Debt Restructuring

Theories of Debt Relief: Odious Debt

[I]f a despotic power incurs a debt not for the

needs or in the interest of the State, but to
strengthen its despotic regime, to repress its
population that fights against it, etc., this debt is
odious for the population of the State.

Elements: Consent of the People, Benefit for the

People, [Sometimes: Creditor Knowledge]

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IV. Odious Debt?

The validity of the public debt of the United States,
authorized by law, including debts incurred for
payment of pensions and bounties for services in
suppressing insurrection or rebellion, shall not be
questioned. But neither the United States nor any
State shall assume or pay any debt or obligation
incurred in aid of insurrection or rebellion against the
United States, or any claim for the loss or
emancipation of any slave; but all such debts,
obligations and claims shall be held illegal and void.
-U.S. Constitution, XIV Amendment, Sec. 4

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What are the

lessons of
“Hunger Bonds”
so far?

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Odious Debt: Stylized Scenarios

• Poor country, despotic ruler, state succession,
official debt
• Middle-income country, despotic ruler, change of
government, private foreign debt
• Poor country, legitimate government, misguided
spending, mix of public and private foreign debt
• Middle income country, legitimate government,
unsustainable private domestic and foreign debt

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IV. Sovereign Debt Restructuring:

Challenges and Responses
• Contract, Consent-Based Regime
• Collective Action Problems: Free Riding,
“Vulture” Litigation
• Inter-creditor equity

• International Response:
Contract Reform v. Treaty Bankruptcy

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IV. Sovereign Debt Restructuring

Regime: Actors, Rules and Institutions
• Sovereign Debtors
• Official Creditors
– Bilateral
– Multilateral
• IMF
• Private Creditors
– Banks
• Paris Club
– Insurance Cos. • London Club
– Pension, Investment, • Contract v. Bankruptcy
Hedge Funds
– Individuals
• Domestic
• Foreign
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IV. Sovereign Debt Restructuring Regime

circa 2000

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IV. Sovereign Debt Restructuring:

Meltdown?

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IV. Sovereign Debt Restructuring

• Collective Action Clauses (CACs)

• Pari passu clauses: Argentina v. NML Capital

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Overview
I. Why borrow?
II. Is Sovereign Debt Different?
– Public Liability, Public Asset - Functions
– Enforcement, Immunity, Bankruptcy - Features
III. Sovereign Debt Management
– Who Borrows, Who Lends?
IV. Sovereign Debt Restructuring
– Overhang, Jubilee, Odious Debt
– International Coordination
– Meltdown?
V. Now What? Implications

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V. Now What: Policy Implications

Time of dramatic change in sovereign debt
• Changing debtors and creditors
• Changing views of “safe” and “credit” assets
• Direct access to international markets by non-
sovereign, sub-sovereign, quasi-sovereign debtors and
creditors creates contingent liabilities
• Institutions for debt restructuring and information
coordination are at risk
• What role for the G-20? … for the G-7? … China? …
the United States? … private market participants?
• Where is the law?

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