NEW YORK – A recent decision by a United States appeals court threatens
to upend global sovereign-debt markets. It may even lead to the US no
longer being viewed as a good place to issue sovereign debt. At the very
least, it renders non-viable all debt restructurings under the standard
debt contracts. In the process, a basic principle of modern capitalism –
that when debtors cannot pay back creditors, a fresh start is needed –
has been overturned.The trouble began a dozen years ago, when Argentina had no choice but to devalue its currency and default on its debt. Under the existing regime, the country had been on a rapid downward spiral of the kind that has now become familiar in Greece and elsewhere in Europe. Unemployment was soaring, and austerity, rather than restoring fiscal balance, simply exacerbated the economic downturn.
Devaluation
and debt restructuring worked. In subsequent years, until the global
financial crisis erupted in 2008, Argentina’s annual GDP growth was 8%
or higher, one of the fastest rates in the world.
Even
former creditors benefited from this rebound. In a highly innovative
move, Argentina exchanged old debt for new debt – at about 30 cents on
the dollar or a little more – plus a GDP-indexed bond. The more
Argentina grew, the more it paid to its former creditors.
Argentina’s
interests and those of its creditors were thus aligned: both wanted
growth. It was the equivalent of a “Chapter 11” restructuring of
American corporate debt, in which debt is swapped for equity, with
bondholders becoming new shareholders.
Debt
restructurings often entail conflicts among different claimants. That
is why, for domestic debt disputes, countries have bankruptcy laws and
courts. But there is no such mechanism to adjudicate international debt
disputes.
Once
upon a time, such contracts were enforced by armed intervention, as
Mexico, Venezuela, Egypt, and a host of other countries learned at great
cost in the nineteenth and early twentieth centuries. After the
Argentine crisis, President George W. Bush’s administration vetoed
proposals to create a mechanism for sovereign-debt restructuring. As a
result, there is not even the pretense of attempting fair and efficient
restructurings.
Poor
countries are typically at a huge disadvantage in bargaining with big
multinational lenders, which are usually backed by powerful home-country
governments. Often, debtor countries are squeezed so hard for payment
that they are bankrupt again after a few years.
Economists
applauded Argentina’s attempt to avoid this outcome through a deep
restructuring accompanied by the GDP-linked bonds. But a few “vulture”
funds – most notoriously the hedge fund Elliott Management, headed by
the billionaire Paul E. Singer – saw Argentina’s travails as an
opportunity to make huge profits at the expense of the Argentine people.
They bought the old bonds at a fraction of their face value, and then
used litigation to try to force Argentina to pay 100 cents on the
dollar.
Americans
have seen how financial firms put their own interests ahead of those of
the country – and the world. The vulture funds have raised greed to a
new level.
Their litigation strategy took advantage of a standard contractual clause (called pari passu)
intended to ensure that all claimants are treated equally. Incredibly,
the US Court of Appeals for the Second Circuit in New York decided
that this meant that if Argentina paid in full what it owed those who
had accepted debt restructuring, it had to pay in full what it owed to
the vultures.
If
this principle prevails, no one would ever accept debt restructuring.
There would never be a fresh start – with all of the unpleasant
consequences that this implies.
In
debt crises, blame tends to fall on the debtors. They borrowed too
much. But the creditors are equally to blame – they lent too much and
imprudently. Indeed, lenders are supposed to be experts on risk
management and assessment, and in that sense, the onus should be on
them. The risk of default or debt restructuring induces creditors to be
more careful in their lending decisions.
The
repercussions of this miscarriage of justice may be felt for a long
time. After all, what developing country with its citizens’ long-term
interests in mind will be prepared to issue bonds through the US
financial system, when America’s courts – as so many other parts of its
political system – seem to allow financial interests to trump the public
interest?
Countries would be well advised not to include pari passu
clauses in future debt contracts, at least without specifying more
fully what is intended. Such contracts should also include
collective-action clauses, which make it impossible for vulture funds to
hold up debt restructuring. When a sufficient proportion of creditors
agree to a restructuring plan (in the case of Argentina, the holders of
more than 90% of the country’s debt did), the others can be forced to go
along.
The
fact that the International Monetary Fund, the US Department of
Justice, and anti-poverty NGOs all joined in opposing the vulture funds
is revealing. But so, too, is the court’s decision, which evidently
assigned little weight to their arguments.
For
those in developing and emerging-market countries who harbor grievances
against the advanced countries, there is now one more reason for
discontent with a brand of globalization that has been managed to serve
rich countries’ interests (especially their financial sectors’
interests).
In
the aftermath of the global financial crisis, the United Nations
Commission of Experts on Reforms of the International Monetary and
Financial System urged that we design an efficient and fair system for
the restructuring of sovereign debt. The US court’s tendentious,
economically dangerous ruling shows why we need such a system now.
Joseph E. Stiglitz, a Nobel laureate in economics and University Professor at Columbia University, was Chairman of President Bill Clinton’s Council of Economic Advisers and served as Senior Vice President and Chief Economist of the World Bank. His most recent book is The Price of Inequality: How Today’s Divided Society Endangers our Future.