The debt mess in the European periphery (Ireland, Greece, Spain, Cyprus and Italy) has been a reminder of how hard it is to sort out sovereign insolvency. Much damage is done to the international economy when there are no clear rules for sovereign bankruptcy, analogous to domestic bankruptcy procedures.
– Reschedulings have been 'too little, too late'.
– The present system of market-based reschedulings is becoming less potent in overcoming collective action problems (i.e. when individual creditors acting in their own interests reach a collective outcome which is sub-optimal).
– Nevertheless there is no prospect of putting into place a more structured sovereign debt restructuring mechanism.
It's not as if we haven't been through all this before. Following the 1997-98 Asian crisis, the fund's then deputy managing director, Anne Krueger, made a valiant effort to establish an SDRM. But the US, reflecting as usual the views of Wall Street, vetoed this attempt to put in place a 'statutory approach' (where an impartial umpire would oversee an arbitration process). Instead, it was left up to individual creditors to use whatever legal processes they could find (including seizing the bankrupt country's overseas assets) to get a better deal for themselves.
We shouldn't be surprised that the resulting free-for-all among creditors is unsatisfactory. Of course it is not equitable, even among the creditors. But the harmful consequences of sovereign insolvency are much wider than private bankruptcy.
Sovereign insolvency routinely involves the IMF supplying funds to support the country's external position. Often, individual countries also join in the rescue. Europe provides the most recent example, where the majority of the support for the peripheral countries came from other members of the European Union, in part via the European Central Bank.
But this type of co-funding goes back much further. During the Asian crisis, the greater part of the support funds came not from the IMF but from other countries' bilateral contributions. As one of these support countries, Australia attempted to ensure that its money (in this case, $1 billion for Thailand) would be used to keep Thailand afloat rather than being used to repay private creditors who, after all, had taken the conscious risk of lending. Shigemitsu Sugisaki, the IMF chairman of the August 1997 pledging meeting, told us that if we raised this issue of 'bailing in' the private sector creditors, the rescue meeting would fail and he would publicly blame us for its failure.
Well over a decade later, this unsatisfactory state of affairs had still not been resolved when Greece was rescued in May 2010. The official support funds were given without requiring the private sector to share the pain (i.e. without what came to be called Private Sector Involvement – PSI). In fact, it was the availability of this official funding that allowed the restructuring of private debt to be delayed. In the two-year delay before PSI was put in place in 2012, any private-sector holder of bonds that fell due was paid out in full, thus requiring further support funds from the EU and the IMF: 'by the time officials decide to administer haircuts to creditors, the barbershop has cleared out'.
It's clear enough why the private sector financiers are happy to retain the informal resolution processes rather than the SDRM that the fund attempted to introduce in 2005. An ad hoc process gives the tough bargainers among them the opportunity to do better, not only at the expense of weaker creditors but at the expense of taxpayers.
This free-for-all is, however, becoming increasingly unworkable. Some holdout creditors from the Argentina debt reschedulings of 2005 and 2010 have obtained a US judgment which would effectively nullify the deal reached with the overwhelming majority of Argentina's bond creditors. In the process, they even managed to temporarily seize an Argentinian navy sailing ship. They will do extraordinarily well if this blackmail stands up. If this court decision holds, the lesson for future reschedulings is that whatever is agreed with the majority of creditors can be readily subverted by a tiny group of holdout bond holders.
Unsatisfactory though this is, it's hard to see how it will change. Private sector creditors in Ireland, Spain, Greece and probably Italy have benefitted hugely from the existing non-system. They should have lost all or most of their money in 2010, and deservedly so because they treated the bonds issued by these countries as being essentially the same as German bonds. They took the risk and should have borne the consequences.
But the contagion risk was assessed to be too serious for that to be allowed to happen. The fund, which in theory should not have taken part in the Greek rescue in May 2010 because Greece clearly did not meet the requirement of having a sustainable debt profile, got around this problem by rewriting its rules so that the risk of contagion could be used as a justification for lending into an unsustainable debt position. The debt sustainability assessment, done under duress, was too sanguine.
This is unsatisfactory, but the influence of the finance sector lobby in setting these rules means that the fund's latest analysis accepts that there is no prospect for a SDRM. This seems to be a suitable issue for G20 to tackle, where the compelling logic of some form of SDRM might achieve sufficient support to allow a sensible framework to be put in place.
Originally published by The Lowy Institute publication The Interpreter. Reproduced with permission.