50:4 A Skeptic’s Case for Sovereign Bankruptcy

Abstract

I have had the privilege of talking sovereign bankruptcy with David Skeel for the past decade. One of the first articles I ever published was part-concurrence, part-debate with David Skeel and his coauthor, Patrick Bolton, about priority structures for sovereign debt. Although we all favored priorities, we differed on the content of the optimal priority scheme and ways to achieve it. Bolton and Skeel advocated a uniform treaty-based scheme, and I a debtor-chosen contractual one. In retrospect, our areas of agreement were much more important than the daylight between us: rather than join the policy establishment in pursuit of the holdout creditor, we looked to the legal structures for sovereign debt management, and found them wanting. I am grateful for the opportunity to continue the conversation here.

It is fair to say that since those early days, I have been a sovereign bankruptcy skeptic. Summarized harshly, I have said that bankruptcy for sovereigns was either pointless or meaningless, and in either case, would never happen. After leaving the government for teaching, I learned that the last argument—it would never happen—was beside the point. If I wanted to be a policy pragmatist, I should have stayed behind. Our job here is to challenge imaginations until reality catches up.

On the other hand, the pointless–meaningless conundrum requires elaboration. My concern is with sovereign bankruptcy proposals that either solve nonexistent problems or purport to be all things to all people. I have argued elsewhere that the pointlessness problem comes from lifting the institutional features of one or another chapter in the U.S. Bankruptcy Code—designed to overcome real obstacles in the U.S. cultural, political, legal, and market context—and grafting them onto sovereign debt markets, where the obstacles may not exist and the solutions would not help. Countries have debt problems; they do not have the debt restructuring problems of U.S. firms, towns, or individuals.

Meaninglessness comes in response to accusations of pointlessness. Confronted with evidence that holdout lawsuits have not disrupted sovereign restructurings, that sovereign immunity has been a serviceable shield from creditors, and that facilitating creditor coordination has not stopped bailouts, proponents might shift from an institutionally specific version of bankruptcy to one that is all-encompassing. They evoke something like Elizabeth Warren’s capacious vision of bankruptcy as “an attempt to reckon with a debtor’s multiple defaults and to distribute the consequences among a number of different actors” on the basis of “a number of competing—and sometimes conflicting—values in this distribution.”

Warren was ascribing purpose to an existing regime in a particular setting. She could afford to be general and poetic because she was not designing from scratch, but rather fighting for the soul of an operating system. Sovereign bankruptcy advocates do not have this luxury. A credible proposal must diagnose the most pressing sovereign debt problems it would solve, offer tools to solve such problems, and explain how these tools improve on the status quo.

Given my record of skepticism, it might come as a surprise that this Commentary is an attempt not only to support the general idea of statutory sovereign bankruptcy, but also to imagine some of the features it should have. I engage in this thought experiment for two reasons. First, despite my reservations about transplanting bankruptcy for sovereigns, I like and respect many of the people who propose it, and want to try my best to agree with them. Second, recent debt restructuring experience in Europe and Latin America convinced me that the existing system for restructuring sovereign debt is deeply dysfunctional and produces bad law. As before, I do not care whether the outcome of my experiment is called “bankruptcy.” But if it makes me a fellow traveler, I would be honored.

With this goal in mind, my Commentary proceeds as follows. First, I lay out the dominant arguments for sovereign bankruptcy and why I think they miss the mark. Second, I identify what are, in my view, the key problems with the prevailing regime for sovereign debt restructuring. These include the unenforceable-yet-nondischargeable character of sovereign debt, fragmentation of the debt stock and of the debt restructuring process, and the overall lack of transparency and legitimacy in debt restructuring. Until now, sovereign immunity has been just barely good enough to preempt demand for a more elaborate institutional restructuring mechanism. However, recent developments in Argentina and Greece highlight the shortcomings of sovereignty as a restructuring regime. With or without immunity, sovereigns get no fresh start. The lack of legitimacy in sovereign restructuring is especially troublesome when it brings about large-scale redistribution within and across societies, and even across generations. Having identified the problems, I proceed to sketch out core features of an institutional response.

I conclude by adding a federalism overlay to my thought experiment. Fiscal federalism can exacerbate some of the problems with sovereign debt restructuring that I identified earlier. Formally embedding a debt restructuring mechanism in a federal bargain can help mitigate these problems. However, it would also require unprecedented political consensus. I suggest that Europe could achieve such a consensus as part of its broader renegotiation of the federal arrangement.