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Do Sovereign Debtors Need a Bankruptcy Law?
By Anna J. Schwartz
Introduction
The idea that there is a "gaping hole" in the architecture of the international financial system that should be filled by a universal bankruptcy tribunal is not credible. For centuries, sovereign debt defaults have been resolved without the benefit of bankruptcy laws. When a financial crisis exposes a sovereign debtor's bankruptcy, it seems wrongheaded to focus on resolving its dishonored obligations rather than expanding efforts on preventing debtors from accumulating excessive obligations.
Implicit in the bankruptcy approach is an assumption that the financial crises that have taken place in emerging markets have been made worse by the difficulties debtor governments have faced when trying to attenuate the commitments they had made to their creditors. But in each of the crises following the Mexican devaluation of 1994, the International Monetary Fund has bailed out creditors, and, to the extent that debt restructuring was involved, that restructuring was not stymied. There has been so much criticism of the moral hazard created by that policy that in the future the IMF may restrain its penchant for bailouts. But even if it does so, its continued sponsorship of a universal bankruptcy law should be questioned. Why would such a law be a higher priority for the IMF than more effective oversight of the economic policies of emerging markets?
The case for setting up an elaborate mechanism for sovereign debt restructuring is weakened to begin with by the IMF's acknowledgment that such an instrument would not be activated often because many countries do not need debt restructuring . Moreover, it is not clear that the absence of a bankruptcy law has produced chaotic conditions in the few countries that have had to settle differences with their creditors. Finally, it is not at all obvious how a sovereign debt bankruptcy law, for which there is no precedent, would work or whose benefit it would serve. If the legislation was intended to serve both debtor nations and their creditors, it is remarkable that the IMF did not consult with representatives of either of the parties to learn their wishes before issuing its proposals.
In this paper, I begin by discussing two recent versions of the proposal for bankruptcy arrangements for sovereign debtors, and the status of the proposal in 2003. I then ask if there is extensive demand for such arrangements from debtor countries, private investors, and disinterested observers and find it lacking. Next, I review the alternatives proposed by various opponents of sovereign bankruptcy legislation, the majority of whom prefer a market solution to bureaucratic management of debt-related problems. I conclude with some observations about the IMF's role in the elusive quest for the development of emerging market countries by means of indebtedness.
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