Since the start of its debt crisis in 2010, Greek citizens have suffered through seven years of agonizing austerity to satisfy the conditions of multiple consecutive bailouts from their official sector creditors – the so-called ‘Troika’, composed of the European Commission, the European Central Bank, and the International Monetary Fund (IMF or Fund). And for what? The Greek government has a higher debt-to-GDP ratio today than it did in May 2010, when it received its first bailout program from the Troika.
What went wrong? There are many valid answers to this question, but an important one has to do with the politics of sovereign debt restructuring. As countless experts have argued and the IMF now admits, Greece should have undergone a sizeable debt restructuring at the outset of its crisis. And when the country did restructure its debt in the spring of 2012, it proved ‘too little, too late’ and was complicated by opportunistic ‘holdout creditors’. Moreover, Greece hasn’t been given any significant debt relief since 2012.
All of this speaks to the core problem in managing sovereign debt crises: the lack of an effective global framework or set of institutional arrangements for restructuring government debt obligations when they become unsustainable. This situation was described famously in 2001 as a ‘gaping hole’ in global financial governance by Anne Krueger, then deputy director of the IMF. To fill this gap, Krueger called for the creation of a ‘sovereign debt restructuring mechanism’ (SDRM) – essentially a formal bankruptcy process for sovereigns.
Her proposal was ultimately rejected by US Treasury officials who preferred an alternative solution: a ‘contractual approach’ which called upon debtor governments to insert ‘collective action clauses’ (CACs) into their international bond contracts. In the event of a default, CACs allowed a super-majority of bondholders to amend their contract terms and bind minority holdout creditors to the newly agreed deal. Sceptical at first, debtors and their private creditors eventually embraced CACs starting in 2003.
At the same time, the IMF introduced a new set of lending rules that prohibited it from making large loans to countries whose debts were not clearly sustainable. Tying the IMF’s hands in this way was supposed to encourage countries that were basically insolvent to restructure their debts, especially now that CACs could provide an orderly and predictable process for doing so.
However, the Greek crisis highlighted the weaknesses of these reforms. The IMF’s 2003 lending rules were bulldozed in 2010 to allow lending to Greece without an upfront restructuring. This decision benefited France and Germany (and their banking sectors, which at the time were highly exposed to Greek debt and would therefore suffer large financial losses from a restructuring) but did little to help Greece itself. And when Greece did restructure its debt in 2012, CACs were either absent (in its domestic-law bonds) or ineffective (in its foreign-law bonds) due to design flaws that were exploited by holdout creditors.
Just months later, the debt regime was pushed into further disarray by a controversial New York court ruling in favour of the holdout creditors that refused to participate in Argentina’s 2005 and 2010 restructurings. The judgment threatened to make future restructurings virtually impossible under New York law, to the detriment of debtors, the majority of their creditors, and the system as a whole.
This context generated three new international reform initiatives. To address the controversies generated by the IMF’s 2010 decision to lend to Greece, the IMF’s lending rules were reformed once more in 2016 to make future decisions of that kind more difficult. But the new rules constrain the IMF lending in a less effective manner than the 2003 rules. And the Greek precedent highlighted to all that any rule was likely to be changed when it became inconvenient for powerful states. Taken together, the 2010 and 2016 changes to IMF lending rules have left the institution less likely to encourage debt restructuring than reformers in 2003 had hoped.
A second initiative focused on further strengthening sovereign bond contracts to facilitate smoother and more equitable bond restructurings. The coverage of CACs has been both expanded (to include all Eurozone countries) and improved to bind holdout creditors more effectively. In contrast to the uncertainties associated with IMF lending rules, these reforms promise to improve future debt restructuring in concrete ways.
The third initiative took place within the UN in 2014-15, where the G77 and China called for an ambitious ‘multilateral legal framework for sovereign debt restructuring’ (an idea that harkened back to the SDRM proposal). Ultimately, however, they settled for creating a set of non-binding principles for debt restructuring in 2015. Because of their voluntary content, the new UN principles are unlikely to have much tangible impact on the way sovereign debt restructurings are done.
These three sets of reforms have thus had a mixed impact on the debt restructuring regime compared to the arrangements put in place in the early 2000s. At the same time, they provide some deeper lessons about the politics involved in reforming the sovereign debt restructuring regime.
One lesson is that reforms focused on creating predefined rules to trigger debt restructuring (IMF lending reforms) run up against the interests of powerful states (and their private financial sectors) which prefer to decide on a case-by-case basis when debt restructuring should be triggered (and avoided). By contrast, reforms that seek to improve the process of restructuring once the decision to restructure has been taken (contract reforms) are more likely to succeed because they help facilitate coordination and reduce freeriding among creditors – goals that became particularly important in the wake of the Greek and Argentina episodes.
The UN initiative also reinforced a lesson learned by Krueger and her allies in the early 2000s: efforts to create an SDRM-style multilateral legal framework face enormous political obstacles. Such frameworks raise sensitive sovereignty issues for all states and present particular challenges to the interests of powerful Western states, private creditors, and even the sovereign debtors that are supposed to benefit from them. The post-2008 experience thus provides a stark reminder that the quest to fill the “gaping hole” in global financial governance identified by Krueger remains a very incomplete project.
Featured image credit: Money bank note euro by moerschy. Public domain via Pixabay.