Sovereign debt restructuring: Is Brookings promoting the IMF’s hidden reform agenda?

Added 29/Nov/13
By Jürgen Kaiser, from Eurodad's member organisation Erlassjahr

The renowned US American Brooking institution recently published a new paper on sovereign debt restructuring entitled Revisiting Sovereign Bankruptcy. The paper is another remarkable contribution to the boom of reform proposals in this area that was triggered by the Euro crisis and the vulture fund lawsuits against Argentina. Its critique of the status quo is close to those of the IMF, and the proposals made allocate a strong role to the Fund. One is left with the suspicion that Brooking’s authors say what the IMF would want to say but cannot due to political constraints. 
Like ourselves, some observers had feared that the IMF’s welcome self-criticism as it struggled to cope with the Eurozone crisis might lead to another genuine proposal for a sovereign insolvency framework. One which included the IMF as the decision-making body, of course. This might then lead to a revival of the 2001-2003 debate which considered the pros and cons of only one proposal: the less-than-perfect Sovereign Debt Restructuring Mechanism (SDRM) of the IMF. Would a new paper coming out of the Fund suffocate new reform dynamics in exactly that same way?

Fortunately not. In a quite remarkable paper that the IMF published last April, Fund staff acted more cautiously. The paper clearly identified the weaknesses of the existing regime, hinted at essential directions which any reform process would have to take, but refrained from present-ing itself as a key player in any process.

This leaves quite some room for proposals from academics, who have been working on sovereign debt workout for decades, and for UN bodies, such as UNCTAD. NGOs also have some clear ideas about the way sovereign debt crises should be dealt with in the future.

However, on the fringes of the 2013 Annual Meetings of the World Bank and the IMF, a very different kind of elephant found its way into the room. The Brookings Institution, a leading US think tank which is very close to the Democratic Party and the Obama administration, published an extensive paper, entitled Revisiting Sovereign Bankruptcy. The paper has been authored by an 18-strong group of leading academics, the “Committee on International Economic Policy and Reform”. We have already been working with some of the authors bilaterally and continue to do so, for example in the UNCTAD experts group on sovereign debt workout.

What makes the paper a heavyweight is the prominence of its authors, including leading academics from the US as well as from Europe, such as EBRD’s Jeromin Zettelmeyer or the former member of the German governments’ economic council, Beatrice Weder di Mauro of Mainz University. On the US side, there is Mohamed El-Erian, one of the leaders of the world’s biggest investment fund – PIMCO - and Lee Buchheit, who was involved in practically all of the bigger sovereign debt restructurings with private creditors during the last two decades. The paper is also important because of the editor’s proximity to the governing party in the US. Our Jubilee USA colleagues have carried the demand for an orderly and fair sovereign debt workout mechanism into both the White House and the US Treasury several times, and have met with polite but lukewarm responses. Now the same proposal – or at least the essential elements of the proposal – are reaching the President’s ears from an angle to which he’s normally more inclined to listen. 

What is the message?

In its substance the paper links very closely to the IMF’s April paper:

  • Indebted sovereign do not have access to debt restructuring too easily, as has often been suggested in the past. Instead the major problem is the eternal “too little, too late” of debt relief. In the past; debt relief has regularly been delayed and minimised, leading to economic hardship in the indebted countries as well as unnecessary losses to creditors when debt, which was rescheduled in vain, ultimately needed to be written off.
  • Intrinsically related to this point is the tendency towards excessive loan taking by debtors, who are being offered loans at unrealistically favourable conditions – under the presumption that “states cannot go bankrupt”; and if they do, the official sector will stand ready with resources for a bail out. The paper is remarkably clear about the preventative effect of an orderly insolvency framework, which would put the burden of losses onto creditors’ shoulder.
  • On the proactive side the authors present several options for a more efficient sovereign insolvency regime:
    1. Without much enthusiasm the authors discuss the limited potential of improved Collective Action Clauses and Aggregation Clauses in bond contracts. They conclude that both are useful instruments, but do not have much to do with re-solving over-indebtedness. They only cover a certain segment of total external debt, one where it will be very difficult to close all the loopholes, which could benefit vulture funds and other rogue creditors. 
    2. In relation to this, they discuss a few technically interesting proposals including how debtors could be protected against assaults from this category of creditors. Among other inspiring examples, they point to the sterilisation of doubtful historical claims against the Federal Republic of Germany, stemming from pre-war debt. Among the more technical proposals of the paper, the reflections on how to tame vultures like NML capital, is certainly the most interesting part. This includes the amendment of the IMF’s Articles of Agreement (see below). But partial solutions, such as the statutory immunisation of the Brussels based Euroclear via a Belgian law, are worth consideration. 
    3. Then the authors proceed to develop the broad outlines of a global sovereign insolvency framework, which they call the “Debt Adjustment Program.” The DAP implies that disbursements from a specially created IMF facility for insol-vent sovereigns is conditional upon a comprehensive restructuring of existing obligations (while any other financing from the IMF is ruled out before the conclusion of the process). The scheme is made watertight by an enhancement of the IMF’s Articles of Agreement. This legal construct would prevent any creditor from acting on the basis of old non-rescheduled claims before any court in any member country. With very few exceptions, all countries of the world are members of the IMF.
    4. Finally – and this is obviously the most heartfelt issue for the authors – the DAP proposal is developed for the Eurozone. They suggest the creation of a “European Sovereign Debt Restructuring Regime” (ESDRR) under the aus-pice of the ESM. Any financing to any Eurozone member beyond a certain pre-defined debt level, will be conditional upon the implementation of a debt restructuring programme as described above. Losses will be imposed onto creditors to a degree, which is sufficient to bring the debtor country below the Maastricht debt limit of 60% of GDP.
What’s good? What’s bad? What’s missing?

The Brookings paper is a politically very influential move to back the notion triggered by the Euro crisis that there needs to be a renewed rule-of-law-based approach to dealing with sovereign debt crises. 

Particularly with regard to the critique of existing procedures, the paper features a lot of elements which and others have been demanding and proposing in the last two decades – in particular the critique of existing procedures. Eloquent and convincing in sub-stance and language, the paper is a great asset. Putting the creditor’s moral hazard to lend irresponsibly to the centre of the debate - where it belongs - rather focusing on wrong incentives for the debtor, has long since been overdue. The paper’s strong insistence on this is laudable. 

Another welcome element is the comprehensive right of stakeholders “including civil society and NGOs” to be heard in the process. Listening to those who potentially pay the price for futile debt restructuring will certainly enhance the quality and social acceptance of any agreement.

On the negative side, however, practical proposals for a reformed scheme are disappointingly weak. The authors understand quite clearly the need for a statutory insolvency framework for sovereigns, but rather than outlining it, they point to a fairly black box of problems with implementation and lack of political acceptance. These “problems” prevent them from supporting more ambitious proposals. So, for example, it reads on page 29:

Given the plethora of sovereign debt problems presented in chapters 2, 3 and 4, the first and best approach to addressing these problems would presumably be fully fledged international sovereign insolvency–cum–crisis management regime that is capable of dealing with many inefficiencies at once. But such a regime is practically and politically unfeasible.

A less than convincing proposal is to trigger a reform process automatically on the basis of one single indicator - the debt-to-GDP ratio - and then leave the rest to direct or less direct negotiations between the debtor and his creditors. If one discusses the pros and cons of such a trigger, the potential downsides of simply focussing on the breaching of a one dimensional sustainability threshold reveals the usefulness of an independent body between the parties – be it a Sovereign Debt Forum, an arbitration panel or just a mediator.

If you look at the literature list, it is quite irritating that almost every piece of literature that NGOs have used for their own human rights and development-oriented proposals, is missing. One finds neither Kunibert Raffer’s chapter9-proposal that was derived from US insolvency law, nor Paulus/Kargman’s proposal for adding an Insolvency Chamber to the International Court of Justice nor the Sovereign Debt Forum of Gitlin and House from the Canadian CIGI. This does not mean that Brookings authors should necessarily have adopted those proposals, but it is about demonstrating that one has taken note of thinking outside the box, even if it is not endorsed. 

One consequence of ignoring such elaborated proposals is that the Brookings’ authors under-line the importance of a sovereign debt court in general, but then conclude that such a “complex mechanisms” is rife with difficulties and would require significant information and com-mitment capacity”. A review of several proposals that have been considering those “difficulties” in detail, would have allowed the pro-reform stance to be less timid. Or was this perhaps intentional?

As the authors mentioned above, and the members of the authors’ committee, have a lot of professional linkages and/or even friendships, one might suspect that the latter's idea was indeed to promote a hidden agenda, one that puts the IMF in the centre of a reformed sovereign insolvency framework. From the point of view of the IMF this scenario would be perfect. Some of the best brains of the relevant academia do suggest a smart re-launch of the SDRM, i.e. a reformed debt work-out procedure, which builds first and foremost on the Fund’s abilities to define and enforce rules – without fund staff having to expose themselves.