debt and bankrupt solutions
Henry C K Liu
This article appeared in AToL
on September 28, 2002
Sovereign debts in local currency usually do not carry any default risk
since the issuing government has the authority to issue money in
domestic currency to repay its domestic debts. The only risk in
excessive domestic sovereign debt comes from inflation. Investors in
domestic-currency government bonds face only an interest rate risk, not
default risk. Thus sovereign debts' default risks are exclusively
linked to foreign-currency debts and their impact on currency exchange
For this reason, any government that takes on foreign debt is
recklessly exposing its economy to unnecessary risk from external
sources. If foreign debt is used to finance exports, a trade deficit
will be deadly. But even the benefit from a trade surplus will first go
to the foreign lenders, and the rest will have to be invested in
foreign assets to defend the exchange rate of the local currency, with
little benefit left for the domestic economy, particularly if global
competition for export markets requires suppression of domestic wages
under a race-to-the-bottom syndrome. That is why all foreign debts will
inevitably become unsustainable and turn into distressed debts that
cannot be cured by the debtor governments.
A movement to tackle distressed sovereign dollar debts, particularly of
the Heavily Indebted Poor Countries (HIPC), through an international
bankruptcy regime has gained momentum in neo-liberal circles in recent
years. A decade after feeble and ineffective attempts to resolve the
Latin American sovereign dollar debt crises that developed in the
1980s, John Williamson of the Institute of International Economics (who
coined the term "Washington consensus") proposed in 1992 an
international legal mechanism for the revision of sovereign debt
contracts "parallel to the Chapter 11 proceedings under the US
After the 1994 Mexican financial crisis, a Bondholders Council was
proposed to negotiate the restructure of dollar government bonds,
together with changes in future bond covenants to permit a majority to
alter terms of repayment to avoid a country default.
Sovereign debt restructuring exercises have now become more complex and
less manageable than in the 1970s and 1980s. The principal sources of
financing then were syndicated loans floated typically as Eurodollar
bonds, managed by a lead manager with the support of a relatively small
group of other creditor banks. Even in the Korean and Brazilian debt
restructuring in the 1990s, the tasks of aggregating loans and arriving
at a common action were relatively simple.
Liberalization of capital markets has led to a proliferation of credit
instruments whose management and control has become a major policy
challenge. Claims held in a variety of jurisdictions, by diverse groups
of creditors and in varying ranges of securities, currencies and
instruments (from sovereign bonds, syndicated loans, mutual funds,
trade finance, distress debts investment and debt derivatives) are
virtually impossible to aggregate and consequently collective action
becomes much more difficult, if not impossible.
In the face of this complexity, an enforceable and credible debt
reorganization needs the sanction of an international treaty. The
essence of the proposed IMF/Krueger Plan claims to be the introduction
of changes in International Monetary Fund Articles of Agreement that
would permit a "super majority" (analogous to the select committee of
creditors under Chapter 11) to take collective action to make the terms
of the agreement binding on the rest of the participants and permit the
sanction of a collective action clause to form an integral part of
future loan agreements, which would expedite the restructuring process,
thereby gaining valuable time for the debtor. Wall Street is reported
to be against the concept of super majority.
Former Harvard (now Columbia) economist Jeffrey Sachs, having landed
Russia in gangster capitalism with his shock-treatment approach to
instant reform, called in 1995 for the provision to transitional
economies the basic protections available to corporate borrowers in the
United States, and proposed an International Bankruptcy Court. While
then US Treasury secretary Robert Rubin was sympathetic, his deputy,
Lawrence Summers, criticized the corporate analogy as potentially
misleading on two grounds: first because "the decision of a state to
suspend its debt service is at least partly volitional", meaning
politically motivated rather than financially based, and second because
"the safeguards against moral hazard built into domestic bankruptcy
codes cannot be applied to sovereign debtors".
The moral hazard problem permeating the system threatens to contaminate
the gains of liberalized capital movements to make dreaded
reintroduction of control of capital flow a rational alternative, as
entertained by defecting Massachusetts Institute of Technology (MIT)
neo-liberal economist Paul Krugman in 1998. US aversion to any
independent international mechanism that would arrive at legally
binding decisions puts it strongly in favor of a voluntary private
contractual approach on any issue, including restructuring sovereign
debts (RSD). The US approach to RSD in HIPCs is in sharp contrast to
its domestic laws concerning bankruptcy-insolvency, which provide
decidedly more enlightened support and protection to corporate and
municipal debtors, a heritage dating back to its debt-ridden colonial
What all these neo-liberal RSD proposals fail to acknowledge is the
fact that a government is not a corporation, former US president Ronald
Reagan's anti-statist rhetorical assertions notwithstanding.
Governments are not instituted merely to make profit for their
power-brokering shareholders at the expense of the general population.
A government belongs to the people, not a few special interest
shareholders. Its job is to safeguard and improve the lives of the
people by maintaining a safe and fair society with sustainable economic
growth. Government cannot be run like a corporation, by externalizing
the social costs of its actions to non-market sectors of the economy
through failed market fundamentalism. Some governments do externalize
such social costs to weaker nations through globalization, a policy
historically known as imperialism.
Getting government off the back of the people and the market is a
euphemism for gangster capitalism, which can thrive on Wall Street as
well as in post-Soviet Russia.
In a market economy, the prime purpose of government credit is to
stimulate employment and economic growth within a context of
enlightened economic nationalism. Thus IMF insistence on fiscal
austerity, increasing unemployment with an aim to service government
foreign debt better, is irrational and self-defeating. Full employment
with a fair and progressive tax structure strengthens sovereign credit
rating through improved tax revenue with which to service sovereign
debt, including foreign debt, even assuming that any government has any
rational basis to incur foreign debt to begin with. Supply-siders
mistakenly fixate on capital investment by focusing on corporate
profits through layoffs and corporate tax reduction, sapping aggregate
demand in the process and landing the global economy in overcapacity as
When Walter Wriston of Citibank asserted three decades ago that
countries do not go bankrupt, he was right on target. What Wriston
failed to anticipate when he catapulted his bank into the largest
international financial institution in the world by recycling
petro-dollars in 1973 was that while countries do not go bankrupt, they
can certainly default on their foreign-currency debts, as history has
The term "bankruptcy" can be traced back to Renaissance Italy, where
private banking flourished by financing international trade and
sovereign ambitions and, over time, evolved into modern financial
institutions. A businessman unable to pay his debts then would have his
trading bench destroyed and his collaterallized inventory foreclosed by
his creditors. "Broken bench", banca rotta in Italian, gave
rise to the word "bankruptcy".
The primary focus of bankruptcy was on recovering the creditors'
exposure, not the welfare of the debtor. In old England, for example,
penalties for bankruptcy could be draconian and ranged from debtors'
prison to the death penalty. To this day, British bankruptcy laws are
much more pro-creditor than those of the United States. Even in the US,
early bankruptcy laws, while relatively pro-debtor as natural in a
debtor nation, were temporary measures taken during bad economic times.
Historically, when economic conditions improved, bankruptcy laws were
repealed. Even now, bankruptcy laws are periodically amended to meet
changing economic conditions and political weather.
Sovereigns do not go bankrupt. Impaired sovereign credit merely makes
the next round of borrowing more costly or unavailable, which may serve
as an effective cure for the neo-liberal financial market
fundamentalist virus of foreign debts to finance exports under
conditions of global overcapacity. RSD proposals are fancy pro-creditor
gimmicks to keep HIPCs from invalidating debts saddled with serious
lender liability issues.
The Bankruptcy Act of 1898 was the first piece of US legislation to
extend protection to corporations from creditors and served as the
foundation of today's Chapter 11 of the bankruptcy code. There have
been many acts and revisions (Bankruptcy Act of 1933 and 1934 during
the Great Depression, Chandler Act of 1938, 1978, the first major
overhaul since the Chandler Act, 1980 Bankruptcy Tax Act, 1984
amendments to the 1978 Act, the 1994 overhaul of the 1978 Act).
From there the bankruptcy regime has evolved under case law, and as of
2002, new legislation is pending in Congress to make it more difficult
for consumers to file a Chapter 7 bankruptcy (complete debt dismissal)
and force them into Chapter 13 (reorganization) repayment plan. Recent
scandals of corporate fraud have given impetus to passage of the new
revised code. Top management of the 25 biggest recent US corporate
bankruptcies walked off with US$3.3 billion from insider share sales,
severance payoffs and other rewards while their shareholders were left
with substantial or total loss.
When creditors suffer a loan loss, it is known in the trade as a
haircut. It is an interesting image when one considers the fact that
even after a person is dead, as bankrupt is financially dead, his or
her hair will continue to grow for some period even in the grave. The
IMF proposals appear to straddle the gray area between a default (ie,
an involuntary haircut resulting in a reduction in net present value of
debt) and a fully cooperative resolution (ie, a negotiated and
voluntary haircut). The view the United States takes on the matter will
determine which approach shall prevail. It is one of the ironies of the
global debt regime that the world's largest debtor nation (the US)
should have the most say about how others outside its borders must
repay their debts on terms much harsher than within its borders.
Bankruptcy in the US today seeks the dual purpose of helping the debtor
as well as the creditor by finding a happy medium where the debtor can
comfortably meet his installment obligation and the creditors can
recoup as much of their principal as possible. The main emphasis is on
rehabilitating the distressed debtor with court protection from
predatory foreclosure by individual creditors, so that creditors
collectively can maximize their recovery through orderly reorganization
of the debtor finances.
In general, a debtor does not need bankruptcy if there are no assets
that creditors with judgments can attach, or the debtor's assets are
exempt by law from seizure. This is generally the case in most HIPC
distressed sovereign debts. Thus the application of a bankruptcy
mechanism to sovereign foreign debt is fundamentally flawed. The worst
that could happen to a sovereign in default would be lack of access to
more foreign debt, a development that in fact would be salutary for
most nations that have since learned from experience the evils of
Chapter 11 allows the corporate debtor to continue core business
activities under court protection while reorganizing it's finances so
that it may continue to pay it's retained employees, reduce immediate
obligations to it's creditors and salvage the salvageable for it's
shareholders. Under this chapter, the debtor retains possession of his
assets and continues operation with DIP (debtor-in-possession)
financing: new loans which are senior to all pre-bankruptcy
obligations, to meet administrative expenses. The order of priming
after DIP financing places secured creditors first, unsecured creditors
next and equity owners last. In other words, if there is not enough
money to pay secured and unsecured creditors, the equity owners
(original shareholders) will be wiped out entirely. Obviously, a nation
with distressed sovereign debt cannot be liquidated and taken from its
people by private foreign lenders. That is why nations do not go
bankrupt. And that is why Chapter 11 bankruptcy proceedings will not
work in sovereign foreign debt resolution.
At the heart of Chapter 11 of the US Bankruptcy Code is an automatic
stay of creditor actions against a debtor and a court-supervised
preparation, confirmation and implementation of a plan of
reorganization. This process is underwritten by the
debtor-in-possession principle under which the debtor keeps control and
possession of its assets.
The logic of developing a reorganization plan is straightforward. Since
the value of an ongoing concern is greater than if its assets were
liquidated in a fire sale, it stands to reason that it is more
efficient to reorganize than to liquidate during financial distress,
since reorganization can preserve jobs and assets. Thus the
international counterpart of the bankruptcy vehicle must also warrant
the development of a reorganization plan that safeguards domestic
development and social objectives and priorities.
In practice, however, the focus of sovereign foreign debt restructuring
has been to sanction officially the protection of foreign creditors,
permitting them to exit non-performing loans at least cost while
leaving the sovereign debtor with drastically scaled-down social and
development goals and programs, usually under an
IMF/creditor-sanctioned program of austere adjustment.
Sovereigns that unwisely assume foreign debt can and often do face
foreign-currency liquidity problems and financial conditions analogous
to insolvency but they cannot be subject to liquidation of assets as
provided for in national bankruptcy laws. Sovereign debt problems
cannot therefore be resolved in the same manner as corporate debt.
Sovereigns cannot have a liquidation value: in case of default on
foreign loans, creditor recovery value would depend on a large number
of intangibles, including the sovereign's capacity to generate future
foreign-exchange earnings and its political/strategic importance to the
official creditor community.
The theory behind Chapter 11 is that an ongoing business is of greater
value than if it is foreclosed on and assets liquidated at its worst
financial phase. After a successful Chapter 11 reorganization, the
business can continue with a restructured debt load and operate more
efficiently than before and in doing so preserve jobs and asset value.
Repayment of debts is made from future profits, proceeds from sale of
some non-core assets, mergers or recapitalization. The shareholders
will end up owning a small company or a company with only negative
asset after debt obligations. Would citizens of HIPC after RSD through
bankruptcy end up owning a smaller nation?
Municipality bankruptcy is handled by Chapter 9 of the US bankruptcy
code. The first municipal bankruptcy legislation was enacted in 1934
during the Great Depression, Public Law No 251, 48 Stat 798 (1934).
Although Congress took care to draft the legislation so as not to
interfere with the sovereign powers of the states as guaranteed by the
Tenth Amendment to the constitution, the Supreme Court held the 1934
Act unconstitutional as an improper interference with the sovereignty
of the states: Ashton v. Cameron County Water Improvement District
(1936). Congress enacted a revised Municipal Bankruptcy Act in 1937,
which was upheld by the Supreme Court in United States v. Bekins
(1938). The law has been amended several times since 1937, most
recently in 1994 (amending section 109(c)) as part of the Bankruptcy
Reform Act of 1994. In the more than 60 years since Congress
established a federal mechanism for the resolution of municipal debts,
there have been fewer than 500 municipal bankruptcy petitions filed.
Although Chapter 9 cases are rare, a filing by a large municipality
can, like the 1994 filing by Orange county, California, involve huge
sums in municipal debt. The December 6, 1994, declaration of bankruptcy
was brought about by $1.7 billion in losses sustained by the 170-member
municipal investment pool managed by Robert L Citron, the former county
Citron, who managed the pool "successfully" for more than two decades,
used a high-risk strategy of investing in derivatives, reverse repos
(repurchase agreements) and leveraging that had generated
extraordinarily high returns until the crash. Responding to the
pressure to keep interest earnings high, Citron, guided by his
investment bankers, speculated on interest rates remaining stable or
decreasing and he sought to maximize his gains by aggressive use of
leverage, borrowing against the assets of the portfolio.
Citron's strategy fell apart when interest rates began to rise and a
substantial pool participant requested a return of its capital and
interest. Within two months, one of the wealthiest local governments in
the United States filed for bankruptcy, primarily to keep pool
participants from draining the fund and thereby worsening the problem.
The bankruptcy disrupted the national municipal bond market, cost local
governments around the United States hundreds of millions of dollars in
higher interest costs, and has spawned widespread retraining for
municipal finance officers and the revision or creation of hundreds of
new municipal investment guidelines and policies. The sudden
evaporation of public wealth forced drastic cuts of social services and
investment all over the country.
Merrill Lynch had a two-decade relationship with Orange county. While
it claimed that it warned Citron many times regarding the dangers of
leverage (Merrill continues to defend the prudence of using derivatives
and reverse repos to this day), it never informed the Board of
Supervisors of its alleged concerns. Nor did Merrill's alleged concerns
deter it from underwriting an additional $600 million bond issue for
the county with all of the questionable practices fully in effect.
The county sued Merrill Lynch for $2 billion for its contribution to
the bankruptcy. In his letter to Judge J Stephen Czuleger requesting
leniency (printed in the Orange County Register, November 19, 1996),
Citron states that he knew nothing about derivatives until Michael
Stamenson and Charles Clough of Merrill Lynch told him that the
instruments could earn pool participants a safe return with higher
yield. If rich and sophisticated Orange county of California could be
misled by Merrill, what chance would HIPCs have?
Public entrepreneurship is a management approach developed by the
reinventing-government movement, part of the decades-long rise of
neo-liberal market fundamentalism. Reinvention is a response to more
than two decades of conservative attacks on the efficacy of government.
The Proposition 13 property-tax revolt in California in the early 1970s
started a relentless public, media-fueled campaign for government to do
more with less. The administrations of Ronald Reagan and Margaret
Thatcher escalated those demands for smaller, cheaper government to the
international level and forced many public officials around the world
to search desperately for a way out of the resultant fiscal crisis they
faced. For many, the answer was simply wholesale privatization of state
monopolies, public utilities and services. For others, it was a time of
giddy receptivity to the promise of speculative manipulation disguised
as creative management innovation.
The proposals for the privatization of social security and the
liberalization on speculative investing of private and public pension
funds were part of this development. Reinvention attempted to provide
risky strategies for improving public management in its time of fiscal
crisis, including a recommendation that managers act entrepreneurially,
taking risks that frequently ended in systemic disaster.
The transformation of traditional bureaucracy into agile, anticipatory,
problem-solving entities is what reinventionists call "entrepreneurial
government". French economist Jean Baptiste Say (1767-1832) developed
the concept of entrepreneurship in the early 19th century as the
shifting of resources out of an area of lower and into an area of
higher productivity and greater yield. Say was unconcerned about
whether higher yield represents greater social good. Nor was he
concerned with the macro effect of the externalized cost of higher
yield. Nor did he emphasize the high risk and failure rate
Accordingly, the entrepreneurial public manager strives to use
resources in new ways to increase efficiency and effectiveness, taking
risks that drastically increase the prospect of failed government.
Instead of regulating the market, government began participating in
speculation in the market, leading to disastrous results.
Many governments in emerging economies, including those of Hong Kong
and Singapore, continue to practice entrepreneurial government, most
visibly with investment policies concerning their foreign exchange
reserves. Hong Kong's Cyberport and the Disneyland project are
potential examples of government entrepreneurship gone wrong.
Also, public and private pension funds managed by professionals
wielding disproportionate market power in effect dilute market
discipline. The deregulated market is no longer driven by millions of
individual investors each making independent decisions based on
self-interest, but by a handful of powerful fund managers who lead and
manipulate the market to gain trading advantages through daily
volatility they engineer.
Reinvention argues that entrepreneurs are not risk-takers, but
opportunity-seekers. They fondly embrace the characterization of a
successful entrepreneur as one who defines risk and then confines it,
pinpoints opportunity and then exploits it. They ignore the natural
odds of thousands of failures for every successful example in
Any organization can be structured to encourage or deter
entrepreneurial behavior, and government organizations have no business
trying to profit from systemic instability it must create in order to
succeed. Yet public administration practitioners have jumped on the
reinvention bandwagon with irrational exuberance.
Bill Clinton and Al Gore campaigned on reinvention in 1992 and 1996.
Former New York mayor Rudolph Giuliani prided himself as a reinvention
mayor. In early 1993, president Clinton gave vice president Gore the
assignment of applying its concepts to the federal government. Many
government leaders around the world, ever so eager for US ideological
approval, were affected by this dubious US trend and promptly pushed
their countries into financial crisis.
The purpose of Chapter 9 of the US Bankruptcy Code is to provide a
financially distressed reinvented municipality protection from its
creditors while it develops and negotiates a plan for adjusting its
debts. Reorganization of the debts of a municipality is typically
accomplished either by extending debt maturities, reducing the
near-term payment of principal or interest, or refinancing the debt by
obtaining a new loan backed by new taxes and budgetary austerity.
Although similar to other chapters in some respects, Chapter 9 is
significantly different in that there is no provision in the law for
liquidation of the assets of the municipality and distribution of the
proceeds to creditors. Such a liquidation or dissolution would
undoubtedly violate the Tenth Amendment to the US constitution and the
reservation to the states of sovereignty over their internal affairs.
Thus Chapter 9 is more applicable to HIPC sovereign debt restructuring,
yet neo-liberals seem to prefer Chapter 11, which could lead to
outright foreign control over the internal political affairs and
economic policies of the debtor nation.
Chapter 9 acknowledges the fundamental importance of enabling local
governments to continue to provide essential services to residents
without interruption or harassment from its creditors. Accordingly, a
central feature of this chapter is that only the debtor can file for
bankruptcy. No involuntary bankruptcy petition from creditors can be
entertained under Chapter 9.
Further protection is provided to the municipalities by forbidding
courts and judges from exercising any influence on the political or
governmental powers of the municipality (since it is accountable to the
electors), or on any of its property or revenues or enjoyment of any of
its income-producing assets. The process is also transparent and
democratic in permitting interested parties such as municipal employees
and their unions a role in a negotiated resolution of the problem.
These protections are not available to HIPC debt resolution in IMF
Before 1970, 90 percent of international transactions were by trade,
and only 10 percent by capital flows. Today, despite a vast increase in
global trade, that ratio has been reversed, with 90 percent of
transactions by financial flows not directly related to trade in goods
and services. Most of these flows take the form of highly volatile
stocks and bonds trades, mergers and acquisition transactions, foreign
direct investment and short-term loans, made incalculably complex and
opaque by the use of structured finance (derivatives).
Exchange-rate regimes, either pegged and floating, in unregulated
global financial markets are the center of the problem. Until recently,
the IMF has championed many pegged regimes as a way to ensure currency
stability, albeit at a cost of independent monetary policy.
Pegged exchange rates have led to financial crises, as in Asia and
Russia in 1997-98, Brazil at the end of 1998, Turkey and Argentina in
2001 and Brazil again in 2002. These were all situations where it was
clear that the fixed exchange rate could not hold, yet the
international banks lent foreign-currency loans with IMF blessing, even
to sustain already collapsing currencies. These foreign-currency loans
led to predictable financial crises, by forcing countries to drain
their foreign-exchange reserves.
A profitable carry trade opportunity presents itself wherever exchange
rates are fixed and interest-rate differentials emerge between two
currencies. Then it is possible to borrow in the low-interest-rate
currency and lend profitably in the high-interest-rate currency with no
risk other than that of a failure in the fixed exchange rate. It is a
profit that is subsidized by the high-interest-rate currency's central
bank. Yet when large numbers of market participants catch on to the
game, the fixed exchange rate cannot hold. When a central bank defends
a fixed exchange rate under these conditions, it is in essence giving
money free to all comers. And the money given away is in the form of
foreign currency that the central bank cannot print.
The British Treasury gave George Soros a windfall speculative profit of
$2 billion in a matter of days in 1992 by trying to defend the
over-valued British pound. Six years later, in 1998, Soros lost $2
billion of his investors' money when Russia defaulted on its sovereign
debt. The Russian default also brought down LTCM, the world's largest
and most profitable hedge fund up to its sudden collapse.
Fixed exchange rates allow all governments to borrow from any bank or
in capital/debt markets anywhere in the world where money is cheapest,
with the full credit backing of their central banks. With this new
competition for funds, international financial markets can force each
nation to get their monetary and fiscal houses in order according to
international standards set by the Group of Seven (G7) if they want to
receive foreign loans with the lowest interest rates.
These interlinked capital/debt markets penalize any nation with budget
deficits or that permits hints of inflation by simply selling off its
currency, robbing it of its sovereign authority to exercise monetary
and fiscal policies in its national interest, for example, providing
government credit to fight unemployment and support national industrial
policy. Domestic development is sacrificed to support neo-liberal
globalization, a process that allows unregulated markets to reduce poor
nations to permanent indentured-servant status.
On April 18, Senators Joseph Biden and Rick Santorum and Congressmen
Chris Smith and John LaFalce introduced companion bills in the House of
Representatives and the Senate called the "Debt Relief Enhancement Act
of 2002", S 2210 and HR 4524. These bills seek to amend the existing
HIPC debt initiative of the IMF and World Bank with more generous
terms, relieving qualified countries from having to pay more than 5
percent of its budget on debt service annually (10 percent if the
country has no health crisis) from the level of over 60 percent in many
countries. This would nearly double current debt relief by cutting an
additional $1 billion in debt service payments.
HIPCs alone are making payments on an estimated debt of more than $220
billion at exorbitant interest rates. When other very low-income
countries such as Nigeria, Bangladesh, Haiti, Peru, and the Philippines
are included, the total is more than $350 billion. The Senate version
of the bill would require that HIPC debt relief not be conditioned on
certain policy measures often associated with "structural adjustment
programs" including user fees on health care and education, the forced
privatization of water, policies that degrade the environment or weaken
labor standards. While this bill is a step in the right direction, it
is merely a drop in the bucket.
Bank of International Settlement (BIS) regulations and the way that
financial market liberalization has been expedited have exposed
vulnerable countries to massive amounts of short-term foreign debt. IMF
intervention, in situations where the panic is just starting, has often
inflamed the panic or exacerbated it rather than calmed it.
In Indonesia, the IMF forced the closure of 16 commercial banks on
November 1, 1997. The absence of deposit insurance set off a banking
panic that set the country on political fire. IMF bailout loans not
only did not prevent capital outflow, such loan often made it possible
for capital to flee safely.
Even in the Mexican bailout, where the US Treasury put in the most
money, it did not stop the panic through a return of so-called
"confidence", which all monetarists talk about though few can identify
what it is. The bailout money merely funded the outflow of previously
trapped short-term capital.
The bailouts - $57 billion for South Korea, $41 billion for Brazil, $22
billion in the July 1998 program for Russia, the Mexican bailout - all
went to finance the immediate outflow of financial capital. The new IMF
$30 billion Brazilian bailout is no different. The money all went
directly to the international creditors while imposing austerity on the
The conventional syndicated loan takes shape in stages. The first stage
is where the borrower issues a mandate letter authorizing a lead bank
to arrange the loan on its behalf. In this role, the lead bank advises
and negotiates with the borrower to establish the terms of the facility
and then provides a term sheet to selected institutions with which it
wishes to share the loan. It will act in ensuring that the borrower
compiles an information memorandum about its financial circumstances
and relays this information to interested syndicate members. These
memoranda are normally based on the forward-looking information
provided by the borrower and are usually subject to disclaimers.
The position of the lead bank in this situation, in negotiating the
terms of the loan agreement with other lenders, is that of an agent
acting for the borrowers. In a syndicated loan, a number of lenders
each agree to contribute a proportion of the loan through a single
agreement. In a structural sense, there will normally be a pool of
lenders (of which the lead manager is one), an agent for the loan, and
inevitably a separate security agent who holds the security. This
security agent will in almost all cases be a subsidiary of the lead
In a participation, one lead bank will agree to take all of the direct
loan at risk and lend the full debt amount. The lead bank will (often
before drawdown but not always) seek participants to share either the
risk or the funding. A participating financial institution will either
take a funding or a non-funding liability. Where a participant is
taking a funding liability it will be required to make advances to the
lead bank matching an agreed proportion of the debt. It is not uncommon
for participants to take a risk-only position, that is, that they will
provide a contractual promise, letter of credit or bank guarantee to
the lead lending bank. Funds are then payable to the debt provider upon
Participation can either be disclosed or undisclosed. Certain lenders
take positions in undisclosed participation. There are a number of
retail banks that, having moved to securitized products, now find that
they have an appetite for use of their capital but not having retained
teams with the required corporate management for syndicated loans. Time
has shown this to be often an unwise decision both for the individual
bank and for the system.
On September 30, 1996, Congress passed and the president signed into
law a new statute, PL 104-208, that definitively establishes the
standards for lender liability under the Superfund law, ie, the
Comprehensive Environmental Response, Compensation, and Liability Act
(CERCLA). One wonders why the IMF does not look to this legislation to
extend lender liability to HIPC debt issues.
Many of these concepts and ideas provided the impetus for discussions
and negotiations on RSD during the 1970s in the United Nations
Conference on Trade and Development (UNCTAD) and at the Conference on
International Economic Cooperation in Paris (1975-76). UNCTAD IV in
1976 provided the basis for decisions leading to the adoption of the
first multilaterally agreed framework for the reorganization of
official debt (Trade and Development Board resolution 222(XXI) of
September 1980). This consensus resolution provides that international
action should be expeditious and timely; enhance the development
prospects of the country bearing in mind its agreed priorities and
internationally agreed objectives; aim at restoring debtor countries'
capacity to service its debt in both short term and long term and
protect the interests of creditors and debtors equitably.
The "Operational Framework" accompanying the resolution establishes a
number of guiding principles for the application of "common features"
for debt reorganization. These include the principle that debt relief
can be initiated only at the discretion of the debtor; and the
recognition that debt problem may "vary from acute balance-of-payments
difficulties requiring immediate action to longer-term situations
relating to structural, financial and transfer of resources problem
requiring appropriate longer-term measures".
Existence of externalities such as, for example, global consequences of
unsustainable exploitation of natural resources to fund debt repayments
or spillover/contagion effects on the international financial system of
sovereign debt crises have been an important contributory factor in
extending the search for solutions to debt problems beyond a particular
sovereign's servicing difficulties.
Growing concern in the creditor community about the long-term viability
of existing ad hoc and voluntary arrangements is perhaps the main
reason for the IMF supporting the creation of independent machinery
endowed with judicial powers to impose solutions on debtors and
creditors alike. New legal strategies by individual creditors now pose
serious threats to voluntary debt-restructuring exercises. By
threatening interruption to the scheduled payments under restructuring
plans, holdouts (as in the recent cases of some of Congo's and Peru's
creditors) can nullify agreed arrangements and succeed in extracting
full payments on its debts.
The present rules of engagement would therefore give the IMF a
prominent role, by virtue of its earlier involvement and claims as a
preferred creditor. The IMF also would assume for itself the role of
analyzing the sustainability of debt, and be the likely lender of last
resort in the standstill phase and during the post-restructuring
period. Although the IMF/Krueger plan formally eschews a role for the
IMF in the setting up of the mechanism (eg in the establishment of
legal structures for debt reorganization), in the decision on
initiating RSD, on whether or not to invoke and sanction a standstill
(including imposing capital controls and a moratorium on debt service
payments) and indeed in the design of a restructuring plan, it will in
practice continue to have a decisive say at virtually all stages of the
The IMF now concedes that temporary controls may be necessary if a
sovereign default threatens capital flight, undermining the country's
ability to return to generalized debt servicing. But the advantages of
controls have to be weighed against the risk that they might broaden a
sovereign debt crisis to potentially solvent private firms. In any
event, IMF insists that controls should be accompanied by policies that
would allow them to be lifted as soon as possible. Countries should not
be encouraged to leave them in place longer than they are needed.
Emerging markets have not performed well in recent years. Investment
flows going through these markets have declined sharply; net private
capital flows dropped from an average of $154 billion per year from
1992 through 1997 to $50 billion per year from 1998 through 2000.
Most sovereign foreign debts are unsustainable and restructuring often
only postpones or exacerbates the problem. Ideally sovereign foreign
debt should not be allowed to exist.
The neo-liberal aim of reforming the sovereign debt restructuring
process is to maintain the incentives of sovereign governments to pay
their debts in full and on time. Those incentives, primarily the
benefit of continued access to foreign capital at market interest
rates, may not be in a country's national interest. Proposals to have
sovereign borrowers and their creditors put a package of new clauses
into their debt contracts amounts to proposals of prenuptial agreements
in marriages between parties of uneven wealth, usually to the
disadvantage of the poorer party. Such clauses represent a
decentralized, market-oriented approach to reform that deepens the root
causes for the needs of reform.
These proposals for reform of the sovereign debt restructuring process
should be exposed as an integral part of a broader strategy toward
emerging markets to keep poor countries permanently chained to the
tyranny of foreign debt and condemn them to the slavery of export to
service such debt.
Foreign debt in the existing international financial architecture is in
essence highway robbery of the poor countries by the rich in the form
of predatory lending. Collective sovereign foreign debt default in a
massive debtor revolt is the only rational solution, and lender
liability action against foreign lenders is the only way out for the
world's indebted poor.
A class-action suit claiming lender liability should be instituted at
the World Court on behalf of the world's poor. Even if a judgment
against the transnational banks is uncollectable, such a judgment will
have value in future debt negotiations. Transnational banks will face
regulatory and licensing problems in debtor jurisdictions with an
unresolved judgment around their necks.
It is time that HIPCs exercised some debtor power. Remember, financial
power under finance capitalism is not a function of how much you own,
but how much you owe.