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Why Sovereign Is the New Black

posted by Anna Gelpern

I am grateful to Adam and the Credit Slips team for indulging this detour.  After years on the exotic fringe of the legal academy sustained by the entrepreneurial spirit of Mitu Gulati, sovereign debt has blown right past the sleepy mainstream into the screaming headines.  Before launching into the substance of today’s crises and controversies, it is worth pausing to ask why.

First, the new celebrity sovereign debt is qualitatively different from the old fringy sort.  Old sovereign debt was about poor and middle income countries.  It surged with petrodollar lending in the 1970s, imploded in 1982, and re-surged in the mid-1990s, when it became Emerging Markets (EM) sovereign debt.  Much theory and jurisprudence ensued, which keyed off the problem of sovereign default:  the debt was apparently unenforceable despite restrictive immunity, yet this did not seem to dissuade lenders from lending and borrowers from paying most of the time.  Law scholars used sovereign debt as a natural experiment in theories about corporate contracts and bankruptcy.  The theory and practice of this “sovereign debt” were worlds apart from “government debt.” The former had an aggregate outstanding stock of a few hundred billion dollars spread among a few dozen countries (J.P. Morgan's EMBI, give or take) and was all about currency mismatch, default and recovery values.  The latter was in the way trillions, risk-free and “information-insensitive.”  You could buy default protection on the former; it made no sense to write protection on the latter.

The latest crisis in the Euro area has helped collapse the distinction between little “them” and big “us”; now everyone is groping along a discomfiting continuum muttering about market confidence.  Emerging Markets analysts are manning mainstream desks, I read about Greece in EM dailies, erstwhile über-skeptic and real-law person Kim Krawiec blogs about it at Faculty Lounge, and the whole thing feels totally self-justified without being useful to corporate theory.

Second, the spate of crisis-driven government interventions in the private sector has reasonably heightened public debt consciousness.  This is not quite the same as U.S. debt apocalypticism that Adam alluded to in his kind introduction (we are still the run-to guys!)  However, it is true that the world’s wealthiest economies are now past the first line of defense:  implicit government liabilities—be it banks or GSEs—are now explicit, if not fully defined.  It is sensible to wonder whether mom and dad can really hold down the fort forever.  And once they stop being infallible, the world starts looking a little less cozy.

Third, people and lawyers are paying more attention to macroeconomics.  This is apparent in the controversies swirling about the Fed, the mainstreaming of macro-prudential regulation, and recent law scholarship that tries to bridge macro and micro regulatory concerns.  Macro-awareness brings welcome nuance to the continuing conversation about bankruptcy and bailouts.  A failure that potentially implicates the fisc and the dollar is quite—though not wholly--different from straight-up firm bankruptcy.  Sovereign debt writers have long borrowed from the corporate literature.  These days it may be instructive to look the other way.


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