Putting the E(lliot) in Sovereign Debt Enforcement...

Until a month or so ago, you could have asked almost any economist or political scientist whether sovereign borrowers worry about legal enforcement, and, by way of answer, you would gotten a technical version of "Huh?" Academics disagree about why sovereigns repay loans, but almost no one thinks they do so to avoid being sued. So although bond investors are technically entitled to sue sovereign borrowers, there is no evidence that these formal legal entitlements actually impact the likelihood of repayment. That's why NML v. Argentina has captured so much attention. Hedge funds like Elliott Associates (and NML Capital, a related fund) are finally at the cusp of creating potent remedies for jilted bond investors.

If this effort succeeds, it will mark a revolution in the sovereign debt markets, one that will give sovereign borrowers reason to fear legal enforcement. And at first glance, one would think investors would welcome such a development. In a private loan, lenders typically want strong legal enforcement rights - the better to ensure they get their money back. Surprisingly, however, this hasn't always been true in the sovereign debt context. In this recent paper, I track how sovereign bonds evolved in response to the momentous changes in the US law of sovereign immunity that happened in the 20th century. Between 1952 and 1976, foreign sovereigns gradually became subject to the jurisdiction of US courts and eventually to coercive methods of judgment enforcement (i.e., asset seizure). Investors had these rights, however, only if the bond contract granted them, and almost no bond contract did. To the contrary, throughout most of the 1970s and 1980s, bonds issued under New York law provided only symbolic enforcement rights - basically, allowing investors to sue the borrower but not to enforce the judgment. What's more, investors didn't seem to be willing to pay more for the new enforcement rights they did receive. Basically, a major doctrinal revolution occurred, but investors didn't seem to notice.

As for NML v. Argentina - well, investors seem to have noticed. Later this week, I'm heading to a conference in Geneva, where a group of lawyers, economists, and political scientists will talk about past debt crises and the lessons they offer for the present one. I expect that NML v. Argentina will capture a fair amount of academic interest. After many years of discounting the relevance of legal enforcement, academics may have to start taking it seriously too.

Comments

[Knute Rife]

Once again the US can't see that what goes around comes around. I'm waiting for the other shoe to drop. The next time the White House and Congress get into a budget stand-off and a bond payment is 60 seconds late, somebody will be going after US assets. Maybe it won't take a late payment. Maybe someone will characterize the stand-off as sufficient uncertainty of performance that "pre-default attachment" is justified. Once you act like a treaty is printed on a sheet of rubber, everyone will start stretching it.