Sovereign Debt Through the Lens of Consumer Debt

Sovereign debt has traditionally been contrasted with corporate debt. Unlike corporations, sovereigns are immune from suit and asset seizure. Unlike corporations, sovereigns can't reliable promise a lender that it will have seniority over other lenders. Unlike corporations, sovereigns can't access bankruptcy. These and other distinctions drive much of the policy and academic thinking about sovereign debt.

But perhaps there are also lessons to be learned from consumer lending. This new paper by Susan Block-Lieb at Fordham (abstract below) suggests that consumer debt may be a more helpful analogy, one with important policy implications. In both the sovereign and consumer context, she points out, lending is primarily income- rather than asset-based. In both contexts, restructuring is difficult primarily because income-based lenders cannot easily distinguish borrowers who will not pay from those who cannot pay. And in both contexts, there are substantial and cumulative incentives towards over-borrowing and over-lending.

The shift in metaphor from corporate to consumer debt has payoffs for policy actors. Perhaps the most important is that it suggests there has been too much focus on the problems associated with debt restructuring, and not enough on the regulation of sovereign loans. Sovereign borrowers, of course, can't be regulated directly. But sovereign lenders, unlike consumer lenders, enjoy almost complete freedom from regulation. Consumer lenders operate in a thick regulatory environment--for example, in some cases a consumer lender's failure to conduct a meaningful pre-loan assessment of the borrower's ability to repay may excuse a subsequent default. By highlighting similarities to consumer debt and regulation, the paper highlights new ways to think about reform in the sovereign debt markets. That's welcome insight in a field where reformers have historically done little more than tinker with contract boilerplate.

Full abstract below the jump:

Following the Asian Financial Crisis, sovereign debt defaults prompted calls by the International Monetary Fund (IMF) for a statutory Sovereign Debt Restructuring Mechanism (SDRM). In promoting the SDRM, IMF leaders argued that countries’ sovereign debt problems needed something like U.S. Chapter 11, which is to say that IMF leaders supported the SDRM proposal with reference to legal claims rather than relying on purely economic arguments about the welfare benefits of resolving debt overhang. Framing the debate in this way caught on, but by 2005 the IMF board of directors had rejected the SDRM proposal. The current Global Financial Crisis similarly has resulted in more than several sovereign borrowers’ defaults and has, in turn, renewed calls for revision of the process for restructuring sovereign indebtedness. This time, however, the rhetoric has shifted away from legal metaphor. Rather than comparing sovereign borrowers to corporations in financial distress, sovereign debt has been discussed in terms reminiscent of household debt. Countries should, we are told, practice financial austerity. This paper unpacks the differences among indebtedness owed by public and private, corporate and consumer, borrowers, and the distinct implications for restructuring these different sorts of debt. It argues that modern economic literature on sovereign debt has been chasing the wrong metaphor. The puzzle of sovereign debt shifts when sovereign borrowing is viewed through the lens of consumer (not corporate) borrowing. This shift in metaphor promises more than a new rhetoric.

Comments

[Raymond Bell]

An excellent opinion paper by Susan.

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