Buckley by pengtt


									The Desperate Need for a Global Sovereign Bankruptcy Regime: Potential and Predictions

by Ross P Buckley*

An effective bankruptcy regime brings many benefits to an economy, including equity and systemic stability. This paper considers the various benefits our system of bankruptcy brings to Australia’s economy and the reasons those benefits are needed even more at the international level. In particular, it is argued, without a bankruptcy regime for sovereign nations, our international financial system will remain crisis-prone and our world less safe and secure than it could be. The current proposals for a global sovereign bankruptcy system advanced by the IMF and US Treasury are analysed and a more ambitious proposal canvassed. The paper concludes by exploring why this issue is one of critical importance to Australia’s security and regional interests.

At the recent Commonwealth Games in Manchester, if Ian Thorpe had been a country his medal tally of six gold and one silver would have placed him tenth, after Scotland and immediately ahead of Nigeria.1 One expects his net worth may already exceed that of Nigeria, and it may only take a few more years of competition before he is richer than Scotland. Now if by some extraordinary turn of fate Ian Thorpe loses all his money, he can be made bankrupt. Scotland and Nigeria cannot. With respect to Scotland you might say this doesn‟t matter, and you‟d be right, for the prospect of bankruptcy for Scotland is so remote. But the inability of Nigeria or, potentially, Indonesia to be made bankrupt does matter – desperately.

Professor and Executive Director, Tim Fischer Centre for Global Trade and Finance, Bond University, Australia. My thanks to my able research assistant, James Walsh, for his assistance with the references.

See “Final Medals Tally”, The Sydney Morning Herald, August 6, 2002, 33.

This paper explores why this is so, and what can be done about it. I am not here to talk to you about what you do on a day-to-day basis. This address is a big-picture thought piece. In the course of today‟s speech, though, we will discover that

bankruptcy practitioners are critically important people; and that bankruptcy is a critical component of any financial system. When you are asked at parties or over cocktails what you do -- and you reply you are an insolvency practitioner – what is the usual response? Do people typically say, “That must be fascinating. Please tell me more.” Or perhaps, “I‟ve always wished I could do something as important and meaningful as that”. I am guessing the announcement of our profession often elicits less interest or open admiration than if you were to say you were a heart surgeon or a cancer researcher. It shouldn‟t you know. The absence of a bankruptcy regime globally has killed more people than all the surgeons in this country put together have ever saved. Indeed, on one view, the absence of a sovereign bankruptcy regime has killed far more people than Hitler and Pol Pot and Milosevic combined. A big statement. I best justify it. To do so, let‟s go back to 1974. Bob Dylan had just recorded Knockin‟ on Heaven‟s Door, for those of you old enough to remember. OPEC had just discovered the delights of being a cartel. And the price of oil had quadrupled, almost overnight. Banks accelerated their lending to developing countries to „smooth out the oil price shock‟, i.e. to allow developing countries to keep buying oil without having to tighten their belts and depress economic growth. The OPEC nations deposited their oil receipts in the banks. And the developed nations had a choice of two options to afford the oil – they could earn more or spend less. Spending less is rarely an attractive option. They chose to earn more, or, in the national context, export more. To do so they needed importing nations with the money to buy from them. This they ensured by encouraging their banks to lend more to developing countries in a process Philip Wellons of Harvard termed, “passing the buck”.2




It was a neat trick. All other things being equal, the oil price rise would have plunged Europe and North America into recession. Just as a massive increase in interest rates is guaranteed to plunge Australia into a recession – just ask Paul Keating. But all other things were not equal -- the governments of Britain, France, Germany and the US formulated this plan to increase their exports and avoid a recession by encouraging lending to their principal markets. The developed nations enjoyed strong economic growth. The OPEC nations enjoyed ever-increasing credits with the world‟s major banks; and the developing nations „enjoyed‟ ever-increasing debits with the world‟s major banks. It couldn‟t last. The Chairman of Chase Manhattan Bank, David Rockefeller, said so, on the front page of the Wall Street Journal, in June 1974.3 However, Walter Wriston, Chairman of Citibank,4 and the most charismatic banker of his time, had made his famous pronouncement that was to influence more lending decisions than any careful analysis by a credit committee, “Countries never go bankrupt”.5 Wriston was legally quite correct and substantively spectacularly wrong. Countries cannot legally become bankrupt without a body of rules under which they may be declared to be so. But throughout history countries have become substantively bankrupt, typically with horrendous consequences for the living standards and human rights of their more vulnerable citizens. But Wriston‟s approach was far more profitable, at least in the short to medium term, than Rockefeller‟s, and so the capital kept flowing south, for another eight long years, until August 1982, when the Treasurer of Mexico flew to Washington DC to say his country could no longer service its debts.

Rockefeller was quoted as saying, “Channelling massive flows of oil dollars from dollarrich to dollar-poor countries once seemed easily manageable. But now it looks more troublesome ... My own view ... is that the process of recycling through the banking system may already be close to the end for some countries, and in general it is doubtful this technique can bridge the [payments] gap for more than a year or at the most 18 months.” See C. Stabler, Mideast Oil Money Proves Burdensome, THE WALL STREET JOURNAL, June 6, 1974, at 1 & 29. Of course, other bankers were of a different view.

And who, incidentally, was quoted as disagreeing with Rockefeller, in the same article, saying, “The Great Crisis ... ain‟t going to happen”. And Wriston enjoyed a higher reputation in the market than Rockefeller!

As cited in Buckley, Emerging Markets Debt¸ at 14.


Mexico‟s insolvency triggered a cessation of capital flows to all of Latin America and Africa that plunged the two continents into crisis. And this debt crisis, as managed under the structural adjustment programs the IMF imposed on the debtor nations, exacted a horrifying human toll.6 According to figures compiled by UNICEF, over 500,000 children up to the age of five years were dying each year in sub-Saharan African in the late 1980s directly due to the effects of the debt crisis and its management. A medium-term or partial solution to the debt crisis was crafted in the early-to-mid 1990s for much of Latin America under the Brady Plan, but the debt crisis has never really been resolved for much of sub-Saharan Africa. Accordingly, one can extrapolate the mortality identified by UNICEF over many years in that blighted part of the world. By extending it to older children, and adults, and also to the poorest regions in Latin America, it is easy to see why Hitler‟s appalling death toll of perhaps 5 million people in the Holocaust could begin to pale by comparison. An effective sovereign bankruptcy regime could have avoided a goodly amount of this appalling human suffering. And thus my statement that global insolvency practitioners could have saved more people than all the surgeons in Australia combined -- if we had ever had an international sovereign bankruptcy regime.

Why Bankruptcy? So why am I advocating a workable, effective system of bankruptcy at the global level for nations? What benefits does a bankruptcy regime bring? This will be answered at the national and global levels. At the national level, the principal benefits of a bankruptcy system are generally enunciated in broad terms as being twofold: to divide the assets of an insolvent debtor fairly and rateably between its creditors, and to allow an insolvent debtor the


Between 1981 and 1986 real GDP per capita fell 10% in Mexico, 16% in Argentina and 27% in Bolivia: James, Deep Red – The International Debt Crisis and Its Historical Precedents, THE AMERICAN SCHOLAR 331, 340 (1987).


opportunity to make a fresh start free from the burden of accumulated debt (provided the debtor has not engaged in dishonest or otherwise improper financial conduct).7 The most thorough Australian analysis of the principles that should underpin and guide a modern insolvency law was conducted by the Australian Law Reform Commission in the General Insolvency Inquiry of 1988 (the “Harmer Report”).8 The report identified the following nine principles for any insolvency regime (corporate or personal).9  The fundamental purpose of an insolvency law is to provide a fair and orderly process for dealing with the financial affairs of insolvent individuals and companies.  The regime should provide mechanisms that enable both debtor and creditor to participate with the least possible delay and expense.   Insolvency administration should be impartial, efficient and expeditious. The law should provide a convenient means of collecting or recovering property that should properly be applied toward payment of the debts and liabilities of insolvent persons.   There should be equality among creditors. The end result of insolvency, particularly as it affects individuals, should be relief from the financial liabilities and obligations.  Insolvency law should, so far as is convenient and practical, support the commercial and economic processes of the community.

This is how the purposes of bankruptcy law are expressed in the leading Australian text, Lewis Australian Bankruptcy Law, (Dennis Rose QC (ed.), The Law Book Company Limited, 1994) at 1. Oddly enough, purposes often receive scant attention: the classic Australian text on liquidation, McPherson The Law of Company Liquidiation (J O‟Donovan, The Law Book Company Limited) is utterly silent as to the purposes of liquidation.

The Law Reform Commission, General Insolvency Inquiry, ALRC 45, Canberra: AGPS, 1988. See also RM Goode, Principles of Corporate Insolvency Law, 1990, London, Sweet & Maxwell, p 3.

The list is mostly in the words of the Harmer Report (Vol 1 at 15-17) but in some places I have paraphrased the language.


 

Insolvency law should harmonise with general law. Cross-frontier insolvencies should be facilitated.

The Fairness Aspects of Bankruptcy The great majority of the principles of insolvency regimes identified in the Harmer Report relate to fairness and efficiency. Insolvency needs to be a fair and orderly process, impartially and efficiently administered, available to creditors and debtor without delay, that treats creditors equally and allows relief and a fresh start for individuals from unsustainable debts. In addition, an insolvency regime should mesh well with the general law and foreign laws for cross-border insolvencies. Finally, it should support the commercial and economic processes of the community. What is missing from that list is any notion, except very obliquely in the final factor mentioned in the summary above, that an insolvency regime should improve dramatically the allocation of credit within an economy. This I have termed the „systemic‟ aspect of bankruptcy – for without a bankruptcy regime, any economy will as a system be unstable.

The Systemic Aspect of Bankruptcy What I have termed the fairness aspects of bankruptcy are important. Internationally, they are most important, as their absence has cost millions of lives. However, notwithstanding this appalling mortality, I will argue that the systemic advantages of having a bankruptcy system are as important at the international level. Another bold statement, best justified. The reason I think the systemic advantages of a global bankruptcy regime at least equals the fairness ones is that a global regime would so sharpen the focus of creditors that financial crises would be less frequent and less severe. I commenced this paper with the potted history of the debt crisis of the 1980s to make two points:


1. The creditors were prepared to keep extending credit, long past the point at which repayment was commercially feasible, because the absence of a bankruptcy mechanism meant they expected to be repaid by the debtor nations increasing taxes and reducing social services to their people. 2. The creditor nation governments encouraged this excessive extension of credit because it served their short-term interest in avoiding a recession; as a recession is rarely the best basis upon which to seek re-election. In the working out of a resolution to that crisis, the international banks engineered the socialisation of irrecoverable debts owed by private sector borrowers and the IMF acquiesced in, and at times directed, the process. After the debt crisis broke in 1982, the international banks required that all loans, corporate and sovereign, be brought under the sovereign guarantee as a way of facilitating rescheduling negotiations. This it did. It also improved the security of the banks, dramatically. The largest banks benefited the most from this strategem, as they held the highest proportion of loans to the less creditworthy private sector. Unsurprisingly, these were the banks in charge of the rescheduling negotiations.10 In East Asia in 1997 the great majority of the debt was to the private sector. But this did not stop the taxpayer from eventually bearing it. The IMF-led bailouts, invariably described as bailouts of Indonesia or Thailand or Korea, were, in fact, long-term loans to these countries that had to be used to repay the short-term creditors. These loans thus became debts of the nation and the bail-outs were of the creditors, not the debtor nations at all.11 The existence of an effective global sovereign bankruptcy regime in the 1970s would have led to far less capital flowing south. The real prospect of massive loan losses would have sharpened banker‟s minds. When a David Rockefeller said these loans unsustainable, bankers would have listened, for if he was right they were set to lose billions.


Buckley, Emerging Markets Debt: An Analysis of the Secondary Market (London: Kluwer Law International, 1999) at 43.

CW Calomiris & AH Meltzer, “Fixing the IMF”, 56 The National Interest, Summer 1999,



We take this simple, systemic effect of bankruptcy for granted in domestic systems. If an Australian bank makes a poor credit decision and lends to a borrower who subsequently becomes insolvent, absent security, the money will be lost. The bank has no right to garnish the borrower‟s wages for the rest of their life to recover the funds. Imagine for a moment if wages could be garnished for life. Would that affect credit decisions? There would still be the equity and social responsibility arguments against advancing credit to those who cannot afford it. Would these arguments be enough to curtail lending? Or does nothing focus a banker‟s mind like the prospect of losing money? You can make your own decision. But Adam Smith is lauded above all else for his discovery of the Invisible Hand – the mechanism by which in a capitalist system if each person chooses to do that which most rewards them, that process will allocate resources effectively and maximise the welfare of all – and on this issue I am firmly in the camp of that famous Scottish moral theologian! I would fear for our economy, as a system, if there was no relief, except repayment, from debts and that debtors could be forced to spend a lifetime repaying loans, or be imprisoned for their failure to do so. Yet globally this is the system we have. When nations have unsustainable debts, they typically must repay them, as there is no alternative, save a highly destabilising default which will deny the nation access to commercial capital for at least a decade. The debts are serviced through higher taxes and lower social services in countries that are already poor -- countries in which lower social services translate into malnutrition, inadequate housing, unsafe water supplies, etc. The debts of effectively bankrupt nations are repaid at the expense of the most basic human rights of their own citizens. We still have something very like debtors‟ prisons for highly indebted nations. Argentina and Brazil and other Latin American countries are still struggling to service the debt that was incurred in the 1970s in the debt crisis. That debt has been restructured, at times reduced, and transformed into Brady bonds, but the bonds are still some fifteen to twenty years away from being fully repaid, and in the interim must be serviced, along with all the debt incurred since the 1970s. Debt is a lifetime sentence for poor countries. The countries wages, in the form of foreign exchange earned from exports, are effectively garnished for up to thirty years, or more!


A sovereign bankruptcy regime, as an idea, remained only that, until the IMF threw its weight behind it, in a signal speech by Anne Kreuger, First Deputy Managing Director of the Fund, to the National Economists Club annual dinner in Washington D.C. in November last year.12 So what is the IMF proposing?

The IMF Proposal The IMF has developed its Sovereign Debt Restructuring Mechanism (“SDRM”) proposal to address two problems it has identified. The first is the absence of “adequate incentives for orderly and timely restructuring of unsustainable sovereign debts”. Collective action and other problems mean sovereign debt restructurings, to the cost of all parties, are initiated far too late and take far too long. The second problem is that without a bankruptcy type mechanism the only choices available when a nation is in serious financial trouble are a default (which is highly disruptive to the debtor and potentially destabilising for the entire international financial system) or a bailout of the private creditors13 thereby, in Anne Krueger‟s words, “contributing to moral hazard”.14 The SDRM is designed to address these two problems. As initially advanced by Anne Krueger in November, 2001, it had six elements:15 1. The imposition of standstills (with the approval of the IMF) so as to provide legal protection for debtors while negotiating the terms of the restructure. 2. Temporary foreign exchange and capital controls during standstills.

Anne Krueger; A New Approach to Sovereign Debt Restructuring; http://www.imf.org/external/pubs/ft/exrp/sdrm/eng/index.htm (Speech at the conference “Sovereign Debt Workouts: Hopes and Hazards”, Institute for International Economics; Washington, DC, 1 April 2002) http://www.iie.com/papers/krueger0402.htm (“Krueger II”)

Anne Krueger; A New Approach to Sovereign Debt Restructuring; (2002) 39 (visited 15 May 2002) http://www.imf.org/external/pubs/ft/exrp/sdrm/eng/index.htm (“Krueger I”) In Krueger‟s words from this speech, “At present the only available
mechanism requires the international community to bail out the private creditors.”
14 15

Krueger III,. Some of the concepts below are taken from Smallhout, op cit n __ .


3. Collective action provisions requiring all creditors to accept the terms agreed to by a super-majority (typically 75%) so as to remove the hold-out, free riding and rogue creditor problems. 4. Seniority for new lending, so as to attract it to the country. 5. An IMF assurance of good economic conduct and policy setting by the debtor to give the creditors an assurance that the debtor will “pursue policies that protect asset values and restore growth”.16 6. Subsequent IMF financing limited to rebuilding reserves and paying for essential services and imports. This proposal was modified in a further speech delivered by Anne Krueger on April 1 this year to a conference in Washington.17 The approach was restated and further refined in a speech by Ms Krueger to the Latin American Meeting of the Econometric Society on July 26 this year.18 In the two subsequent speeches the IMF has changed its position in two important regards: 1. In response to criticism of the conflict inherent in being both a creditor and fulfilling some of the judicial functions inherent in the SDRM, such as determining whether a debtor is entitled to a standstill, the IMF has reduced its role significantly and given control over major decisions in the restructuring process “to the debtor and a super-majority of creditors, not to the Fund.” 2. In response to the championing of the extensive use of collective action clauses (CACs) in bond documentation by the current US administration (termed the „contractual approach‟ by Ms Krueger),19 the IMF has adopted a “twin-track” approach of supporting both the extensive use of CACs and also the statutory approach of the SDRM.20

16 17 18

Krueger III. Krueger II.

Anne Krueger, Preventing and Resolving Financial Crises: The Role of Sovereign Debt Restructuring (Speech to the Latin American Meeting of the Econometric Society, Sao Paolo, Brazil, July 26 2002) http://www.imf.org/external/np/speeches/2002/072602.htm (“Krueger

19 20

Krueger III. Krueger III.


Both changes are sensible. The conflict inherent in the IMF‟s two roles is stark and must be ameliorated as far as is possible. Likewise, CACs can do no harm and will do some small good – so the IMF should support them. The problem with CACs is not that they won‟t help, but that they won‟t solve the problem and thus the US is wrong to support them as a solution for the sovereign insolvency problem. The IMF continues to attract criticism for its unwillingness to extend the SDRM to debts owed to it. It argues that it is not a commercial lender that seeks profit, but rather a creditor that lends at concessional rates precisely when others will not. There is some substance to this position, though some authors dispute the extent to which IMF interest rates are concessional.21 And, as the IMF has pointed out, sovereign creditors adopt the same stance with less justification.22 Notwithstanding the substance behind the IMF‟s claim, to push forward a debt relief mechanism while exempting one‟s own claims from it, does not exhibit tremendous moral leadership. In war the officers who lead from the front line tend to be far more effective than those who lead from ten miles behind! Nonetheless, that the IMF should forcefully support this initiative places me in the unusual situation of agreeing strongly with a policy prescription of the Fund. I generally, almost reflexively, find myself in disagreement with the policy prescriptions of the Fund for developing nations.23 Now, for once, to my mind the Fund is seeking to implement an innovative and broadly correct initiative, and, what happens, the G-7 nations resist it. But more of the ignorance of bankers, and the governments that do their bidding, later.

21 22

Krueger III. „Official debt‟ is that extended by multilateral institutions such as the IMF and the World Bank and other development banks and by sovereign creditors. Traditionally poor nations do everything within their power not to default on official debt, on the basis that such lenders will be the only source of funds when all others dry up.

For the most sustained and forceful critique of the IMF and its policies, see Joseph Stiglitz, Globalization and Its Discontents, Norton. (A poorly titled book as it is almost entirely focused on the IMF, and not on globalisation; but a brilliant book in its critique of the Fund and its policies).


The US Treasury Proposal – Debt Documentation and Collective Action Clauses Collective action clauses are clauses in debt documentation by which creditors agree in advance to accept the determination of a majority of them, usually a super-majority of 75% of creditors, as to the terms of any rescheduling or restructuring of the debt. This removes many of the collective action problems inherent in bond debt, in which the bonds may be held by hundreds or thousands of creditors. It prevents the freerider problem, in which small creditors may allow the others to restructure the debt, and then insist on repayment in the full, original terms. It makes a debt workout with bonds more workable. Bonds issued under U.K. law typically have such clauses in them, and those issued under New York law do not. The same sovereign issuers issue in both markets. The leading research on this shows that collective action clauses (CACs) tend to lower the borrowing cost for more credit-worthy issuers and raise it for less credit-worthy issuers. Presumably the more credit-worthy benefit from being able to take advantage of a more orderly restructuring process should it ever become necessary, whereas for less creditworthy issuers, any provision which makes a rescheduling easier is viewed askance by the market as such an event is quite likely.24 This is all well and good. It stands as the centrepiece of the US response to the SDRM proposal. The US, with the support of the other G-7 nations, wants to see CACs made mandatory in all sovereign bond contracts. CACs would help, so we should advocate them. However the proposal misses the point on two fronts: 1. CACs will not solve the remove the need for a sovereign bankruptcy regime. They will facilitate reschedulings, but not afford major debt relief when major debt relief is what is needed to allow a nation a fresh start and to permit it to honour most of the human rights of its people.

Barry Eichengreen, Ashoka Mody, Would Collective Action Clauses Raise Borrowing Costs? 1999 NBER Working Paper No.w7458 Issued in January 2000 http://papers.nber.org/papers/w7458 ; Barry Eichengreen, Ashoka Mody, Would Collective Action Clauses Raise Borrowing Costs? An Update and Additional Results, NBER Working Paper No.w7458, (2000), 4. (visited 19 June 2002) <hhtp://papers.nber.org/papers/w7458>


2. The debt workout for the Debt Crisis took from 1983 to 1994 – a lost decade of development in Latin America and Africa – and this debt workout faced very few collective action problems. The debts were loans by a relatively small number of banks, not bonds held by many creditors. The banks were highly susceptible to the moral suasion of their respective central banks, and it was this pressure, and this pressure only, that eventually led to the Brady Plan and some slight relief for debtors – but a decade too late for most debtors! Collective action problems are only a small part of the problem. The US proposal implicitly assumes they are most of the problem.

The Comprehensive Proposal – A Global Bankruptcy Court The comprehensive proposal would be an established sovereign bankruptcy court applying a highly developed body of rules and procedure, very much like the International Criminal Court that commenced on July 1 this year. Such a court and rules would, without doubt, require years of careful planning and negotiations and would be implemented by a treaty between nations. As I note later the most striking aspect of the literature is not so much that people think this court would be a bad idea, but rather that they think it is not an achievable idea. Ultimately, however, the strongest argument for a Court is made by the stance of the people who would most resist it. On February 6, 2002 the Chief Executives of five financial market associations wrote a joint letter to Horst Kohler, the Managing Director of the IMF, to express their concerns with the SDRM proposal.25 They disagreed strongly with several of the key assumptions behind the SDRM, viz. that there are collective action problems preventing creditors as a group from reaching agreement on restructuring terms, that IMF bailouts have the effect of bailing out private creditors and that the SDRM would be analogous to domestic bankruptcy procedures. They even had the chutzpah to put the word “unsustainable” in quotation marks when referring to an “unsustainable” level of external debt.


Letter dated 6 February 2002 from the Securities Industry Association, Emerging Markets Traders Association, International Primary Market Association, International Securities Market Association and The Bond Market Association to Mr Horst Köhler <http://www.emta.org/ndevelop/newfin.htm>


As most experienced litigators know, when the respective parties see reality in radically different terms and cannot agree upon the most basic facts, recourse to a court is almost certainly going to be necessary to resolve a dispute. To deny the existence of collective action problems is ludicrous.26 From the perspective of the creditors who typically continue to receive interest in the years that debt restructurings take to work out, such delays might appear acceptable. However such delays are not acceptable from the perspective of debtor country citizens who cannot find work or feed and educate their families in those years. Ask any of the citizens who protest, by their thousands, on the streets of Argentina, Indonesia or Venezuela. To deny that IMF bailouts serve to bailout private creditors is even more outrageous. The IMF itself admits this is the consequence of the IMF organised loans to sovereign debtors in times of crisis – in fact, such a use of the funds is mandated by the terms of the loan.27 The financial industry associations assert that “private creditors have and undoubtedly will continue to experience substantial losses on their exposure to emerging market sovereign debtors who have experienced payment difficulties”.28 So what? This is irrelevant. No one has asserted that bailouts completely protect

creditors from losses. The problem is that bailouts shield creditors of short-term debt from much of the losses that an unfettered market would impose upon them – thereby encouraging the very type of debt that is most volatility enhancing and least desirable from the debtor nations perspective!29 The third objection of the financial industry associations has more substance and is arguable.

Any cursory study of the resolution of the debt crisis in the 1980s discloses substantial collective action problems back in the days when the debt was in the form of loans owed to relatively few banks, not in bonds and owed to a plethora of bondholders as is the case today.

C.W. Calomiris & A.H. Meltzer, Fixing the IMF, 56 THE NATIONAL INTEREST, Summer 1999, at 88. See also H.S. SCOTT & P.A. WELLONS, INTERNATIONAL FINANCE: TRANSACTIONS, POLICY, AND REGULATION 1204-05 (6th ed., 1999).
28 29

Letter page 2.

RP Buckley, “International Capital Flows, Economic Sovereignty and Developing Countries”, Yearbook of International Economic and Financial Law 1999 (London: Kluwer Law International, 2001), 17; RP Buckley, “Six Lessons for Banking Regulators from the Asian Economic Crisis”, chapter in Weerasooria (ed), Perspectives on Banking, Finance & Credit Law (Sydney: Prospect Media, 1999) 51; and RP Buckley, “A Tale of Two Crises: The Search for the Enduring Lessons of International Financial Reform”, (2001) 6 UCLA Journal of International Law and Foreign Affairs, 1 at 42-43.


However the putting of the word „unsustainable‟ in quotation marks so as to suggest that nations do not have unsustainable debts is quite simply immoral. Many poor nations today are burdened by debt levels that prevent adequate housing, nutrition, education or medical care for their citizens. Such debt can only be serviced at the direct expense of the human rights of millions of people.30 Such debt levels can only be considered sustainable by those whose moral compass has been utterly corrupted. For as long as creditors are adopting such positions, there will be little prospect of negotiated justice for debtor nations. Indeed such attitudes provide much of the answer to the next question, also.

Why Is There No Global Sovereign Bankruptcy Regime? The answer to why there is no global sovereign bankruptcy regime has four elements to it: 1. The lack, before the 1980s, of an overarching need for a sovereign bankruptcy regime. 2. The profound difficulties of creating international institutions and gaining widespread implementation of treaties. 3. The perceived interests of the creditors and debtors.

4. The ignorance of the creditors and debtors. Each element will be considered.

Absence of an Overarching Need for a Sovereign Bankruptcy Regime Let‟s look at a few dates: 182831, 187632, 193033, 198234, 199535, 199736, 199837 and 200238. These are the dates of significant international financial crises. What do you

30 31

J Dohnal, “Structural Adjustment Programs: A Violation of Rights”, (1994) 1 AJHR 57.

The First Latin American Debt Crisis. For more, see F.G. Dawson, The First Latin American Debt Crisis: The City of London and the 1822-1825 Loan Bubble (New Haven, CT: Yale University Press, 1990).


notice about that progression of dates?

You don‟t have to be a distinguished

economist to notice something is going on, do you? Crises are becoming far more frequent, and more severe, as the growing interconnectedness of markets means that national crises, that once would have been limited to that one country, as Argentina‟s was in 1894,39 now routinely spread throughout their region, and often to the other emerging markets of the world. In the „good old days‟, developing countries had financial crises intermittently and there was simply no pressing need for a supranational institution to deal with them – they were insufficiently frequent to warrant it. Yet, the proliferation of crises in the past twenty years means today that any such institution, for the first time in history, would, if it were to exist, be busy indeed. There are reasons for this recent proliferation of crises. The principal one is the convergence of financial markets under globalisation. Until the 1970s most national financial systems functioned as relatively self-contained units: savings within an economy funded investment within that economy. The internationalisation of finance since that time has meant ever-increasing capital flows, particularly portfolio capital flows of commercial banks and institutional investors, between nations.40 The spread of modern telecommunications has meant information travels quickly between nations and capital can react quickly to adverse developments in a country. All in all,
32 33 34 35 36 37 38 39

Second general debt crisis in Latin America. A general debt crisis in Latin America, as well as the Great Depression. The Debt Crisis involving Latin America and Africa. The Mexican Peso Crisis (that actually erupted in December 1994). The East Asian Economic Crisis that commenced in Thailand in July 1997. The economic meltdown of Russia. The current devastating economic crisis in Argentina.

This economic crisis in Argentina pushed Barings Bank to the edge of insolvency and meant it required a Bank of England bailout (which it received, as was not the case after Nick Leeson‟s exploits a century later).

In 1970 the capital that moved around the globe to support trade in goods and services far exceeded that which moved to support direct and portfolio investment. More recently capital flows have outweighed trade flows by a factor of over 60 to one: P. Sutherland, Managing the International Economy in an Age of Globalisation, The 1998 Per Jacobsson Lecture, the annual meeting of the IMF and the World Bank (Oct., 1998). By institutional investors, I am referring to mutual funds, pension funds, and other managers of other people‟s money.


contemporary capital flows swiftly into developing nations when prospects look good and there is a surplus of liquidity in the developed world, and as swiftly out of those nations when storm clouds gather there,41 or prospects in the developed nations‟ markets look better.42 In the title of a recent book by the insightful emerging markets banker, Michael Pettis, our contemporary international financial system, particularly as it relates to developing nations, is “The Volatility Machine”.43

Difficulties of Creating International Institutions History teaches us to never underestimate the difficulty of establishing an international institution. Witness the abortive history of the precursor to the United Nations, the League of Nations, and the International Trade Organisation. The story of the League of Nations is well known. That of the ITO is perhaps less well known. The ITO was to be the third Bretton Woods institution, to accompany the IMF and the World Bank. These three institutions were the brainchildren of the towering intellects of John Maynard Keynes and Harry Dexter White – the Englishman and American charged with shaping the international economic architecture after World War II whose proposals were adopted at a conference at Bretton Woods. Keynes and White had fresh in their minds the experience of the Great Depression that had dominated most of the inter-war years. They foresaw the need for a regime of fixed exchange rates to promote international trade, a monetary fund to assist with the implementation and operation of that regime, a development bank to assist with rebuilding Europe after the war and then to aid the development of poor countries, and a trade organisation to ensure the liberalisation and promotion of international trade. The IMF and World Bank came into existence, but due to subsequent US opposition the International Trade Organisation was never formed, and only the treaty it was to administer, the General Agreement on Tariffs and Trade, was implemented.


RP Buckley, “International Capital Flows, Economic Sovereignty and Developing Countries”, Yearbook of International Economic and Financial Law 1999 (London: Kluwer Law International, 2001), 17.

For instance, there were substantial capital outflows from emerging markets in the halcyon days before the “Tech-wreck” in April 2001.

M Pettis, The Volatility Machine, (Oxford: Oxford University Press, 2001).


The scale of accomplishment in establishing the IMF and World Bank should itself not be undervalued. It took a global cataclysm, preceded by the Great Depression, to summon the political will to make those ideas reality. And in the late 1980s and early 1990s it took years of failure by the U.S. and E.U. to extend the GATT to protect intellectual property rights to persuade them of the need for an International Trade Organisation, and to allow the ITO to come into being, fifty years late, under the name, the World Trade Organisation. Indeed, fifty years was roughly the gestation time also for the International Criminal Court that came into being in The Hague on July 1 this year. The Nuremburg War Crimes Tribunal was an ad hoc international criminal court formed for the purpose of trying the Nazi war criminals of WWII, and at that time the need for a standing court was recognised and articulated. The realisation of that idea took 56 years. An international sovereign bankruptcy regime would have saved millions of lives in the 1980s, and so the need for it was critical, but the idea wasn‟t seriously considered until the mid-1990s. Let us hope history is not a firm guide to the gestation periods of such organisations, and we don‟t have to wait until 2050 for a sovereign bankruptcy regime.

Perceived Interests of Creditors and Debtors We don‟t have a global sovereign bankruptcy regime because the creditors believe its absence works in their favour. The apt analogy is with debtors‟ prisons.44 In domestic legal systems, debtors‟ prisons were replaced with relatively enlightened bankruptcy regimes a long time ago. However, the absence of a sovereign bankruptcy regime means the equivalent of debtors‟ prisons persist in developing countries. If you doubt me, take a walk in any of the poorer neighbourhoods in Indonesia today, or in Sudan, or in Nigeria. The general consensus is that developing country debtor governments tend to postpone initiating a restructuring of their debt, until far later than is optimal from the

An excellent analysis of the history of the early common law remedies against debtors, including imprisonment for debt, can be found in Lewis Australian Bankruptcy Law, (Dennis Rose QC (ed.), The Law Book Company Limited, 1994) at 7-10.


perspective of their creditors45 and their own citizens.46 This tendency to be late to restructure, and even late to default, is strongly supported by the prospect and actuality of IMF rescue packages.47

The Ignorance of the International Financial Community The banks have argued vociferously against a bankruptcy regime internationally when they accept, and indeed welcome, them nationally. Why? In the words of William Rhodes, Senior Vice-Chairman of Citibank, “the existence of a formal bankruptcy mechanism, whether invoked or not, would cause uncertainty in the markets, deter potential lenders and investors, and drive up the countries‟ borrowing costs”. This is nonsense. National bankruptcy regimes greatly enhance certainty and this serves generally to attract lenders and investors and thus diminish borrowing costs and there is no reason it would be any different internationally. On the other hand,

See comments of Mohamed El-Erian reported in James Smallhout, “Critics Attack IMF‟s Standstill Proposal”, 393 Euromoney, Jan 2002, 110.

In the words of Anne Krueger, “Like a patient with a toothache avoiding a trip to the dentist, a debtor country will all too often delay a necessary restructuring until the last possible moment, draining its reserves and increasing the eventual cost of restoring sustainability. Creditors suffer too, as the fear that some may be unfairly favored in a disorderly workout depresses the value of claims on the secondary market and, at worst, may block agreement on a necessary restructuring. All this can leave the international community with the unpalatable choice of accepting a disruptive and potentially contagious unilateral default, or bailing out private creditors and thereby contributing to moral hazard.” See Anne

Krueger, New Approaches to Sovereign Debt Restructuring: An Update on Our Thinking, (Speech at the conference “Sovereign Debt Workouts: Hopes and Hazards”, Institute for International Economics; Washington, DC, 1 April 2002) http://www.iie.com/papers/krueger0402.htm. Or in Eichengreen‟s words, “Why are governments prepared to impose extraordinary hardships on their constituents to avoid a [debt restructuring]”: Barry Eichengreen, “Crisis resolution: Why We Need a Krueger-Like Process to Obtain a Taylor-Like Result”, (2002) <http://emlab.berkeley.edu/users/eichengr/POLICY.HTM> See also, Thomas Dawson, “A Contribution to an Online Discussion on Sovereign Debt Restructuring”, a letter by Thomas C Dawson, February 7, 2002, http:www.imf.org/external/np/vc/2002/020702.htm

Barry Eichengreen, “Crisis resolution: Why We Need a Krueger-Like Process to Obtain a Taylor-Like Result” (2002) <http://emlab.berkeley.edu/users/eichengr/POLICY.HTM>


there is no formal structure for the resolution of sovereign debt crises and each crisis typically casts a pall for many years on debtor country prospects and bank profits. Debtor countries suffer with no new capital and ever increasing debt loads and banks suffer as in most cases they have to keep advancing new funds for years to enable the debtors to keep paying interest. The history of the past fifty years tells us that debtor nations usually continue to service their debts, even when as nations they are functionally bankrupt and can do so only by borrowing ever more debt. It was Citibank‟s former Chairman, Walter Wriston, who in the 1970s famously pronounced that “Countries can‟t go bankrupt”. And in the absence of some form of global bankruptcy regime, this is technically true, as there is no bankruptcy regime available. But countries can always repay loans precisely because they can always increase taxes and reduce spending on health, education and nutrition – and at some point with poor countries such reductions in spending lead to unconscionable hardship. The most impoverished nations today spend four times more repaying debt than on health, education, sanitation and other basic needs and the total external indebtedness of developing countries exceeds $2,000 billion. National bankruptcy regimes seek to ensure the maximum return to creditors while ensuring the debtors have food, housing and the capacity to work. Humane nations tolerate nothing less. We rejected debtors‟ prisons centuries ago. Yet the absence of an international bankruptcy regime means people starve, and live without adequate shelter, healthcare and education, while their country‟s wealth goes to service loans. Why is it that what is considered unacceptable within any developed nation, is considered acceptable by the international financial community when it applies in other, poorer, borrowing countries? William Rhodes is the world‟s most experienced banker in sovereign debt restructurings. He must know he is speaking nonsense, but does so presumably because he is too embarrassed to admit the truth – that the banks like the present arrangement under which, when a crisis hits, the poor in developing countries are


consigned to the debtors‟ prisons of poverty, ill-health and ignorance48 so that the loans made by the banks can be repaid. The G-7 nations have opposed the IMF‟s SDRM proposal and supported the far more limited, contractual approach of the U.S. The G-7 nations are acting at the behest of their banks,49 who appear unable to learn the lessons of history or appreciate the benefits to themselves of a more enlightened approach. The debt crisis of 1982 was resolved in part by the Brady Plan of the early 1990s under which the loans were converted into bonds with principal or interest discounted by 35%. History has proven that the debt relief in the Plan was necessary to allow Latin American economies to grow again and restore capital flows to the region. The Plan also gave the banks readily tradable bonds, rather than illiquid loans, that permitted many banks to sell their exposure to investors comfortable with risk, and free up their own capital to move on and undertake new business. The Brady Plan proved to be a huge boon to banks, yet at the time they resisted it strongly, and only agreed to it under enormous pressure from their own national banking regulators.50 The banks, in opposing the IMF‟s SDRM proposal, have got it wrong, again.

Conclusion The work of the Institutional Economists, such as Douglass C North, sheds much light on why a bankruptcy regime is such a boon for Australia and so difficult to implement


In developmental terms, virtually everyone agrees that the 1980s was a lost decade in Latin America due to the Debt Crisis. (Even Anne Krueger agrees: see Krueger III). No progress was made between 1982 and 1989 on debt relief or meaningful ways forward for debtor nations, and so the continent‟s poor went hungry, its young poor went uneducated, and its infrastructure crumbled, as nations continued to service an overwhelming debt burden (usually through new loans which simply increased the total indebtedness). The debt gridlock of the 1980s was in no one‟s long-term interests but damaged the debtors far more than the creditors. See C MARICHAL, A CENTURY OF DEBT CRISES IN LATIN AMERICA (1989) at 237; and RP Buckley, Emerging Markets Debt, Kluwer Law International, London, 1999 at 34-36.

G-7 Finance Ministers Adopt Financial Crises Action Plan, (visited 15 June 2002) <http://www.fin.ge.ca/news02/02-034e.html>

RP Buckley, “The Facilitation of the Brady Plan: Emerging Markets Debt Trading from 1989 to 1993”, (1998) 21 Fordham International Law Journal 1802.


globally. According to North,51 successful economic systems are predicated on three essential bases: 1. Systems of formal rules that reward people for their efforts. 2. Norms of behaviour that support the rules, and support compliance with the formal rules. 3. Effective enforcement mechanisms for the rules. Australia has each of these elements in place with respect to bankruptcy. There are the various statutory regimes. There is the broad community acceptance of the notion and principles of bankruptcy and the strong adherence to the rule of law in our community. And, finally, there is our independent court system that enforces the rules relatively effectively. Internationally none of these elements are present. There is no formal system of rules for sovereign bankruptcy. (The IMF proposals are mere ideas at this stage and are not nearly as developed as dispositive rules.) There is no uniform model law, no international treaty, no specification of the rules that might govern in such a regime. There are, as yet, no widely accepted norms of behaviour beyond the general adherence of the international creditor and debtor communities to the rule of law. By this I mean that the international financial community, in particular, does not accept that bankruptcy is an appropriate mechanism by which to resolve sovereign insolvencies. The intellectual and political battles still have to be fought to persuade the creditors that what works, and what justice demands, domestically; is also what will work, and what justice demands, internationally for nations. Finally, there is no court system in place to administer and enforce any global bankruptcy regime. And strikingly, to the best of my knowledge, a global bankruptcy court is not being seriously advocated by any credible proponents. This is not

because such a court is considered a poor idea, but simply because no one believes it

Summary of a speech by Douglass C North, delivered at Chicago-Kent Law School, Chicago, October 1999.


is achievable. The ambivalence or hostility towards supranational institutions that many developed and developing nations share, plus the massive difficulties in creating global institutions considered above, means virtually no one believes such a court can be established. In the absence of such a court, the IMF, in its proposal, has kept for itself some of the functions of a court, such as determining whether the economic position of a debtor nation is such that it should be entitled to a standstill on its repayments. And the IMF, predictably and rightly, has received widespread criticism for this, as it will be a major creditor of any such nation and no one should be a judge in their own cause. It is easy to see why the IMF has reserved these powers for itself – there is no other entity to exercise them, and no real prospect of establishing such an entity -- but that does not overcome the fundamental objection to a creditor deciding if and when a debtor deserves protection from its creditors. So there is a long, long road ahead for anyone who advocates a global bankruptcy regime. So what advantages would a bankruptcy system bring to the global scene? Five come quickly to mind. 1. The socialisation of private irrecoverable debts, which the IMF has acquiesced in, and at times engineered, would never be permitted by any decent court. 2. The unconscionable delays that occasion most sovereign debt workouts would be dramatically shortened, to the benefit of creditors and debtors. 3. The appalling human suffering, and the state mandated infringements of basic human rights, that have accompanied the overwhelming majority of IMF Structural Adjustment Programs, would be dramatically ameliorated. 4. Capital flows to less credit worthy developing countries would be ameliorated by the prospect of national insolvency. 5. The international financial system would be far more stable as capital would flow within it, only after far more careful credit decisions than is now the case. This greater stability would benefit both creditors and debtors – both of who


lose heavily in crises. In short, capital would flow between economies as it does today within economies. A global bankruptcy court with a fully developed accompanying jurisprudence would be a tremendous asset to the world. However, it is not likely to come about anytime in the foreseeable future. The SDRM of the IMF is the best hope for the short to medium term. Many of the advantages of a court listed above would be realised by the SDRM, though critically not the first at all, and the second and third advantages only in part. Nonetheless the SDRM is well worth having and is probably the first step on the road that one day, hopefully, will see the International Court of Justice and International Criminal Court in The Hague accompanied by an International Court of Sovereign Bankruptcy. Australia has particular reason to support the SDRM, and the wider issue of a sovereign bankruptcy court. For these initiatives would bring one very specific

advantage for Australia in terms of regional stability. Indonesia is the world‟s fourth most populous nation, and most populous Muslim nation, and lies immediately and near to our north. The maturity profile of Indonesia‟s sovereign debt is alarming in the extreme. Without putting too fine a point on it, the repayments due by Indonesia to its, mainly official,52 creditors between 2004 and 2006 will far exceed any capacity Indonesia could even potentially have to pay them. By 2005, Indonesia will be bankrupt, in the sense that it will not be able to service its sovereign debt. The traditional response to this problem is to reschedule the debt – spread the repayments out over a very long period – and advance new money to enable the debt to be serviced. This traditional response, by advancing new money, simply capitalises the interest payments and adds them to the debt. The negotiation of such a

rescheduling traditionally takes at least a year and is acrimonious and hard fought. The consequences of such reschedulings, that increase and prolong the debt burden on the debtor, have traditionally meant far less money for health, education and social


Official debt is debt owed to multilateral institutions such as the IMF and World Bank and to other nations, principally developed countries such as Canada, the US and Japan.


programs in the debtor nation, and corresponding increases in political instability as citizens resist the often dramatic diminution in their living standards. These consequences of such a restructuring are all but inevitable. In middle-income countries like Argentina, Brazil and Venezuela, the human suffering is appalling and the political instability very significant indeed. For instance, many hundreds of

people died in 1989 in Venezuela in riots protesting against the effects of the IMF programs which accompanied the restructuring of their national debt.53 However Indonesia is no middle-income country with a relatively long democratic tradition. It is a low-income country with a fractured, unstable politic whose people in many parts are suffering severely already. One suspects our national political leaders see the IMF‟s SDRM proposal as irrelevant to our national interests. For Australia is not at risk of needing the protection of a bankruptcy regime! But nothing could be further from the truth. For does Australia really want a disintegrating Indonesia on its doorstep – an Indonesia in which assuredly the only stable, cohesive force will be the military? Or would Australia prefer a stable Indonesia under democratic rule, relieved of some or much of its debt burden through a bankruptcy procedure?


RP Buckley, Emerging Markets Debt, at 101.


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