A radical solution to resolve Argentina’s debt woes (and other countries)..

An interesting piece by Prof Laura Alfaro of HBS. She goes down the history lane to understand Argentina’s recent (nth) debt crisis. Till 1970s there was very little foreign borrowing. Moreover, there was complete sovereign immunity and one could not sue foreign governments in US courts:

Until the 1970s, the act of lending to a foreign country was little more than “an act of faith,” as economic advisor Herbert Feis said in 1930. Given that sovereign immunity prevented nations from being sued in foreign courts without their consent, the ability to enforce the terms of foreign loans often led to pitched political battles of will with the implicit threat of war as the only recourse for creditors. Between the end of World War II and the 1970’s there was little foreign borrowing, making default a relatively uncommon occurrence.

The passage of the Foreign Sovereign Immunities Act (FSIA) in the United States in 1976 changed all that. After the passage of the FSIA, sovereign debtors started to waive their sovereign immunity. Private institutions could now sue foreign governments in US courts in the event of a default, an epic change that many believe helped the sovereign lending market evolve on a grand scale.

Hmm.. this act changed the game completely. There was a feeling one could lend freely to foreign govts and if not repaid, then sue them,. However, they realised it was not easy to sue govts and attach assets:

It also led to a wave of litigation that did little more than disrupt or delay sovereign debt restructurings. Over the next two decades, lawyers, lenders and borrowers realized the actual implications of the law: Obtaining a favorable court judgment was possible with the right covenants; collecting on that debt was not. Finding “attachable assets” that successful litigants could access remains challenging to this day, since sovereign nations have few available commercial assets overseas that can be attached.

One of the most damaging results of the FSIA is a false perception that foreign debt was made less risky than it is. The limited enforcement rights of investors means that sovereign debt remains risky, regardless of whether it is issued under foreign law. In fact, there is no grand scheme that will emerge from the Argentina case that will in some way ameliorate the risk. Given the lack of conversation about changes to the international financial architecture to manage and resolve debt crises more effectively, let me offer a radical proposal to get a discussion started before a new wave of crises emerges.

She says we should go back to the world before FSIA:

I recommend returning to the pre-1976 world where there was absolute sovereign immunity, where each country issued sovereign debt under its own legal jurisdiction, and a creditor could not sue Argentina in New York. This may be a shocking idea for the banks and fund managers who trade in foreign debt as well as for emerging market countries. “The cost of funds will go up,” naysayers may cry. “We won’t get any money; no one will invest in us.”

But I predict the opposite will happen—an outcome with potentially significant positive results. This change will allow debtors and creditors alike to better understand and acknowledge the risk inherent in sovereign debt lending. If you lend to Argentina, you are dealing with Argentina. Giving the legal power to New York has not made it easier to collect on defaulted debt.

In truth, most countries repay their debts, and sovereign default is far from the norm. At stake in the Argentina case is the idea that one should use foreign institutions and foreign courts to help financially suspect countries improve their lack of policy credibility and the weakness of their domestic institutions. In fact, no such panacea exists. The Argentina scenario is a harsh reminder that attempts to improve the international financial architecture without addressing the underlying weaknesses and distortions of a debtor nation are simply counterproductive.

Rather than stifling investment, the proposed change will hopefully trigger increased focus on equity-type investments, on entrepreneurial activities that actually produce products and services to attract investors, and it will shine a positive light on an emerging economy. With these actions, developing countries may concentrate more on the economic building blocks needed for a stable future.

Hmmm… Did not really know an act like this helped push foreign lending by US banks…But then we are hardly taught all this…it is usually mentioned as some invisible hand which did the magic..

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