Thursday, July 31, 2014

Court Order Creates Sovereign Default

It is the first time I have heard of an involuntary sovereign default. Argentina set aside the money to make its bond interest payments today, but a U.S. court ordered it not to make the payments and ordered its bank to return the money. The court also ordered Argentina to find a way to pay everything it owed from its last sovereign default, but that was rather like ordering a stone to bleed. A court can make the decree but the material world cannot make it happen.

There is much in this case that is worthy of a Shakespearean drama, with unsavory characters on all sides, but there are other considerations that are perfectly prosaic. The implications are absolutely appalling when you trace them through to their logical conclusion. First, there is the question of how successful a Wall Street hedge fund might be in seizing the U.S. assets of Argentina. I don’t know what U.S. assets Argentina has, so I don’t know how significant a point this might be. In past cases of judgements against foreign countries, plaintiffs have succeeded in freezing the unrelated assets of a country’s citizens. If such a rule applied in this case — and at this point, nothing this court might do would shock me — it could wipe out the checking accounts of Argentinian students studying at U.S. universities. That obviously would have real-world implications more severe than the funny-money at stake in the case.

Looking farther ahead, there is the question of whether the United States is still an appropriate venue for sovereign bonds. A U.S. court has asserted jurisdiction in this case because the bonds were originally issued in the United States. It is hard to imagine a country getting into this predicament if its bonds were issued anywhere else in the world. Bonds are disproportionately issued in the United States because of its history of evenhanded jurisprudence, a reputation that is being sorely tested right now. It is a bizarre ruling that goes against the interests of debtors and creditors alike, but it has stood up to appellate review. Any solution would involve changing U.S. law to allow for something resembling a sovereign bankruptcy, or reissuing the bonds in another jurisdiction outside the United States. Fundamentally, it is the U.S. legal and political system that is broken here. A law that allows a court to order a sovereign default is a problem in itself, and the lack of a response from Washington is worse. I can easily imagine the bond market moving from Wall Street to the European Union or even a minor offshore banking center such as Antigua as a way to avoid just this risk.

Speculating further, if bond markets do move to Europe, and the United States is the only country still auctioning its bonds on Wall Street, that becomes an awkward situation for the U.S. Treasury. Unless the U.S. economy can become strong enough to finance its own government, the Treasury could eventually be forced to follow the international bond market to its new home. That’s a scenario that in various ways drastically increases the risk of a U.S. sovereign default. If such a thing were to come about, we would be able to trace the sequence of events back to the precedent of today.