ZACHARY HAGEN-SMITH – OCTOBER 20TH, 2022
EDITOR: SELINA YANG
When I spoke with New York Assemblywoman Pat Fahy in September, she was days out from a press conference on her foreign debt bill. It had been two years since Zambia started missing payments on its debt, and a year since Ethiopia and Chad followed suit. They weren’t alone. COVID-19 had stimulated countries’ spending while slashing their revenue, catalyzing an unprecedented, global accumulation of government (“public”) debt.
Though wealthy countries led the debt surge, developing nations have faced its harshest consequences. Many defaulted, breaking their loan contract by missing a debt payment. Argentina defaulted. So did Lebanon. Ecuador, too. In 2020, the UN calculated that 44% of low-income countries were at high risk of debt distress or already in it.
Defaults are bad news. They precipitate economic devastation — soaring unemployment, trade disruption, market contraction — worsened today by climbing interest rates and a strong US dollar. And they’re contagious: a default in one country can create a regional or global crisis. During the pandemic, things seemed to be headed that way. In November 2020, the Financial Times warned that a “debt tsunami” was hurtling towards the developing world. Catastrophe loomed.
“It’s not something you typically picture New York State having jurisdiction over,” said Jake Egloff, Fahy’s legislative director, “but we do.”
Since New York City is the capital of global finance, most internationally traded assets are governed under New York State law. Stocks, bonds, securities, you name it. Whenever assets are traded across borders, New York is probably involved. Its financial omnipresence makes the Albany state legislature one of the most powerful regulatory bodies in the world. Especially for debt.
Over half of public debts, in the form of international sovereign bonds, are governed by New York.
“Because I’m at the state level, I don’t usually do international affairs,” said Assemblywoman Fahy, “this bill is probably one of the most unusual bills I’ve ever done, but it’s also one of the most fascinating.”
The story behind Fahy’s bill starts in May 2020, when the G20, an intergovernmental group composed of the world’s top twenty economies, suspended debt payments for a number of low-income countries during the pandemic recession. This Debt Service Suspension Initiative (DSSI) was popular, but temporary, set to expire in December 2021. So, the G20 hacked out a permanent DSSI-like alternative: the Common Framework.
It’s way different than the DSSI, though. Instead of suspending debt payments, the Common Framework lets the world’s most impoverished countries erase chunks of debt. In a first for relief initiatives, China, Saudi Arabia, and other lending countries outside the traditional, US-aligned “Paris Club” are also participating. Nothing like this has ever happened.
Before the Common Framework, debt restructuring relied on individual contracts rather than international procedure. This decentralized system — still in effect for most countries — involves debtor nations engaging in complicated negotiations across conflicting legal jurisdictions with an array of separate creditors, each with specific interests. Some want to stabilize economies. Others want to make a buck.
These “vulture” creditors buy bad debt at bargain prices and sue defaulting countries for full loan repayment plus interest. It happens all the time. During its 2001 default, Argentina, despite arranging a settlement that 93% of their creditors accepted, had to negotiate a separate deal with a group of hedge funds demanding full compensation. Argentina couldn’t even start repaying the creditors they had settled with, since under New York State Law, debt restructurings can’t go through without approval from 100% of creditors. After an eleven-year court battle and the seizure of an Argentine navy ship, Argentina reluctantly footed a $4B bill plus legal fees — just for the vultures.
While the new Framework may be preferable to the old system, it’s not perfect: many developing countries aren’t poor enough to qualify, and debt service payments are still required during debt negotiations. Its biggest problem is that for any restructuring to go through, private creditors (commercial banks and hedge funds) need to participate on comparable terms as public creditors (lending countries and multilateral groups, like the World Bank).
Banks hate this set-up. Though the Framework is supposed to involve all creditors coming to shared relief agreements, banks, who own most sovereign debt, worry that their public counterparts could just dictate numbers without concern for private creditors’ balance sheets.
Of the three countries that applied to the Common Framework — Chad, Ethiopia, and Zambia — none have begun restructuring. In October 2021, the President of the World Bank told the G20 that, “progress on debt has stalled.” Part of the delay is on countries’ ends: Chad needs to reorganize government debt tied to a private company, Ethiopia is in a civil war, and Zambia is recovering from a polarized presidential transition. But, as the Director of the IMF’s Africa Department acknowledged, “The challenge is a coordination problem.” Translation: private creditors ain’t biting.
While lending countries have put up substantial financing, the Framework requires that, for any deals to take place, private creditors offer equivalent amounts. So far, they’ve offered zilch.
That’s where Fahy comes in.
Her New York Taxpayer and International Debt Crises Protection Act, introduced in May, would require banks and other private creditors to join debt relief initiatives at the same rate as public creditors. Egloff said they view the bill as an enforcement mechanism for the Common Framework. The plan, Fahy said, is to keep the global economy stable: “[We’ll] still require some debt payment but work with them on what would be feasible to write off.”
This is the second time in a year that significant sovereign debt legislation has been introduced to the New York legislature.
In February 2021, Senator Gustavo Rivera and Assemblywoman Maritza Davila introduced a bill that would allow a supermajority of creditors to restructure debt, rather than a 100% total majority. This would prevent “vulture” holdouts from strong-arming countries into legal battles that block the debtors from important international credit markets, like Argentina was during its default.
Fahy’s bill and the 2021 legislation haven’t made it to the floor yet, and some would like it to stay that way.
“The idea of the New York State Legislature… having anything to do with anything important is absolutely terrifying,” Virginia law professor Mitu Gulati said on a March podcast on the 2021 supermajority bill, “I find this whole thing just a bit loony.”
“If major countries and so on start to legislate individually in this space, there’s going to be very significant market fragmentation,” his guest Deborah Zandstra, a partner at the law firm Clifford Chance, said, “I think the problem is that it leads to uncertainty, unpredictability, complexity… everyone will suffer.”
Fahy’s team has consulted an array of experts, among them, renowned Georgetown Law Professor Anna Gelpern, as well as Aldo Caliari, the Senior Director of Policy at Jubilee USA, an advocacy group that traces its origins to the Jubilee 2000 campaign. Founded in 1996, Jubilee 2000 fought for debt cancellation for the world’s poorest countries, making its name with flashy endorsements from celebrities like Muhammad Ali, Annie Lennox, and U2.
“I had the chance to meet Bono,” said HEG professor Nicolás Depetris Chauvin, “I was working at UNDP, part of the UN, and he was there. He was super smart.”
Jubilee 2000’s flare kick-started Depetris’ interest in sovereign debt. In the mid-2000s, as the UN’s HIPC waned and the Easterly-Sachs debate called foreign aid into question, Depetris grew skeptical of relief. He conducted an early study in the burgeoning subfield: “What Has 100 Billion Dollars’ Worth of Debt Relief Done for Low-Income Countries?”
Depretis’ answer: debt relief issued between 1989 and 2003 wasn’t helpful.
“There’s not a lot of evidence that any form of [national] debt relief has been super effective,” Depetris said.
But not all debt relief is created equal.
A 2015 Harvard study found that borrowing countries’ economies significantly improved after debt write-offs; in low-income countries, GDP per capita increased by 11%. However, the loan extensions and interest reductions found in most debt restructurings weren’t beneficial, only delaying root problems.
Despite growing research, there’s still no consensus on debt relief. Depetris acknowledges the effectiveness of some micro-level relief initiatives and sympathizes with Fahy’s bill: “The devil is in the details… I’m not saying it’s not worth trying. I’m saying incentives work in weird ways and markets don’t forgive.”
He worries that Fahy’s bill could make things worse by chasing debt out of New York to legal jurisdictions where debtors have fewer protections.
“It’s a legitimate question.” Egloff acknowledged “For me, New York State has such a favorable legal regime… it wouldn’t behoove them to go somewhere else.” Additionally, Egloff said, since New York City is the world’s financial center, if private creditors want the best business professionals and most financially-literate courts, they have to stay. Fahy also mentioned that England adopted similar legislation years ago without losing its 45% slice of the sovereign bond market. “It’s a strong precedent,” she said.
Depetris raised another issue: who’s paying for the relief? When debt is erased, banks need to cover their erased finances. It’s possible that they could be forced to inflict expensive premiums on future loans to poor countries or block them from borrowing entirely.
“This actually dovetails well into why we believe this is actually in these financial institutions’ interest.” Egloff said. Fahy’s office, and some academics, theorize that partial debt relief could forestall political turmoil that would erase more. “If you’re at all familiar with what’s gone on the past year or so in Sri Lanka, they have had such a heavy debt burden, their political system collapsed under the weight of that debt,” Egloff said. “China has actually been forced to just write off a lot of that debt. They’re never going to collect on that.” For banks, it’s better to collect on 75% of a loan than nothing at all.
“I’m a progressive person, so I would like all these things to work, but I’m not that convinced.” Depetris said.
The economics of the Common Framework are hard to put a finger on. Moderate relief seems like a good thing, but it might not be the right thing. While debt “haircuts” could let debtor countries access international credit markets, if trims are too small, their debt problems will persist. Another issue: relief could absolve or even encourage the bad policy that got countries in debt in the first place.
Though the Common Framework is a modest risk, if it can unify public and private creditors towards safeguarding the global economy and help poor countries, it will be worthwhile. Some experts think the ultimate path for global debt is a multinational default structure, like a world bankruptcy court, which could offer more reliable restructuring to thwart future balance-of-payment crises while also strengthening debtors’ rights and bargaining power.
The Common Framework could be the beginning of a much bigger change in how the world treats sovereign debt. But for any of that to happen, the Framework needs New York. It needs Fahy.
“It is going to be a lift,” she told me, “Our next objective is to find a senate sponsor.”
With inaction on the world stage, legislation in New York could be the greatest hope for a more just and stable global economy. Albany holds the world in its hands.
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