Bankruptcy, Backwards: The Problem of Quasi-Sovereign Debt
Gelpern, Anna, The Yale Law Journal
FEATURE CONTENTS INTRODUCTION I. OUASI-SOVEREIGNS AND THEIR DEBTS A. Quasi-Sovereign and Private Debtors B. Quasi-Sovereign and Other Public Debtors II. QUASI-SOVEREIGN DEBT: DISTRESS, RELIEF, AND RESTRUCTURING A. Public Debt Overhang (Efficiency) B. Jubilee and Odious Debt (Autonomy and Legitimacy) C. Quasi-Sovereign Debt Restructuring III. MAPPING TO BANKRUPTCY CONCLUSION
Bankruptcy--a set of legal institutions to manage private debt distress--has long captivated thinkers and politicians solving public debt problems. (1) Adam Smith observed in 1776 that a sovereign state, like an individual, may find it necessary "to declare itself bankrupt," and that "a fair, open, and avowed bankruptcy" was more constructive and honorable than printing money "to cover the disgrace of a real bankruptcy." (2) Yet the intellectual success of sovereign bankruptcy has far outstripped its policy traction: there is no bankruptcy regime for nation-states; examples of subnational bankruptcy are rare and limited to nonsovereign localities. (3) This seems puzzling, because sovereign debt history is replete with examples of distress, default, and messy restructuring. (4)
My Feature considers the puzzle in light of recent proposals to adapt bankruptcy institutions for U.S. states (5) and members of the European Union. (6) These public debtors share a quality that sets them apart from the protagonists in earlier bankruptcy debates: they remain sovereign but have ceded important aspects of their sovereignty to a central government in the name of economic and political integration. The fiscal troubles of "quasi-sovereign" (7) states present a distinct economic context for bankruptcy as a public debt management tool, and a constellation of political interests potentially more amenable to trading sovereignty for solvency.
The latest proposals were quickly abandoned, even as public debt problems have continued to dominate the policy agenda on both sides of the Atlantic. Their demise revives an old question: is state bankruptcy a good idea perennially thwarted by bad politics, or a tempting analogy courting problems it cannot solve? Although the answer is probably both, I argue that it is closer to the latter.
In the recent crop of initiatives, even the best had it backwards. They started with a bankruptcy solution, and extrapolated to the state debt problem. To be sure, they have prompted a useful conversation joining previously disparate scholarship about credit market institutions, sovereign debt, fiscal federalism, and local government. But framing the conversation mainly in bankruptcy terms is unhelpful for three reasons. First, starting with bankruptcy flips the logical sequence: it posits an institutional fix for a theoretically undefined and empirically contested problem. As a result, a debate that should be filling gaps in public debt theory yields yet another chapter on the uses of bankruptcy. Second, the bankruptcy label presumptively narrows the inquiry, making creditor collective action problems and the Contracts Clause of the U.S. Constitution play host to broader principles of fiscal policy and democratic governance. That such broad principles arise in response to bankruptcy concerns, not vice versa, is distortive. Third, the bankruptcy label injects the intellectual and political conflicts of bankruptcy into the world of public debt. "Bailout" and "cramdown" are fighting words in both worlds, but such overlaps are misleading. Talking about state debt as "state bankruptcy" sets the stage for replaying entrenched arguments from a different field, and threatens to derail a useful exchange for the wrong reasons.
My Feature is an effort to reframe but continue the conversation. The goal is to refocus on the problem of quasi-sovereign debt, without losing the benefit of the debate that started with state bankruptcy.
Over the past year, supporters have offered a wide range of rationales for state bankruptcy. …