There are no doubt a number of new realities created by the US Supreme Court’s decision this week to let stand a lower court ruling supporting hedge fund bond holders who refused to accept reduced payments after Argentina’s 2001 default. By definition, the outcome strengthens the hand of private lenders in the push and pull between sovereigns and their creditors in periods of debt distress. In Piketty terms, score another win for capital.
While the hedge fund plaintiffs and the courts seem to have been at pains to emphasize that this case is only about Argentina, the broader policy implications are undeniable. In a paper last year, the IMF warned: “The Argentine decisions—if upheld—could exacerbate collective action problems and risk undermining the sovereign debt restructuring process.” (see paragraphs 43 & 44). Indeed, it seems clear that sovereign debt restructuring just got messier and costlier for governments and their citizens.
A less obvious reality that the international policy community may need to confront is a world in which the de facto “preferred creditor status” of the IMF and multilateral development banks (MDBs) is undercut by the de jure ruling in the United States. Georgetown University law professor and international debt expert Anna Gelpern flags this possibility here.
Should this come to pass, the developing world can count itself as a victim of the Supreme Court’s decision. With international financial institutions’ preferred creditor status in doubt, the public investments in development programs spearheaded by the MDBs will become more expensive, and all other things being equal, more limited.
The MDBs have long enjoyed an increasingly rare commodity in financial markets – the highest possible credit rating, which allows them to borrow on the cheapest possible terms. And the cheaper they can borrow, the more financing they can deliver for their development programs.
So what determines the MDBs’ AAA ratings? One significant factor has been the long standing agreement in the international community that these institutions are to be treated as preferred creditors, with their claims on sovereigns prioritized in times of debt distress.
Take a look at this summary of the most recent reaffirmation of the African Development Bank’s AAA rating. Preferred creditor status is invoked more than once in these short summaries.
The practice of treating the multilateral institutions as preferred creditors does not have a legal basis, but it has coexisted more or less peaceably with existing legal regimes. The lower court decision upheld by the Supreme Court (specifically, its interpretation of pari passu) could up-end this status quo. At a minimum it creates new uncertainty about multilateral financial institutions’ preferred status.
It remains to be seen how the ratings agencies will grapple with this uncertainty in their future assessments of the multilaterals.
The hedge funds in the Argentina case have been endlessly clever in pursuit of their claims (with their tactics self-documented here). But policymakers are certainly no slouches, and we can expect the policy community to be hard at work on new approaches to try to right the ship when it comes to sovereign debt workouts. In the meantime, let’s hope that the public benefits that have long held as a result of the MDBs and IMF’s preferred creditor status are not lost.