The Tyranny of Bondholders
To Read Kevin's story, please visit: http://ase.tufts.edu/gdae/policy_research/sovereigndebtrestructuring.html
PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I’m Paul Jay in Washington. When a corporation wants to raise money, either for growth or other reasons, they can issue shares, which–investors can buy equity, in which case they share the upside and the downside risk, or they issue bonds. And investors buy corporate bonds knowing there’s a risk, and they expect to be repaid. On the other hand, they charge more interest if they think there’s more risk. And if the company goes bankrupt, then they don’t collect on their bonds. But that’s not the case when it comes to countries. When investors buy bonds from countries, they assess a risk, they charge higher interest rates based on what they say is a perceived risk. But the truth is, when a country gets into trouble, the investors, the bondholders, do not accept any part of that trouble or that risk. They expect to be paid in full. In other words, the obligation of a state to bondholders is absolute, whereas in the eyes of the bondholders, at least, and often in the eyes of the governments and local elites of these countries, their obligations to their own citizens are quite relative when compared to the obligation to the bondholders, even though a lot of the money that’s being borrowed is actually being borrowed to pay back previous debt. So once again it’s all about the absoluteness of repaying back the bondholders. And then what happens when a country does get into crisis? How is its dispute with its bondholders settled? Now to talk about all of this and unravel this process, and perhaps envision a more sane and rational process, is Kevin Gallagher. Kevin is a professor at Boston University, he’s a research fellow at the Global Development and Environment Institute, and he’s at Tufts University. Thanks very much for joining us, Kevin.
PROF. KEVIN GALLAGER, BOSTON UNIVERSITY: Thanks for having me, Paul.
JAY: So what do you–in terms of my opening remarks, do you agree? I mean, this–the underlying law, what there is here, seems to be more contract law than international law. Is that you better pay us back and we don’t really much care what your obligations to your citizens are?
GALLAGER: That’s certainly the tune that we’re hearing in Europe right now, and it’s being echoed by the Germans and the ECB and so forth. They want their money back. They wanted 100 percent of the value of those bonds, and don’t talk about restructuring. And so there’s always a new bailout and the can gets kicked down the road. But eventually, if you look at the Argentine case, Brazil, Russia, Argentina in the ’90s, and so forth, eventually you’re going to have to restructure, and it’s better now than then.
JAY: Now, let’s–just to back up a bit, you know, the press is filled with–and commentary and pundits, you know, talking about how the European countries, they have their pensions’ ages too low, and the benefits are too much, and they can’t pay for this welfare state they’re carrying. But how much is the welfare state in Europe responsible for the current crisis in these countries? And how much it has to do with external factors, for example, a global financial meltdown triggered by American banks?
GALLAGER: Sure. It varies across countries. And perhaps Greece is one of the more profligate countries in the region. But in general this is not a crisis of the welfare state. This is indeed public governments were bailing out the private sector that got overextended and took too many risks during the crises, and now their balance sheets are in the red, and those same banks are asking for the full money back on all of their investments.
JAY: I guess that’s the other absolute in this equation, that big banks are too big to fail, so states have to bail out the banks. Then–and they borrow money to bail out the banks, and then the citizens are supposed to repay the loans to bail out the banks, all considered absolutes of the current economy.
GALLAGER: Sure. Sometimes it doesn’t get as sharply said in public, but I think it’s clear it needs to be more clearly said for everybody to understand, and that’s when the European Central Bank and the International Monetary Fund come in and do a, quote-unquote, bailout for one of these countries, what they’re doing for the most part is giving the country money, and that money is global taxpayer money. If it’s the IMF, it’s global taxpayer money. If it’s the European Central Bank, or the Europeans in general, that’s European taxpayer money. And they’re handing it to the country to turn around and pay banks back. It’s not a stimulus package to get a country’s growth back on track. Indeed, it’s borrowing, taking on more debt, to pay back foreign and some domestic creditors, and not really helping their economy get back up and recover.
JAY: Now, the law or contracts that govern a lot of this state debt is something called the international investment agreements, if I have it right. What is that all about, and how does that function?
GALLAGER: Well, interestingly, that’s the dirty little secret that governs this debt. What the biggest problem is, perhaps one of the most glaring gaps in global economic governance is that we just don’t have a globally agreed-upon regime to work out sovereign debt crises. It’s just every time it happens, we say, oh, we need a global regime because we didn’t like the way Argentina did it or we didn’t like the way Brazil did it or we didn’t like the way Russia did it. But then there’s always a boom and people forget about it. And boy do we wish now that we had an agreed-upon system for when the world says, okay, it’s time for this country to default, how should it be done. We don’t have that. And the de facto regime may be trade and investment agreements. While we weren’t looking, international trade treaties or international investment treaties now cover sovereign debt, and so they treat sovereign debt just like they treat a shoe or a television set, meaning that it has to adhere to the same kind of roles that we have in the World Trade Organization and trade treaties like NAFTA. One key thing is that no investment can be, quote-unquote, expropriated, and that foreign investors have to be treated at least in the same manner as domestic investors. That all seems fine and good for televisions and shoes, and perhaps even for sovereign debt until there is a crisis. If there’s a crisis and a country defaults on its debt and the value of those bonds devalues, the trade treaty is going to see that just the way they would see an expropriation, like a country’s national troops coming in and taking over a foreign oil company.
JAY: And then you could then–this party then sues the country, and in theory can win a lawsuit that would force the country to repay what they’re calling expropriated debt. And if the country doesn’t play ball with the decision, then they actually get excluded from some of these global trade agreements. So it’s a pretty big hammer they have.
GALLAGER: It’s a pretty big hammer that they have. One of the things that many folks don’t see unless you follow this closely is that trade treaties outside of the World Trade Organization have something called the investor-state arbitration, so a private investor can actually directly sue a foreign government for some sort of a dispute. That stands in stark contrast to what we have in the World Trade Organization, where, say, the United States is concerned with subsidies for aircraft in Europe. We–our aircraft industry has to go to the United States government and say, hey, we’re losing to these subsidies that the Europeans are giving to their aircraft producers. Would you take them to the WTO and file a case against them so we can have a more level playing field? So that’s what we call state-to-state disputes. And when you have that kind of a mechanism, the state thinks about a whole bunch of different factors before they go ahead and file a case: they look at other geopolitical things that they have going on, they look at the full welfare benefits for the whole country, and so forth. The private sector can totally circumvent that kind of a process in a regional or a bilateral treaty. There, a private firm can say, hey, we’re losing the value of our bonds. Let’s not even let our government know. Let’s go in there and sue another government in a very private and nontransparent tribunal that’s housed at the World Bank.
JAY: It’s an interesting form of double blackmail that takes place. Like, first the banks say, you bail us out or your economies will be destroyed, even though the reason you have to bail us out, to a large extent, is because of the high-risk plays we were making. And then, once we’re bailed out, you’d better borrow money to pay for the bailout, or we won’t loan you money again, in which we’ll find that will also destroy your economy. So this is a double blackmail. But Argentina a few years ago said no to all of this and did default. So what happened? And is this a model of what some of these other countries might consider to be doing?
GALLAGER: Argentina had to do two exchanges. They did one in 2005 and they did one last summer. And finally they got over 90 percent of the bondholders involved. But, interestingly, some of the key holdouts are a number of Italian pension funds, 150,000 or more of them, who are suing Argentina to the tune of $4.3 billion under the Italy-Argentina bilateral investment treaty. This is one of these treaties that covers sovereign bonds. And those investors see the haircut as tantamount to an expropriation. And there’s a pending case right now at this World Bank tribunal, which houses something called the International Center for the Study–I’m sorry, for the Settlement of Investment Disputes, where these private bondholders are directly suing the Argentine government.
JAY: So why can’t other countries do what Argentina did, like, for example, Spain? Why can’t Spain say–and I guess there’s two issues people raise. At the time, if I understand it correctly, Argentina was–had pegged their currency to the US dollar. And part of this default was they delinked from the US dollar. So if a Spain or Greece was to do something similar, would they have to start off with a delink from the euro?
GALLAGER: Yeah. In general it’s more difficult for European nations to do what Argentina, quote-unquote, did, because they’re part of the European Union and so they have their own single currency. They can’t make a sovereign decision to delink from the euro and let their currency devalue. So even though Argentina had pegged its currency to the US dollar, they were–they had the freedom to make the sovereign decision to let go of that and let their currency devalue. They also got really lucky. They’ve got a lot of soybeans and some oil and gas. And right after they devalued, there was also a major commodity boom that they were able to ride on. Many of these European countries, one, can’t devalue, and two, don’t have some of the hot commodities that are making developing countries really grow quickly right now.
JAY: Well, if the–most of the European countries and other countries that get into this predicament can’t necessarily go the Argentinian route so easily, what could be done in terms of a global structure that would balance, at the very least, the interests of the citizens of these countries with the bondholders? I mean, the other–I think the other part that doesn’t get talked about this very much is that the majority of the citizens of these countries don’t have a heck of a lot to say about how these economies are run and why this money got borrowed in the first place. I mean, a lot of these countries it’s ’cause they don’t tax their own local elites enough to pay for a lot of the programs. But any rate, what would you suggest should be a global structure?
GALLAGER: Well, there was one proposed after the Argentine crisis by Anne Krueger when she was at the International Monetary Fund, called the sovereign debt restructuring mechanism, which would be a global mechanism whereby the parties would get to the table, decide on a haircut, freeze capital so you couldn’t sneak it in and out of the country or, you know, take it out of the country during the negotiation process, agree on a haircut, and have it be done in a swift manner. The IMF, of course, wanted to be the international body that oversaw that. Many of us were a little concerned that since they’ve accentuated so many of these crises, why should they be the ones to oversee it. But nevertheless, some sort of a global neutral body needs to be able to parachute in and be rational about the process. In the European case, we’re dealing with an emergency right now. If you can’t delink from the euro, austerity is not the answer. And the Europeans are going to need to go in there and have some real fiscal stimulus to help the country grow in tandem with some of their budget cuts and so forth. Yes, Greece has been profligate, but it wasn’t a country that analysts were really concerned about five or seven years ago.
JAY: But the idea of stimulus rather than austerity doesn’t even seem to be on the table in Europe right now. The quick and guaranteed repayment to the banks seems to be far more important than the idea that Spain and Italy and Greece and some of these other countries could be in a decade of recession. They seem not–they don’t–they being the powers that be, Germany and the big banks in France, they don’t seem to be very concerned about that.
GALLAGER: Yeah. We’re–we’re sort of living under the tyranny of the bond markets right now. There’s a narrative in the mainstream press that we need to make investors feel calm and feel settled, and make sure that their expectations are met, that things are going to be cut and so forth, and that austerity brings growth. During the Great Depression, we had John Maynard Keynes that completely contradicted that narrative and said, no, you need to go into debt if you don’t have a surplus, and you need to have fiscal stimulus. We’re experiencing that in the United States. We’re starting to see job losses here in the US now that the stimulus is petering out, and we’re starting to have an austerity economics kind of discussion here as well. And there are many voices of sound economists, many of them that you’ve had on your show and that are found in the mainstream media here and there as well, that are pushing hard for saying, no, we need a new stimulus. Laura Tyson, University of California economist and Obama advisor, broke with many other Obama advisors and wrote a piece in The Financial Times last week saying we need more stimulus. And this is something we need to communicate more.
JAY: But stimulus doesn’t necessarily mean more debt. There’s other ways to have stimulus, I mean, including, number one, real taxation on wealthy, real taxation, for example, been proposed on stock and other kinds of finance sector areas, real budget cuts in other sectors, like the military. I mean, one doesn’t have to go into more debt to have stimulus.
GALLAGER: No, absolutely not; you don’t need to go into more debt if you have stimulus. And Robert Pollin, who you’ve had on here a number of times, has proposed a bank levy to make them lend. And certain targeted taxation can be possible as well. You just have to be careful when you tax during a recession, because that is a disincentive, right? If you have a surplus, the idea is, well, when times are bad, you cut taxes and increase spending. When times are good, you increase taxes and decrease spending. Unfortunately, during the Bush era, we decreased taxes and increased spending during the boom.
JAY: But I thought that research has shown that taxation at the upper end is not–is less a destimulant than when those taxes are raised and then the state spends that money as direct stimulus money, that the wealthy don’t actually spend or invest that much of their extra capital, that when a state taxes it and uses it, it’s more stimulus.
GALLAGER: Well, like I said, it has to be–taxes need to be targeted. You have to be careful where the tax goes.
JAY: So what measures can–do you think people could demand from their governments that will break some of this tyranny of the bond market?
GALLAGER: Well, we need to have a more serious economic narrative about what causes economic growth during a crisis, and that needs to include stimulus. It’s clear that in the developed world, countries are not growing because of austerity economics and we need to be very serious about targeted stimuli. And we also need to de-shackle ourselves from these de facto regimes that can snare us while we’re trying to get out of crises. And the key one from the study that I published this week, called The New Vulture Culture: Sovereign Bonds and International Investment Agreements, is that these trade treaties that we think govern shoes and television sets actually can snare us while we’re trying to prevent and mitigate a financial crisis. This is a problem that’s not their original intent. These things crept into trade treaties while we weren’t looking. And we need a global regime for sovereign debt workouts, and it should not fall back to private investors to decide how a sovereign bond is dealt with during a crisis.
JAY: Thanks for joining us, Kevin.
GALLAGER: Thank you for having me.
JAY: And thank you for joining us on The Real News Network.
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