Weidemaier Testifies Before U.N. Committee on Sovereign Debt

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Mark Weidemaier

For two centuries, governments and the investors who buy sovereign bonds have struggled with the problem of how to help countries get debt relief without inviting excessive borrowing and undisciplined lending. Contract-based reform has been the most common attempt to address the issue, but due to the limits of that approach, the system for restructuring government debt remains flawed.

Those were among the points made in testimony by UNC School of Law associate professor Mark Weidemaier before the United Nations General Assembly, which has created a committee to study ways to reform sovereign debt restructuring processes. The session, on Feb. 5 at U.N. headquarters in New York, was convened to discuss a legal framework for restructuring.

One drawback to contract-based reform is that it often is out of step with changes in sovereign bonds.

“Many government bonds now give creditors the power, at least potentially, to interfere with the government’s use of property needed for basic financial, diplomatic, and even military activities abroad. Giving private creditors that kind of power can cause international conflict,” says Weidemaier, Ralph M. Stockton Jr. Distinguished Scholar.

Yet contract reform efforts don’t address that scenario.

“Countries cannot file for bankruptcy, which means their debts last forever. This makes it hard for over-indebted countries to regain their financial footing. The problem is compounded by the fact that a small group of investment funds has made a business buying debt issued by financially-distressed governments and then suing the governments to enforce the claims. These lawsuits can frustrate a restructuring approved by the vast majority of a government’s creditors and can even destabilize sovereign debt markets,” says Weidemaier, who spoke on a panel on the political economy of debt restructuring.

The debt crises in Greece and Ukraine underscore the need for a solution to government debt restructuring challenges and are keeping the issue top-of-mind for policymakers. Although Greece restructured its debt in 2012, the nation remains deeply indebted, and it’s unknown whether Greece will be able to stay in the eurozone.

The current method for restructuring government debt entails separate negotiations with official and private creditors and the International Monetary Fund (IMF).

“Ideally, there would be a mechanism for coordinating these negotiations, deciding how to structure any program of debt relief, and making this decision binding on all affected parties. Most observers agree that this is a desirable goal. But there is no political consensus as to what such a mechanism should look like,” Weidemaier says.

The lack of consensus carries risks with broad implications.

“Individual creditors wield disproportionate power. This threatens to make restructurings more difficult and protracted, and that makes everyone — not just a country’s citizens, but also most of its creditors — worse off,” Weidemaier says.

Potential solutions include creating a system within the U.N. or IMF or periodic improvements to bond contracts.

“Everyone agrees the system is flawed. The disagreement is about how to improve it,” Weidemaier says.

-March 3, 2015

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