From Rogue Creditors to Rogue Debtors: Implications of Argentina's Default

The past three decades have witnessed the rapid globalization of stock, bond, and currency markets, which has been facilitated by advances in telecommunications and the liberalization of previously sheltered, and often repressed, domestic capital markets. The process has been spurred by the search for higher yields and undervalued assets, wherever they may be located, on the part of individual and institutional investors; and also by the desire to mitigate asset-concentration risks via diversified, uncorrelated portfolios. This globalization has also been accelerated by the mushrooming of trade linkages and the spread of multinational corporations, which have put pressure on banks and other intermediaries to deliver all kinds of financial services-from oldfashioned trade credits to currency swaps and asset-backed finance-everywhere and around the clock. The birth of globalized capital markets has been painful, pockmarked by periodic crises spanning at times a multitude of countries: the industrialized nations in the 1970s, Latin America in the 1980s, and Asia in the 1990s. Governments have usually planted the seeds of those crises: first, by holding onto artificial exchange rate regimes even as their ability to control foreign exchange flows was fast diminishing; and second, by failing to set prudent limits on their own foreign indebtedness and on the mismatching of liabilities by their banks, even as the opportunities for financial mischief multiplied.1 Financial historians will recall Argentina in the 1990s as an extreme case: a country that pretended for a decade that its historically weak currency (the peso) could be as strong and stable as the US currency, at a fixed one-to-one exchange rate set by government fiat. To make matters worse, the authorities there literally "bet the ranch" by borrowing almost exclusively in dollars and other foreign currencies to finance a string of budgetary deficits, even though their revenues were due and collected only in pesos. 2 Once an erosion of export competitiveness, aggravated by fiscal and political indiscipline, undermined the regime's credibility and led to a run on available dollars, bank deposits were frozen, capital controls were imposed, and soon after the peso had to be sharply devalued. A sinking currency rendered the government instantly insolvent: the net public debt, which at the one peso per dollar exchange rate was equivalent to nearly three times annual tax revenues and 50 percent of GDP, virtually tripled once the currency sank to around three pesos per dollar, becoming unaffordable to service. I. DIFFERING PERSPECTIVES ON SOVEREIGN FINANCIAL CRISES Most academic economists, legal scholars, and policy gurus have focused their attention upon the alleged inefficiencies in international financial markets that supposedly lead to these periodic crises and complicate their resolution.3 They have argued that globalization has spawned increasingly diverse, diffuse, and unmanageable creditor and debtor communities that pose coordination and collective action problems. Gone are the days when a relatively small syndicate of commercial banks could gather quickly in New York or London, spurred into action by urgent telephone calls from their supervisory authorities, to deal with whatever financial emergency had erupted in some distant corner of the world. Nowadays, everything can be and is securitized and distributed widely around the globe, such that a financial "hiccup" in some corner of the world can affect a huge constituency half a world away-everyone from naive retail investors to savvy hedge funds. As a result, governments that lose the confidence of their bank depositors, bondholders, or bank creditors, or fall victim to regional "contagion" effects, are claimed to be unable to work out constructive solutions prior to a major currency, banking, or debt crisis. After a crisis erupts, it is said, financial stability can only be restored by obtaining a massive package of loans from the G-7 governments acting through the International Monetary Fund ("IMF")-the now classic "bailout. …