What are the consequences of a country going bankrupt? Recently we have had a number of potential “scares” that certain Eurozone countries might go bust, Greece, Ireland and now Portugal.
So what actually happens if a country is unable to pay its debts? Has it ever happened? And most importantly what happens to the people of the country?
It was very common in Latin America throughout the 19th century - in fact, Argentina, for instance, had a number of defaults during the first decades of its existence.
The methods of creditor countries to enforce debts were rather crude then, as was demonstrated in 1861 when Mexico suspended debt payments to its European creditors, triggering a French-led military intervention that led to the overthrow of the government and the installation of Maximilian from the Austrian imperial dynasty as Emperor of Mexico.
It can be very difficult for that country to then get credit in the future. It can destabilize the economies of neighboring countries and major creditors. It can cause serious political upheaval in the defaulting country.
For more recent examples:
They’d usually allow “representatives” from the Kingdom of Sicily to come over and “break things”, leaving with rather vague threats making you think twice about not honouring your debts.
“Nice army base here, Colonel. Be a shame if something … broke.”
I know everybody says so, but this is actually not supported by empiry. If you look at countries that defaulted on their debts - such as Latin American governments or Russia -, you will see that these countries manage to get credit now (and often they get enough credit to default yet another time some years or decades later); they are able to find investors buying their recently issued bonds. Sometimes this may be because the country’s financial situation improved considerably, as was the case with Russia and its oil revenue that boosted public finances as compared to the 1990s. Sometimes investors believe that the country has a new government that will be more willing to honour debts. Sometimes the memory of the market is simply of too short a horizon to care about past defaults. The reasons may vary, but the popular notion that once you default you will never, or only at prohibitively high rates, get credit is simply not true.
There have also been statistical analyses examining if there was a correlation between a country’s past credit history and the credit ratings awarded to them by the big rating agencies. The correlation was quite weak, much weaker than that between the rating on one hand and present economic indicators such as GDP per capita or foreign exchange rate stability on the other. Investors care more about a country’s present ability to pay its debt than about what it did in the past.
Er, how is the Asian financial Crisis an example of a country defaulting? Countries ran up large amounts of debt when their economies crated, but I don’t think there was a string of defaults.
If I recall from several media discussions about this:
Countries don’t go “bankrupt” like people or countries, as in “I can’t pay my debts, please take all that you can from my assets and don’t bother me again…” They simply stop paying their debts - because they can’t or won’t.
First thing - obviously - any immediate transactions from now on will be on a cash-on-delivery basis, unless the supplier is pretty stupid. The Upper Slobivia air force buys some parts, hey write a cheque; where is the cheque drawn, and who guarantees it will be cashed? SOme serious negotiations will happen, probably involving multi-way barter to produce enough cash-flow to meet operating requirements. Not much different from a company in dire straits, the bank or country supplying the cash will want something physical to back up the transactions. Assets like gold reserves will quickly end up in some third country’s vaults as “assets in trust to guarantee eventual repayment of the loan”. If something can be sold, it probably will.
Bond-holders, and other countries who hold such assets or guaranteed debts before crash, will all line up for renegotiated payments. Like a company trying to prevent failure, the negotiations will basically boil down to - “Here’s what we can afford to pay, and for how long. Settle for 75 cents on the dollar.” A country has the advantage that it can’t really be sold off or dismantled (usually) soit’s more of a “take it or leave it” proposition. The only advantage the debtors have is that the country will find it difficult to do business if they spend too long or demand too much leniency.
The local currency will not be worth much, so odds are the country will have to take charge of finding foreign currency (i.e. US dollars, Euros) to perform transactions.
The internal economy will take a dump. Most larger economies rely on easy currency exchange and relatively stable exchange rates. If the local Best Buy of Upper Slobivia Ltd. can’t pay for new stock from China, and can’t price their TV’s or computers in local currency low enough that people can afford them, then they close up and all their local geeks are unemployed. Multiply this by every business that touches on foreign goods, and your whole economy is toast.
(This is what happened to the car industry. The banks were not sure they had money to lend, and were too scared to lend anyone any money - so nobody bought cars, since a $20K to $60K purchase usually needs credit. When sales basically tanked, so did the auto industry. Notice how they recovered pretty well since people can and will borrow again.)
The people that have money won’t spend it (except on substantial things with real tradeable value, like gold). If the country does not impose currency controls, people will move what they have into foreign currency, thus making the bad exchange rate situation worse. Exchange controls - even worse. How would Best Buy run if they cannot pay their Taiwanese suppliers?
Eventually, down the road, the country’s economy slowly reboots and gets going again. The situation that caused the problem - poor mortgage investments, invasion, or really bad political management - likely has corrected itself. People begin to trust… Does the market really have a poor memory? No, it’s more likely that the people willing to take a risk and lend to a less reliable partner stand to reap huge rewards if the gamble pays off. Once one starts reaping, everyone else joins in.
Fortunately for the world, most collapsing economies are pretty third world; when complex economies - Argentina, for example - bite the big one, it’s pretty spectacular.
Countries like Greece or Portugal are a special case; since they don’t print their own currencies, they probably are more like US states or provinces economically. You can’t sell bonds? You stop paying people, you stop paying debts. The huge debts got you into this mess; all the debt(bond) holders stop getting their payments. That’s probably all the major financial institutions, pension funds, and anyone else who buys bonds. Pensions stop being paid. Banks start to fail. Greece drags down all the banks in Europe (by the time it reaches this point, everyone has a ton of Greek bonds). The whole region’s economy grinds to a halt… The euro crashes and now nobody in Europe can afford that big screen TV from Best Buy, businesses start to go under. You can see why the rest of europe wants the situation fixed ASAP.
the solution is the same; the rest of the countries chip in a bit, Greece goes on austerity and bond holders agree to less money paid. Everone suffers except the people who got to spend that borrowed money before the crisis.
Another recent example of a country defaulting on (part of) its debt is Argentina, in 2001. My impression is that the country is still viewed with suspicion on the financial markets, though I could be wrong.
Countries are sovereign, and can’t be taken to court over their debts and I’ve never heard of seizures of government property or private citizen’s property. Imagine if that was the case:
Germany: “Argentina, please pay back your loan.”
Argentina: “We can’t, we’re broke.”
Germany: "We’ve obtained a court order to levy property. The Buenos Aires City Police Headquarters, the Outer Pampas Army Training Center, and the Naval destroyer Bona Vida Del Sur are hereby seized for Germany. The police headquarters is now an annex of the German Embassy, the army training center is being sold to Volkswagen for their new factory. Please have the destroyer ready for pickup. We will be sending a German cruiser with a crew for our new Destroyer Bundeswaffe.
Legal options if a sovereign welches on its debts are limited, as robert_columbia points out, though there may be some limited possibilities of recovery by setting of amounts due to the sovereign. Obviously it puts a question-mark over the ability of the sovereign to borrow further, but if the assessment of later lenders is that political/economic conditions which caused the default have altered, and are now such that they are likely to get their money back, they will lend. No doubt, though, a history of prior default implies a greater risk of future default if political/economic conditions move yet again, and this risk will be reflected in the interest rate which lenders demand.
As a result of the Great Depression, in the early 1930s the self-governing Dominion of Newfoundland announced that it would have to default on its very substantial public debt (largely incurred during the Great War). The British Government stepped in, providing the necessary financial support, but in return ending self-governing status and resuming colonial rule from London. Newfoundland remained under colonial government until 1949, when it became a province of Canada. So there is an example of a state which lost its independence as a result of being unable to meet its financial obligations, and never regained it.
It’s quite simple.
newly-defaulted countries are well situated to incur new debt, since they don’t have any obligation to pay the old ones back. if the investor believes that there is enough economic activity/government tax revenue coming in to pay back the new debts, and also believes that the country isn’t going to turn around and declare a subsequent default, he’ll lend. the degree of the investor’s confidence in these propositions is reflected in the interest rate he will demand.
usually the people of the country will suffer. governments will impose austere budgets to free up tax revenue to pay back their new debts (either to demonstrate their ability to repay, or to actually repay the debt with the higher interest rates being charged). whether it’s sufferance of their own making or not really depends the circumstances of that individual nation’s debt.
further, (I believe, may be wrong about this) most countries usually have laws (again, the degree to which the sovereign adheres to their own laws vary) that require them to make the payments. Ignoring the perils of doing so, it’s not like Barack Obama can issue an executive order to stop paying interest on certain classes of US Government debt - the legal “obligation” for the sovereign to repay the debt is part of the security that it can offer to investors.
Yes, it happens. Not infrequently. However, it doesn’t really happen to the economic leaders of the world - their modus operandi thus far has been to rely on continued economic growth (and the continued increases in tax revenues that creates) to fund perpetual re-financing of their debt (or pay it down if they are able to run budget surplusses).
IIRC, its major utility, Telefónica de Argentina, made full restitution of its dollar-denominated bonds, despite the national default. Is that a common-place? Private company “keeping its honor” despite a national default?
Oh, sure. When we talk about a country defaulting on its debt, we mean that the government defaults on (some or all of) the government debt. Other persons within the country do not automatically follow suit. Individuals, corporations, etc have the same legal obligation that they had before to pay their debts, and of course they don’t enjoy any kind of sovereign immunity so if they don’t pay their debts then the usual range of remedies and enforcement procedures are open to creditors.
Admittedly, government default may well take place in the context of, or even trigger, a general economic dislocation which leads to an increased rate of default by individuals or corporations.
This is a frequent misunderstanding about international law. Sovereign immunity is not absolute. For one thing, it is now an established fact in international law that sovereign immunity does not extend to instances where countries act in a commercial capacity like other, non-sovereign actors, e.g. corporations; and in many countries, the position of the national courts is that borrowing money is a commercial non-sovereign activity, so foreign governments can be sued before other countries’ domestic courts. It has happened and is becoming more frequent.
Besides, sovereign immunity can be waived, and it can also be waived in advance. It is possible to contract with a government and include in the contract a clause in which the government waives its immunity and agrees to be sued in the case of dispute. These clauses are now normally introduced in international bond issues, even though the normal way there is for a clause giving jurisdicton to a non-state arbitral tribunal, rather than a foreign state’s courts.
The days when governments could comfortably hide behind immunity for basically anything are long past.
To flesh this out a little, the American position on the immunity of foreign governments before U.S. courts is codified in [url=http://www.law.cornell.edu/uscode/html/uscode28/usc_sec_28_00001605----000-.html]28 USC § 1605[/url):
A few years ago, Argentine President Kirchner wanted to come on a visit to Germany, and rumours that German bailiffs were standing ready to seize the Argentine government jet on behalf of German creditors were sufficiently real to make Kirchner come in a chartered plane rather than his official governmental one.
An ongoing dispute between Germany and Greece concerns the Greek courts’ seizure of property of the Goethe Institute (the German government-funded cultural institute) in Greece on behalf of Greek creditors. This may have been in violation of international law, but the question is unresolved.
Thanks for all your responses, it seems that bankruptcy is more common than I thought.
Thanks for fighting my ignorance.
A quick google gives me google books’ Procedures in international law By Gernot Biehler P115 disussing the Goethe Institut; it says in fact that Greek courts ruled a sovereign government could not be sued in another country’s court, that was an article of Greek law. Greeks owed debts due to damages from WWII then sued to collect and seized the institute in Italy which had no such exemption.
Generally (IANAL) the principle is that if the court has no jurisdiction, it cannot make an order; so the German courts cannot order the seizure of a property in Argentina, since ownership of property is up to the local government. You would have to sue the Argentine government in its own courts for the money owed or restitution; and if they had issued a decree or whatever nullifying or postponing payment - well, I assume that would override any outstanding debt under local law.
In a not quite analogous case, some large copper company from the USA was suing the Allende government in Chile because their copper mines had been nationalized and the company did not agree with the price. Every time a large ship of copper concentrate arrived in a foreign country (i.e. the Netherlands), the company lawyers filed a suit which included having the copper impounded until the suit could be settled. IIRC it was debatable whether the suit would win - supposedly a sovereign country CAN unilaterally “buy” an internal asset at whatever price they set. However, copper was a major source of foreign exchange at the time, and having most of it tied up in court for several years with lawsuits meant a big hole in foreign currency earnings which added to the economic woes that ended up toppling Allende.
You have to distinguish here between a judgment and the enforcement of a judgment. Can someone sue state A before the courts of state B, ordering state A to pay debts? Under international law yes, provided one of the exceptions from sovereign immunity (most importantly, waiver of immunity or the commercial acticity exemptions) applies (and the instances of their application are becoming more frequent). Of course, the fact that international law permits country B to assume jurisdiction does not mean it has to, but many countries nowadays do, and, as the USC excerpt I quoted demonstrates, the U.S. does as well.
But obtaining a court order to pay is only half of the story; what if state A, having been ordered by the courts of state B to pay, doesn’t pay? In that case you need to enforce the ruling, which may be more difficult. Obviously the courts of state B cannot order the seizure of property located in state A. They may, however, seize property of state A located in state B, unless the assets to bei seized are themselves immune. Absolute immunity still pertains to embassies and their assets, such as bank accounts of embassies, but not necessarily to things such as state-owned ships or aircraft while they are in ports or airports of state B.
When the Confederacy fell, its bonds and banknotes became effectively worthless. The Washington government not surprisingly repudiated any suggestion that it might honour the debts incurred by its late enemy in Richmond. Messrs Fraser, Trenholm the CSA’s bankers in England, went broke.
Another interesting example of this is the Persepolis Fortification Archive, a set of clay tablets dating from the fifth century BCE and loaned by Iran to the United States in the '30s. About five years back, a group of victims of Hamas and Hezbollah bombings, having won judgment against the government of Iran, attempted to have the tablets seized and sold. This caused something of an uproar among those who believe that the tablets are culturally important and would lose much of their scholarly value if they were split up and sold. To the best of my knowledge, the issue hasn’t yet been resolved.