Published on Fri, 2011-05-27 09:24
By Roberto Bissio
Lending money to the sovereign can be a risky business. In 1307 the King of France was in debt to the Knights of the Temple, warrior monks who did not just fought the Crusades but also funded them and in the process invented a system of traveler's checks collectable between Europe and the Holy Places. So big was the debt of Philip IV, that to get rid of it the king accused the Templars of heresy and sodomy, burned them at the stake by the thousands and confiscated their property.
His namesake Philip II of Spain, who came to the throne in 1556, inherited a debt of twenty millions of ducats. He declared himself bankrupt three times, in 1557, 1575 and 1596. In what we now call "default", Philip ended up negotiating with the bankers of Genoa and the Netherlands to pay them not in gold but with papers promising seven percent annual interest, thus inventing the bonds as a mechanism of sovereign debt. Philip was able to impose these conditions because in his realm the sun never set and he controlled the Great and Most Fortunate Navy", badly dubbed "invincible."
In contrast, when President Cipriano Castro of Venezuela refused to pay its foreign debt in 1902, Britain, Germany and Italy blockaded the ports of La Guaira, Puerto Cabello and Maracaibo and occupied the country's customs to levy themselves what they claimed in capital and interests.
International law has not progressed much since then in terms of what to do with the sovereign debts when countries are unable (or unwilling) to pay and the dispute remains dependent on the relative strength of the sovereign in relation to its creditors. At a time when the International Monetary Fund recently approved a loan of 26 billion euros to Portugal and the Greek finance minister, Giorgos Papaconstantinou said that his country will default of he does not receives 12 billion euros in June, the issue is back dramatically in the global negotiating agenda.
To resolve with justice and not by force the future and apparently inevitable sovereign debt crises, the United Nations is proposing a set of principles that establish duties and responsibilities of debtors and creditors, both public and private.
The document, drafted by the United Nations Conference on Trade and Development (UNCTAD), is circulating as a "draft" and is the result of several months of consultations initiated in 2009, soon after it became clear that the solution for the global financial crisis of 2008 was to turn the un-payable debt of private banks into public debt.
If a consensus is reached on these criteria, says UNCTAD, we would have a world standard for assessing the quality of the contracts, prevent irresponsible practices and have fewer defaults.
According to the principles proposed, based on universally accepted rules for private debts, the lender must ensure that the "agents" (i.e. government officials who sign the loans) are legitimate representatives of their constituents (i.e. the state and its citizens). A loan will be illegitimate if the fiduciary duty of these agents is distorted, for example through bribery. The decision to contract sovereign debt must be "informed" and the lender must ensure that the debtor understands the risks and benefits of the transaction and that the agent has been duly “authorized under local law to enter into the deal”.
This would outlaw all kinds of secret clauses, as the sovereignty resides in the people (who are also those who will pay the debt). Parliamentary approval of the contracting of public debt would be required, either by setting borrowing ceilings, overseeing the finances of the government or auditing transactions.
Debtor governments, meanwhile, would be required to disclose information in a transparent and not misleading way, both to its citizens and to its creditors, about the fiscal situation, the volume and the conditions of all its debts, the external accounts and other obligations that may affect their ability to pay.
To avoid "undisciplined, inefficient, abusive or non-cooperative behaviour" from both sides, “governments should weigh costs and benefits when seeking sovereign loans”, and “they should seek a sovereign loan if it would permit additional public or private investment, with a prospective social return at least equal to the likely interest rate”.
Lenders, meanwhile, should not extend credit “beyond a borrower’s reasonable capacity to repay”, because this behaviour “not only risks a default on the loan in question, it adversely affects the position of all other creditors of that sovereign debt”. In a purely commercial transaction, the lender must take a risk if it does not assess the borrower's ability to pay. On the other hand, if a credit from government to government is extended “as a means of enhancing the lender’s geopolitical influence” or financing “military exports from the creditor country”, these benefits “should not alter a bilateral lender’s duty to perform a sober assessment of the borrower’s repayment capacity”.
As a last resort once a crisis breaks, a mechanism is needed for an orderly debt restructuring in which the borrower does not discriminate its creditors and the burden of sacrifices is divided equally between all parties involved and does not falls only on the citizens’ shoulders.