Posts Tagged ‘Debt default’

How did U.S. courts get to rule on Argentina?

June 27, 2014

A financial speculator won a decision in U.S. courts against the government of Argentina which could mean years of unemployment, high taxes, cutbacks in public services in that court.

I am mystified about a number of things in this case, including why the U.S. courts have jurisdiction over Argentina, a sovereign country, and how this decision is to be enforced.

Agentina's economic recovery.  Click to enlarge.

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The background is that Argentina defaulted on its government bonds back in 2001.  Between 2005 and 2010, it worked out a deal with bondholders for them to write off about two-thirds of the debt in return for payment of the rest.

This was a good decision from the standpoint of the people of Argentina and, for the bondholders, better than nothing.

But the U.S. courts have negated that deal by ruling that a speculator who bought some of the original bonds for 20 cents on the dollar is entitled to be paid in full.

Default is a serious matter for nations, just as bankruptcy is a serious matter for individuals and corporations, but sometimes it is necessary.

For a head of state or a head of family, it is better to refuse to pay your creditors than to let people who depend on you go hungry.

Government defaults should, like individual bankruptcy, destroy or greatly harm the credit rating of the defaulter or bankrupt.   In practice, this rarely happens as often as it perhaps should.   Banks have so much more money than good ideas for investing it that they soon start lending again to defaulters and bankrupts.

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Source: New York Times.  Click to enlarge

But how is it that U.S. courts have jurisdiction over a dispute between sovereign country and its creditors, who are based in many countries?  Is it because the payments go through the Bank of New York Mellon, which is in New York City?

How do U.S. courts propose to enforce their decision on a sovereign country.   Does their jurisdiction over New York City banks give them leverage over the whole world banking system?

It seems to me that this decision is a good reason for Argentina and other countries—including the BRIC group, Brazil, Russia, India and China—to create their own payments system outside U.S. jurisdiction.   Another thing I do not understand is why they have not done this already.  Is it because they fear being locked out of the old system in retaliation, before the new system is in place?

What’s needed is an international bankruptcy court, not under control of any government nor of banks, that could.  Its mission would be to resolve disputes between governments and their creditors when national leaders say they are unable to pay in full, in a way that was fair to the lenders without imposing undue hardships on peoples.

Such a court would have authority to free democratic governments of “odious” debts incurred by previous dictatorships.   Yes, that would make lending to dictatorships risky for banks.  It should be.

LINKS

Supreme Court Dismisses Case Between Argentina and U.S. Vulture Funds by Mark Weisbrot, co-director of the Center for Economic and Policy Research, for US News.  Hat tip for the link to Bill Harvey.

Paul Singer v. Argentina: A Thriller Reaches Its Climax by Ignacio Portes, a Buenos Aires journalist, for Naked Capitalism.

US vulture fund ruling pushes Argentina towards a second bankruptcy by Philip Inman for The Guardian.   [Added 6/28/14]

What if the U.S. defaults on its debts?

October 14, 2013

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What will happen if the U.S. government suspends interest payments on its bonds?

The answer is:  Nobody knows and no sensible person wants to find out.

U.S. Treasury bonds are regarded as the world’s most secure investment because the U.S. government is trusted to pay principal and interest without fail.  This is of enormous benefit to Americans, and this advantage is lost if the world comes to regard the U.S. government as just one more government that may or may not pay its obligations.

The least bad consequence is that the United States will have to offer higher interest rates, which will be a burden on U.S. taxpayers for decades and maybe longer.   Another is a freezeup of routine financial transactions in which Treasury bonds are used as collateral.

A worse possible consequence is that the U.S. dollar would cease to be the world’s reserve currency.  American leaders would have much less of a say in international economic policies.  Ordinary Americans would have less buying power even if their nominal paychecks stayed the same.

The worst case scenario is a severe United States and global recession, as the failure of the U.S. to pay its bills ripples through the economy and the U.S. government becomes unable to function.

I hope and believe that it won’t come to this.

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Who holds the U.S. government’s IOUs?

October 14, 2013

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We like to say that the U.S. government is financed by borrowing from China.  That’s either a metaphor or an exaggeration.  Most of the U.S. government debt is owed to Americans and much of it to government trust funds, but it is true that if Chinese and other foreign investors decided U.S. Treasury bonds were a bad investment, financing the U.S. government would become a lot harder.

Click on Federal Debt Basics by the Government Accountability Office and What a U.S. Default Would Mean for Pensions, China and Social Security by NPR’s Planet Money for an explanation of the chart.

Since the Federal Reserve Board holds $2.1 trillion worth of Treasury bonds, Florida Democratic Rep. Alan Grayson argued that the debt crisis could be postponed if the Fed simply forgave this debt or suspended collecting interest payments.  Click on Bernanke Could End the Debt Limit Crisis for Grayson’s argument.

I think this would work.   I think it would set a bad precedent.   I think it might be worth risking the bad precedent, but I’m pretty sure that the Federal Reserve Board thinks differently.

The budget crisis: Links & comments 10/2/13

October 2, 2013

What If Voters Don’t Punish Extremism? by Ed Kilgore for Washington Monthly.

Barack Obama has a history of standing aside and giving his opponents enough rope to hang themselves, then jerking on the rope.  I think this is what he is doing in the government shutdown and debt default crises.

Ed Kilgore thinks this might backfire in the current crisis.  Voters are being told by that both sides are equally to blame—even though, in his opinion, the blame rests mainly with the Republicans.

Shutdown Could Last Weeks by Jonathan Strong for National Review Online.

Neither side is willing to back down.  Obama insists on a “clean” continuing resolution to allow the whole government to keep functioning.  Congressional Republicans plan to introduce “rifle shot” bills to keep specific government departments and programs functioning, but President Obama has said he will veto them (although he did sign a bill to continue paying active duty military personnel).

Strong said it is not just a conflict between the President and the House Republican caucus.  The real deadlock is between House Speaker John Boehner and Senate Majority Leader Harry Reid, who detest each other.

The Individual Mandate and the Government Shutdown by Ian Welsh.

Welsh argued that the Republican Obamacare proposal is reasonable.  It did not suspend Obamacare, but only its most unpopular provision, the individual mandate to buy health insurance whether you want it or not.

The problem with Welch’s argument is that, without the individual mandate, the complicated Obamacare system crashes.  If the people who sign up for Obamacare are only people who are poor and already sick, the system cannot pay for itself itself.

What Exactly Did Boehner Promise at Williamsburg? by Jonathan Strong for National Review Online.

The House GOP’s Legislative Strike by Jonathan Chait for New York magazine.

The Republican congressional caucus agreed in January to the Williamsburg Accords, an agreement to use the threat of a government shutdown and debt payment default to force President Obama to agree to their program.  The current crisis is not an accident.  It is part of a planned strategy.

Why Boehner doesn’t just ditch the hard right?, an interview of Robert Costa, the National Review’s Washington editor, by Ezra Klein of the Washington Post.

The Speaker of the House of Representatives has less influence on the Republican caucus than does the Tea Party or Fox News.

Who to blame for the U.S. budget crisis?  Try the Kaiser by Uwe Bott for the Toronto Globe & Mail.

Once upon a time the President had to ask Congress for approval each time the government borrowed money.  In order to pay for the cost of fighting in World War One, President Woodrow Wilson asked for, and got, approval to borrow money, up to a certain limit—the debt ceiling.

Shutdown, default and the debt ceiling

May 25, 2011
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The refusal by the Republican majority in Congress to raise the ceiling on federal debt means that, on the one hand, they think this issue is so important they are willing to put the functioning of the federal government at risk, but, on the other hand, they are unable to come up with a plan to actually bring the budget under control, and so leave it to President Obama to figure out.

A lot of people who discuss this issue assume that this would mean that the federal government would default on its existing debt.  A default would be catastrophic.  U.S. government bonds would no longer be considered an absolutely safe investment, which means the Treasury Department would have to pay more interest to attract lenders.  This would not only mean the federal debt would compound at a faster rate.  It would push up U.S. interest rates generally.  It would be more expensive to take out a car loan, a home mortgage or a small business loan.

Fortunately there are other options.

The most likely option would be a partial shut-down of the federal government.  I can’t guess what would be cut.  Presumably the military and Homeland Security would be exempt.  Would the national parks be closed?  Would the Postal Service suspend or reduce mail deliveries?   I don’t know.  Would it be legal to reduce or suspend payments for Social Security, Medicare and other so-called entitlements programs mandated by law? I don’t know.  Would federal employees have to take a pay cut or suspension of wages? Maybe.

Another possibility would be that the Federal Reserve system would simply create money to pay down the national debt.  That, in fact, is the normal mechanism by which money is “printed.”  It is what was done with “quantitative easing.”  I can’t guess the long-term consequences of this would be, but it doesn’t seem like a good idea.  But it is an option (if the Fed agrees – admittedly, a big “if”).  Creating money by buying Federal bonds would provide a means to keep the federal debt within the legal limit while continuing the normal operations of the federal government.

The final possibility is that President Obama would simply refuse to comply with the debt ceiling on Constitutional grounds.  But such a confrontation wouldn’t be his style, and the Constitutional argument seems weak to me.  It rests on Section 4 of the 14th Amendment states that “the validity of the public debt of the United States, authorized by law … shall not be questioned.”  But it is an option.  He could make his Constitutional claim and see what the courts say.

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