Rules, Institutions, and the Legal Theory of Finance


The International Monetary Fund (IMF) recently published its first major policy treatment of sovereign debt restructuring since 2003. It was prompted by the flawed restructuring in Greece, high profile litigation against Argentina, and recurring crises in smaller economies that failed to deliver needed relief in a timely way. The paper proposes a work program to bolster the Fund’s analytical and policy tools, as well as contract reform to expand countries’ restructuring capacity.

Taking initiative on sovereign debt is a risky move for the Fund. Between 2001 and 2003, IMF staff designed and lobbied for a treaty-based Sovereign Debt Restructuring Mechanism (SDRM), only to suffer a bruising political defeat before its governing board. Steadfast opposition from the United States and large emerging market economies (especially Mexico and Brazil) doomed SDRM, and made sovereign bankruptcy advocates at the Fund along with some fellow travelers outside wary of treaties going forward. Henceforth, reform would focus on private contract design, and proceed through more-or-less organic market innovation. A decade later, the politics remain intractable (the latest paper says as much). While some remain convinced that SDRM would have mitigated recent sovereign dysfunctions, few believe it is poised for a comeback. The puzzle, then, is what would prompt the IMF to wade back into such tricky waters at a time when the global economy and its own institutional credibility are in a delicate state.

Katharina Pistor’s theory suggests possible answers and raises more questions. In LTF terms, the 2003 experience was a failed bid to reconstitute the sovereign debt market in a statutory regime, with the IMF at or near the center. Some governments at the center, notably members of the European Union, had sought to limit taxpayer transfers (bailouts) with a rule-based bankruptcy process that would constrain governments on the periphery and their enablers in the capital markets. Predictably, those on the periphery did not want to be constrained—and found key allies at the center (the United States). U.S. officials wanted to limit bailouts too, but they also wanted to shrink—not boost—public institutions at the heart of a rules system. One way to limit other people’s options and minimize formal regulatory intervention is to induce “spontaneous” change in their contracts. Bankruptcy died; contract change and moral suasion prevailed in its wake.

Contract reform to facilitate debt renegotiation was a fabulous success on the one hand—the entire New York market changed sovereign bond boilerplate virtually overnight beginning in 2003—and a big failure on the other. By 2013, contract terms that had taken hold in the market looked powerless to prevent determined holdouts from disrupting a restructuring, and did nothing to make bailouts disappear.  True to the U.S. objectives in 2003, they bypassed the IMF, but they also framed nothing and constrained no one.

Meanwhile, the IMF had a rather humiliating run as the junior horse in the “troika” managing the European sovereign debt crisis since 2010. By its own admission, the Fund stretched its access rules and strained its economic analysis under political pressure to defer restructuring in Greece. Even the relatively loose institutional constraints that had framed the IMF’s response to earlier emerging markets crises, without sovereign bankruptcy, were abandoned in Europe. Crisis at the center almost by definition poses a grave threat to global financial stability and justifies rule suspension.

Europe’s response to rampant rule suspension was to promise more, better rules and contract reform going forward. Whether these will survive the next shock is an open question, and ultimately one that is less important than the question of member states’ political commitment to one another. In contrast, the IMF’s success at recapturing credibility post-Europe depends on its capacity to deliver economic recovery within a rule framework that is visibly binding and at least somewhat insulated from political pressure. It needs rules to decouple from Europe and regain its place in the global financial architecture.

The latest foray into sovereign debt, then, is an attempt to reconstruct an institutional space for the IMF to mediate between states and markets. The risk of reviving a politically fraught issue and recommitting to rules (if on a modest scale) is justified by the IMF’s own need for self-preservation. Meanwhile, the latest episode highlights the role of international institutions as a distinct constituency for law and rules in international finance, which could be profitably explored through the LTF lens.