The problem is simple. Individuals and corporations have recourse to bankruptcy codes that give them protection from creditors. Sovereign states do not. A plan to remedy this omission was floated by
In place of a sovereign debt bankruptcy mechanism, the IMF backed collective action clauses (CACs), designed to allow a country to do a deal with the bulk of its creditors that would apply to all bondholders. But CACs have proved to be no panacea. They take an eternity to negotiate and can still be challenged by creditors, as the legal action taken against
So what happens now? The immediate reaction of the markets to the default was muted, in part because it came as no surprise and in part because there is an assumption that a deal will be cobbled together in the next few days. Given that both sides have dug in their heels so far, it may not be.
Failure to settle matters rapidly will have consequences for
There are wider implications. If the so-called "vulture funds" that have brought the current action emerge victorious, it will not only encourage legal action in other cases where creditors have been forced to take a "haircut", but will make future debt restructurings more difficult to organise.
The danger here is all too easy to see. Many countries are saddled with big budget deficits. In the event of another financial crisis - something that seems all too likely - there would be a wave of sovereign debt defaults.
Is the international community prepared for this? Clearly not. The imperative, therefore, is for the IMF to draw up a new blueprint for a sovereign debt mechanism and for the US to announce that it fully supports such a scheme.
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