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What Happened to the U.S. Constitution? Effects of Changing Interpretations on International Debt and Banking—Part II

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In Part I of my article, I described how the decision of an obscure federal judge promises to transform world debt markets. I planned in Part II to describe the Argentinean debt deal, but in the interim Bloomberg published an article that elucidates this matter in sufficient detail (Levine 2014). Furthermore, the document describing the debt settlement is available online (Securities and Exchange Commission 2005). I cannot claim to have read the entire document—219 pages of prospectus and approximately 150 pages of supplement—but I gleaned enough by browsing. It contains interesting information on how international debt is settled, and if I were to teach international finance, I would make a case study out of it.

The only note that I want to make concerning this enormous document is that, in my understanding, Judge Thomas Griesa based his judgment on a very questionable application of the text (page S-67) that designates Bank of New York as a “paying agent and transfer agent.” The purpose of this designation probably was to ensure correct tax reporting of the disbursements and had nothing to do with the settlement itself, because in several places the document mentions “Bank of New York” and “government of Argentina” interchangeably as the controlling authority.


As a rule, sovereign bonds are not collateralized. This stems from the fact that a recovery of collateral is impossible with respect to a sovereign obligor. In the less-enlightened nineteenth century, there existed a practice of military sanctions—hence the term “gunboat diplomacy”—with respect to debtor nations. Since the time of the formation of the League of Nations, these methods have been correctly viewed as contributing to international instability.

The question of how to manage sovereign debt arose before the establishment of the League of Nations, in the handling of German reparations after World War I (Clough and Cole 1952). In 1930, the BIS (Bank for International Settlements) was formed to manage the annuities payable as reparations (Bank for International Settlements 2015). (I tried to clarify for myself the institutional relationship among the BIS, IMF [International Monetary Fund], and World Bank, but to no avail; this was probably as futile as the attempt I made while in business school to figure out the difference between Fannie Mae and Freddie Mac.) Yet John Maynard Keynes (1920) immediately recognized the drawbacks of the German settlement; his proposals came to fruition in the creation of the IMF and World Bank after World War II.

To get to the essence of Keynes’ argument, we must go further back into economic history. In a famous thought experiment by David Hume, suggested that if all specie suddenly disappeared in England, things would return to normal after a short period of adjustment. Indeed, domestic salaries would fall, leading to accelerated exports, diminished imports, and the growth of domestic substitution until the country’s monetary position restored the balance of trade.

Post-Keynesian thought revised this outcome because, unlike Adam Smith’s imagined economy of pie bakers and cobblers, modern economies require investments with long-term commitments of funds. Furthermore, Smith’s concept did not apply to Germany because international trade in the aftermath of the World War I was, as it is now, far from free.

The finances of Weimar Germany, like those of any country in a similar predicament—modern Argentina, for example—suffered a triple whammy. First, with no currency reserves, the nation could not make up for the lack of private investment with government programs. Second, although the classical argument says that foreign investment can remedy the lack of domestic private investment as long as there are profitable production opportunities, there was no guarantee that foreign investors could repatriate their profits. Finally, because of its distressed finances, the country could not borrow on the international financial markets. Post–World War I German governments found their way through the hyperinflation of national currency, and the rest is history.


Other countries will inevitably push back against American courts’ expansion of judicial powers and will attempt to form financial structures independent of the system that the U.S. created with such effort after World War II. While these attempts will reflect a relative shift of economic power from the West to Asia, the opinions of Asian governments are divided on the merits of accelerated movement in that direction. In October 2014, China and 20 other countries agreed to form the AIIB (Asian Infrastructure Investment Bank), despite concerns expressed by the U.S. Department of State about the ambiguous nature of the new entity (Reuters 2014). The U.S., along with Japan and many European countries, is a major financial backer of a rival bank, the ADB (Asian Development Bank). Singapore, a member of the ADB, has decided to join the AIIB.

Judge Griesa’s ruling has echoes in the way receivership covenants are stated in new borrowings—by Kazakhstan, for example (Moore 2014). While this gives more accurate language in debt agreements provides me some reassurance against arbitrary confiscation of related funds, I have no doubt that the U.S. Congress and courts, prompted by big donors, will find even more sophisticated ways to get hold of the assets of weaker nations, which will result in even greater pushback. In 1979, President Carter called for the seizure of Iranian funds in retaliation for the taking of American hostages; now, someone at the level of federal judge or Treasury official can attempt to take the assets of a sovereign nation for much less compelling reasons. The city of Providence, R.I., is suing Brazilian company Petrobras over ostensible losses suffered by investors in that company (BBC 2014).

I find the dynamics of this situation to be analogous to schoolyard bullying. When bullied students cannot overcome the bullies, they can try to establish alternative game venues in which a more equitable balance of forces prevails. Bullies may succeed in disrupting some of these. However, the goal is not to defeat the bullies, but rather to complicate logistics for them so that most of the weaker classmates can escape unmolested at any given time.

While my premonitions will not find favor with neoconservatives in Washington, I propose the following steps to prevent the world financial system from dissolving into separate and nearly isolated playgrounds. First, CDSs (credit default swaps) must be recognized as one-sided bets on financial outcomes entailing no obligations for the debtors. In particular, if hedge-fund claims on Argentinean debts resulted from their CDS positions, similar claims must be declared null and void in the future.

Second, a way to avoid an avalanche of spurious financial claims in American courts—claims that the U.S. government would be obliged to enforce but that might violate international treaties—would be the creation, under the IMF’s auspices, of SDR-denominated (special drawings rights) vehicles that could only be used to satisfy claims of holders of a particular sovereign bond. Such vehicles could be capitalized by the borrowing countries themselves or by an international consortium. I have no doubt that judges and members of Congress would find creative pretexts to sanction IMF donor countries on behalf of their wealthy donors or political agendas, but this would make their task slightly more difficult.

Finally, there is the question of securitization of sovereign debt by a third party. One such action was initiated in 2004 with respect to Greek bonds and dubbed by one Greek banker as “buying fire insurance on one’s neighbor’s house.” In an ideal world of completely efficient markets and politically independent courts, the securitization of sovereign debt would not be considered objectionable. In the real world, the idea that securitized debt notes are only the pass-through entities, which do not entail any rights on the part of the holders to sue the original issuers, is rarely appreciated.

Similar abuses occurred in seventeenth-century Holland, where it was possible to buy life insurance on an unrelated person and then hire cutthroats in Amsterdam port for a fraction of the premium. At least, unlike hedge-fund managers, these wrongdoers were slightly deterred by the possibility of being quartered and nailed to a post—a typical punishment at the time—if their agents got caught and talked under torture. When Dodd-Frank legislation tried to prohibit similar practices with respect to mortgage-based securities, which were considered to be a culprit of the 2008 financial collapse, Wall Street revolted.

Nations paid dearly in World War II for the rapacity of the victors of World War I and their desire to impose unilateral settlements on the weaker members of international community.

The revision of the international financial system to reflect the relative shift of economic activity from the West to Asia must be managed more wisely.

–Peter Lerner, MBA, PhD, is a semi-retired financial researcher who lives in Ithaca, NY.


Bank for International Settlements. 2015. “BIS History—Foundation and Crisis (1930–39).” 

BBC. December 26, 2014. “Brazilian Oil Company Petrobras Sued by U.S. City.” 

Clough, Shepard Bancroft, and Charles Woolsey Cole. 1952. Economic History of Europe. Boston, MA: D. C. Heath & Co.

Keynes, John Maynard. 1920. The Economic Consequences of the Peace. New York, NY: Harcourt, Brace and Howe. 

Levine, Matt. October 31, 2014. “Hedge Fund Thinks Fighting Argentina over Bonds Looks Fun.” Bloomberg View

Moore, Elaine. October 5, 2014. “Kazakhstan First to Introduce Post-Argentina Bond Contracts.” Financial Times.

Reuters. October 24, 2014. “Three Major Nations Absent as China Launches W.Bank Rival in Asia.”

Securities and Exchange Commission. January 10, 2005 [December 27, 2004]. “The Republic of Argentina.” Prospectus and Supplement


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