Crippling debt and bankrupt solutions

Henry C K Liu

This article appeared in AToL on September 28, 2002

Sovereign debts in local currency usually do not carry any default risk since the issuing government has the authority to issue money in domestic currency to repay its domestic debts. The only risk in excessive domestic sovereign debt comes from inflation. Investors in domestic-currency government bonds face only an interest rate risk, not default risk. Thus sovereign debts' default risks are exclusively linked to foreign-currency debts and their impact on currency exchange rates.

For this reason, any government that takes on foreign debt is recklessly exposing its economy to unnecessary risk from external sources. If foreign debt is used to finance exports, a trade deficit will be deadly. But even the benefit from a trade surplus will first go to the foreign lenders, and the rest will have to be invested in foreign assets to defend the exchange rate of the local currency, with little benefit left for the domestic economy, particularly if global competition for export markets requires suppression of domestic wages under a race-to-the-bottom syndrome. That is why all foreign debts will inevitably become unsustainable and turn into distressed debts that cannot be cured by the debtor governments.

A movement to tackle distressed sovereign dollar debts, particularly of the Heavily Indebted Poor Countries (HIPC), through an international bankruptcy regime has gained momentum in neo-liberal circles in recent years. A decade after feeble and ineffective attempts to resolve the Latin American sovereign dollar debt crises that developed in the 1980s, John Williamson of the Institute of International Economics (who coined the term "Washington consensus") proposed in 1992 an international legal mechanism for the revision of sovereign debt contracts "parallel to the Chapter 11 proceedings under the US bankruptcy law".

After the 1994 Mexican financial crisis, a Bondholders Council was proposed to negotiate the restructure of dollar government bonds, together with changes in future bond covenants to permit a majority to alter terms of repayment to avoid a country default.

Sovereign debt restructuring exercises have now become more complex and less manageable than in the 1970s and 1980s. The principal sources of financing then were syndicated loans floated typically as Eurodollar bonds, managed by a lead manager with the support of a relatively small group of other creditor banks. Even in the Korean and Brazilian debt restructuring in the 1990s, the tasks of aggregating loans and arriving at a common action were relatively simple.

Liberalization of capital markets has led to a proliferation of credit instruments whose management and control has become a major policy challenge. Claims held in a variety of jurisdictions, by diverse groups of creditors and in varying ranges of securities, currencies and instruments (from sovereign bonds, syndicated loans, mutual funds, trade finance, distress debts investment and debt derivatives) are virtually impossible to aggregate and consequently collective action becomes much more difficult, if not impossible.

In the face of this complexity, an enforceable and credible debt reorganization needs the sanction of an international treaty. The essence of the proposed IMF/Krueger Plan claims to be the introduction of changes in International Monetary Fund Articles of Agreement that would permit a "super majority" (analogous to the select committee of creditors under Chapter 11) to take collective action to make the terms of the agreement binding on the rest of the participants and permit the sanction of a collective action clause to form an integral part of future loan agreements, which would expedite the restructuring process, thereby gaining valuable time for the debtor. Wall Street is reported to be against the concept of super majority.

Former Harvard (now Columbia) economist Jeffrey Sachs, having landed Russia in gangster capitalism with his shock-treatment approach to instant reform, called in 1995 for the provision to transitional economies the basic protections available to corporate borrowers in the United States, and proposed an International Bankruptcy Court. While then US Treasury secretary Robert Rubin was sympathetic, his deputy, Lawrence Summers, criticized the corporate analogy as potentially misleading on two grounds: first because "the decision of a state to suspend its debt service is at least partly volitional", meaning politically motivated rather than financially based, and second because "the safeguards against moral hazard built into domestic bankruptcy codes cannot be applied to sovereign debtors".

The moral hazard problem permeating the system threatens to contaminate the gains of liberalized capital movements to make dreaded reintroduction of control of capital flow a rational alternative, as entertained by defecting Massachusetts Institute of Technology (MIT) neo-liberal economist Paul Krugman in 1998. US aversion to any independent international mechanism that would arrive at legally binding decisions puts it strongly in favor of a voluntary private contractual approach on any issue, including restructuring sovereign debts (RSD). The US approach to RSD in HIPCs is in sharp contrast to its domestic laws concerning bankruptcy-insolvency, which provide decidedly more enlightened support and protection to corporate and municipal debtors, a heritage dating back to its debt-ridden colonial days.

What all these neo-liberal RSD proposals fail to acknowledge is the fact that a government is not a corporation, former US president Ronald Reagan's anti-statist rhetorical assertions notwithstanding. Governments are not instituted merely to make profit for their power-brokering shareholders at the expense of the general population. A government belongs to the people, not a few special interest shareholders. Its job is to safeguard and improve the lives of the people by maintaining a safe and fair society with sustainable economic growth. Government cannot be run like a corporation, by externalizing the social costs of its actions to non-market sectors of the economy through failed market fundamentalism. Some governments do externalize such social costs to weaker nations through globalization, a policy historically known as imperialism.

Getting government off the back of the people and the market is a euphemism for gangster capitalism, which can thrive on Wall Street as well as in post-Soviet Russia.

In a market economy, the prime purpose of government credit is to stimulate employment and economic growth within a context of enlightened economic nationalism. Thus IMF insistence on fiscal austerity, increasing unemployment with an aim to service government foreign debt better, is irrational and self-defeating. Full employment with a fair and progressive tax structure strengthens sovereign credit rating through improved tax revenue with which to service sovereign debt, including foreign debt, even assuming that any government has any rational basis to incur foreign debt to begin with. Supply-siders mistakenly fixate on capital investment by focusing on corporate profits through layoffs and corporate tax reduction, sapping aggregate demand in the process and landing the global economy in overcapacity as a result.

When Walter Wriston of Citibank asserted three decades ago that countries do not go bankrupt, he was right on target. What Wriston failed to anticipate when he catapulted his bank into the largest international financial institution in the world by recycling petro-dollars in 1973 was that while countries do not go bankrupt, they can certainly default on their foreign-currency debts, as history has plainly shown.

The term "bankruptcy" can be traced back to Renaissance Italy, where private banking flourished by financing international trade and sovereign ambitions and, over time, evolved into modern financial institutions. A businessman unable to pay his debts then would have his trading bench destroyed and his collaterallized inventory foreclosed by his creditors. "Broken bench", banca rotta in Italian, gave rise to the word "bankruptcy".

The primary focus of bankruptcy was on recovering the creditors' exposure, not the welfare of the debtor. In old England, for example, penalties for bankruptcy could be draconian and ranged from debtors' prison to the death penalty. To this day, British bankruptcy laws are much more pro-creditor than those of the United States. Even in the US, early bankruptcy laws, while relatively pro-debtor as natural in a debtor nation, were temporary measures taken during bad economic times. Historically, when economic conditions improved, bankruptcy laws were repealed. Even now, bankruptcy laws are periodically amended to meet changing economic conditions and political weather.

Sovereigns do not go bankrupt. Impaired sovereign credit merely makes the next round of borrowing more costly or unavailable, which may serve as an effective cure for the neo-liberal financial market fundamentalist virus of foreign debts to finance exports under conditions of global overcapacity. RSD proposals are fancy pro-creditor gimmicks to keep HIPCs from invalidating debts saddled with serious lender liability issues.

The Bankruptcy Act of 1898 was the first piece of US legislation to extend protection to corporations from creditors and served as the foundation of today's Chapter 11 of the bankruptcy code. There have been many acts and revisions (Bankruptcy Act of 1933 and 1934 during the Great Depression, Chandler Act of 1938, 1978, the first major overhaul since the Chandler Act, 1980 Bankruptcy Tax Act, 1984 amendments to the 1978 Act, the 1994 overhaul of the 1978 Act).

From there the bankruptcy regime has evolved under case law, and as of 2002, new legislation is pending in Congress to make it more difficult for consumers to file a Chapter 7 bankruptcy (complete debt dismissal) and force them into Chapter 13 (reorganization) repayment plan. Recent scandals of corporate fraud have given impetus to passage of the new revised code. Top management of the 25 biggest recent US corporate bankruptcies walked off with US$3.3 billion from insider share sales, severance payoffs and other rewards while their shareholders were left with substantial or total loss.

When creditors suffer a loan loss, it is known in the trade as a haircut. It is an interesting image when one considers the fact that even after a person is dead, as bankrupt is financially dead, his or her hair will continue to grow for some period even in the grave. The IMF proposals appear to straddle the gray area between a default (ie, an involuntary haircut resulting in a reduction in net present value of debt) and a fully cooperative resolution (ie, a negotiated and voluntary haircut). The view the United States takes on the matter will determine which approach shall prevail. It is one of the ironies of the global debt regime that the world's largest debtor nation (the US) should have the most say about how others outside its borders must repay their debts on terms much harsher than within its borders.

Bankruptcy in the US today seeks the dual purpose of helping the debtor as well as the creditor by finding a happy medium where the debtor can comfortably meet his installment obligation and the creditors can recoup as much of their principal as possible. The main emphasis is on rehabilitating the distressed debtor with court protection from predatory foreclosure by individual creditors, so that creditors collectively can maximize their recovery through orderly reorganization of the debtor finances.

In general, a debtor does not need bankruptcy if there are no assets that creditors with judgments can attach, or the debtor's assets are exempt by law from seizure. This is generally the case in most HIPC distressed sovereign debts. Thus the application of a bankruptcy mechanism to sovereign foreign debt is fundamentally flawed. The worst that could happen to a sovereign in default would be lack of access to more foreign debt, a development that in fact would be salutary for most nations that have since learned from experience the evils of foreign debt.

Chapter 11 allows the corporate debtor to continue core business activities under court protection while reorganizing it's finances so that it may continue to pay it's retained employees, reduce immediate obligations to it's creditors and salvage the salvageable for it's shareholders. Under this chapter, the debtor retains possession of his assets and continues operation with DIP (debtor-in-possession) financing: new loans which are senior to all pre-bankruptcy obligations, to meet administrative expenses. The order of priming after DIP financing places secured creditors first, unsecured creditors next and equity owners last. In other words, if there is not enough money to pay secured and unsecured creditors, the equity owners (original shareholders) will be wiped out entirely. Obviously, a nation with distressed sovereign debt cannot be liquidated and taken from its people by private foreign lenders. That is why nations do not go bankrupt. And that is why Chapter 11 bankruptcy proceedings will not work in sovereign foreign debt resolution.

At the heart of Chapter 11 of the US Bankruptcy Code is an automatic stay of creditor actions against a debtor and a court-supervised preparation, confirmation and implementation of a plan of reorganization. This process is underwritten by the debtor-in-possession principle under which the debtor keeps control and possession of its assets.

The logic of developing a reorganization plan is straightforward. Since the value of an ongoing concern is greater than if its assets were liquidated in a fire sale, it stands to reason that it is more efficient to reorganize than to liquidate during financial distress, since reorganization can preserve jobs and assets. Thus the international counterpart of the bankruptcy vehicle must also warrant the development of a reorganization plan that safeguards domestic development and social objectives and priorities.

In practice, however, the focus of sovereign foreign debt restructuring has been to sanction officially the protection of foreign creditors, permitting them to exit non-performing loans at least cost while leaving the sovereign debtor with drastically scaled-down social and development goals and programs, usually under an IMF/creditor-sanctioned program of austere adjustment.

Sovereigns that unwisely assume foreign debt can and often do face foreign-currency liquidity problems and financial conditions analogous to insolvency but they cannot be subject to liquidation of assets as provided for in national bankruptcy laws. Sovereign debt problems cannot therefore be resolved in the same manner as corporate debt. Sovereigns cannot have a liquidation value: in case of default on foreign loans, creditor recovery value would depend on a large number of intangibles, including the sovereign's capacity to generate future foreign-exchange earnings and its political/strategic importance to the official creditor community.

The theory behind Chapter 11 is that an ongoing business is of greater value than if it is foreclosed on and assets liquidated at its worst financial phase. After a successful Chapter 11 reorganization, the business can continue with a restructured debt load and operate more efficiently than before and in doing so preserve jobs and asset value. Repayment of debts is made from future profits, proceeds from sale of some non-core assets, mergers or recapitalization. The shareholders will end up owning a small company or a company with only negative asset after debt obligations. Would citizens of HIPC after RSD through bankruptcy end up owning a smaller nation?

Municipality bankruptcy is handled by Chapter 9 of the US bankruptcy code. The first municipal bankruptcy legislation was enacted in 1934 during the Great Depression, Public Law No 251, 48 Stat 798 (1934). Although Congress took care to draft the legislation so as not to interfere with the sovereign powers of the states as guaranteed by the Tenth Amendment to the constitution, the Supreme Court held the 1934 Act unconstitutional as an improper interference with the sovereignty of the states: Ashton v. Cameron County Water Improvement District (1936). Congress enacted a revised Municipal Bankruptcy Act in 1937, which was upheld by the Supreme Court in United States v. Bekins (1938). The law has been amended several times since 1937, most recently in 1994 (amending section 109(c)) as part of the Bankruptcy Reform Act of 1994. In the more than 60 years since Congress established a federal mechanism for the resolution of municipal debts, there have been fewer than 500 municipal bankruptcy petitions filed.

Although Chapter 9 cases are rare, a filing by a large municipality can, like the 1994 filing by Orange county, California, involve huge sums in municipal debt. The December 6, 1994, declaration of bankruptcy was brought about by $1.7 billion in losses sustained by the 170-member municipal investment pool managed by Robert L Citron, the former county treasurer.

Citron, who managed the pool "successfully" for more than two decades, used a high-risk strategy of investing in derivatives, reverse repos (repurchase agreements) and leveraging that had generated extraordinarily high returns until the crash. Responding to the pressure to keep interest earnings high, Citron, guided by his investment bankers, speculated on interest rates remaining stable or decreasing and he sought to maximize his gains by aggressive use of leverage, borrowing against the assets of the portfolio.

Citron's strategy fell apart when interest rates began to rise and a substantial pool participant requested a return of its capital and interest. Within two months, one of the wealthiest local governments in the United States filed for bankruptcy, primarily to keep pool participants from draining the fund and thereby worsening the problem.

The bankruptcy disrupted the national municipal bond market, cost local governments around the United States hundreds of millions of dollars in higher interest costs, and has spawned widespread retraining for municipal finance officers and the revision or creation of hundreds of new municipal investment guidelines and policies. The sudden evaporation of public wealth forced drastic cuts of social services and investment all over the country.

Merrill Lynch had a two-decade relationship with Orange county. While it claimed that it warned Citron many times regarding the dangers of leverage (Merrill continues to defend the prudence of using derivatives and reverse repos to this day), it never informed the Board of Supervisors of its alleged concerns. Nor did Merrill's alleged concerns deter it from underwriting an additional $600 million bond issue for the county with all of the questionable practices fully in effect.

The county sued Merrill Lynch for $2 billion for its contribution to the bankruptcy. In his letter to Judge J Stephen Czuleger requesting leniency (printed in the Orange County Register, November 19, 1996), Citron states that he knew nothing about derivatives until Michael Stamenson and Charles Clough of Merrill Lynch told him that the instruments could earn pool participants a safe return with higher yield. If rich and sophisticated Orange county of California could be misled by Merrill, what chance would HIPCs have?

Public entrepreneurship is a management approach developed by the reinventing-government movement, part of the decades-long rise of neo-liberal market fundamentalism. Reinvention is a response to more than two decades of conservative attacks on the efficacy of government.

The Proposition 13 property-tax revolt in California in the early 1970s started a relentless public, media-fueled campaign for government to do more with less. The administrations of Ronald Reagan and Margaret Thatcher escalated those demands for smaller, cheaper government to the international level and forced many public officials around the world to search desperately for a way out of the resultant fiscal crisis they faced. For many, the answer was simply wholesale privatization of state monopolies, public utilities and services. For others, it was a time of giddy receptivity to the promise of speculative manipulation disguised as creative management innovation.

The proposals for the privatization of social security and the liberalization on speculative investing of private and public pension funds were part of this development. Reinvention attempted to provide risky strategies for improving public management in its time of fiscal crisis, including a recommendation that managers act entrepreneurially, taking risks that frequently ended in systemic disaster.

The transformation of traditional bureaucracy into agile, anticipatory, problem-solving entities is what reinventionists call "entrepreneurial government". French economist Jean Baptiste Say (1767-1832) developed the concept of entrepreneurship in the early 19th century as the shifting of resources out of an area of lower and into an area of higher productivity and greater yield. Say was unconcerned about whether higher yield represents greater social good. Nor was he concerned with the macro effect of the externalized cost of higher yield. Nor did he emphasize the high risk and failure rate entrepreneurs face.

Accordingly, the entrepreneurial public manager strives to use resources in new ways to increase efficiency and effectiveness, taking risks that drastically increase the prospect of failed government. Instead of regulating the market, government began participating in speculation in the market, leading to disastrous results.

Many governments in emerging economies, including those of Hong Kong and Singapore, continue to practice entrepreneurial government, most visibly with investment policies concerning their foreign exchange reserves. Hong Kong's Cyberport and the Disneyland project are potential examples of government entrepreneurship gone wrong.

Also, public and private pension funds managed by professionals wielding disproportionate market power in effect dilute market discipline. The deregulated market is no longer driven by millions of individual investors each making independent decisions based on self-interest, but by a handful of powerful fund managers who lead and manipulate the market to gain trading advantages through daily volatility they engineer.

Reinvention argues that entrepreneurs are not risk-takers, but opportunity-seekers. They fondly embrace the characterization of a successful entrepreneur as one who defines risk and then confines it, pinpoints opportunity and then exploits it. They ignore the natural odds of thousands of failures for every successful example in entrepreneurship.

Any organization can be structured to encourage or deter entrepreneurial behavior, and government organizations have no business trying to profit from systemic instability it must create in order to succeed. Yet public administration practitioners have jumped on the reinvention bandwagon with irrational exuberance.

Bill Clinton and Al Gore campaigned on reinvention in 1992 and 1996. Former New York mayor Rudolph Giuliani prided himself as a reinvention mayor. In early 1993, president Clinton gave vice president Gore the assignment of applying its concepts to the federal government. Many government leaders around the world, ever so eager for US ideological approval, were affected by this dubious US trend and promptly pushed their countries into financial crisis.

The purpose of Chapter 9 of the US Bankruptcy Code is to provide a financially distressed reinvented municipality protection from its creditors while it develops and negotiates a plan for adjusting its debts. Reorganization of the debts of a municipality is typically accomplished either by extending debt maturities, reducing the near-term payment of principal or interest, or refinancing the debt by obtaining a new loan backed by new taxes and budgetary austerity.
Although similar to other chapters in some respects, Chapter 9 is significantly different in that there is no provision in the law for liquidation of the assets of the municipality and distribution of the proceeds to creditors. Such a liquidation or dissolution would undoubtedly violate the Tenth Amendment to the US constitution and the reservation to the states of sovereignty over their internal affairs. Thus Chapter 9 is more applicable to HIPC sovereign debt restructuring, yet neo-liberals seem to prefer Chapter 11, which could lead to outright foreign control over the internal political affairs and economic policies of the debtor nation.

Chapter 9 acknowledges the fundamental importance of enabling local governments to continue to provide essential services to residents without interruption or harassment from its creditors. Accordingly, a central feature of this chapter is that only the debtor can file for bankruptcy. No involuntary bankruptcy petition from creditors can be entertained under Chapter 9.

Further protection is provided to the municipalities by forbidding courts and judges from exercising any influence on the political or governmental powers of the municipality (since it is accountable to the electors), or on any of its property or revenues or enjoyment of any of its income-producing assets. The process is also transparent and democratic in permitting interested parties such as municipal employees and their unions a role in a negotiated resolution of the problem. These protections are not available to HIPC debt resolution in IMF proposals.

Before 1970, 90 percent of international transactions were by trade, and only 10 percent by capital flows. Today, despite a vast increase in global trade, that ratio has been reversed, with 90 percent of transactions by financial flows not directly related to trade in goods and services. Most of these flows take the form of highly volatile stocks and bonds trades, mergers and acquisition transactions, foreign direct investment and short-term loans, made incalculably complex and opaque by the use of structured finance (derivatives).

Exchange-rate regimes, either pegged and floating, in unregulated global financial markets are the center of the problem. Until recently, the IMF has championed many pegged regimes as a way to ensure currency stability, albeit at a cost of independent monetary policy.

Pegged exchange rates have led to financial crises, as in Asia and Russia in 1997-98, Brazil at the end of 1998, Turkey and Argentina in 2001 and Brazil again in 2002. These were all situations where it was clear that the fixed exchange rate could not hold, yet the international banks lent foreign-currency loans with IMF blessing, even to sustain already collapsing currencies. These foreign-currency loans led to predictable financial crises, by forcing countries to drain their foreign-exchange reserves.

A profitable carry trade opportunity presents itself wherever exchange rates are fixed and interest-rate differentials emerge between two currencies. Then it is possible to borrow in the low-interest-rate currency and lend profitably in the high-interest-rate currency with no risk other than that of a failure in the fixed exchange rate. It is a profit that is subsidized by the high-interest-rate currency's central bank. Yet when large numbers of market participants catch on to the game, the fixed exchange rate cannot hold. When a central bank defends a fixed exchange rate under these conditions, it is in essence giving money free to all comers. And the money given away is in the form of foreign currency that the central bank cannot print.

The British Treasury gave George Soros a windfall speculative profit of $2 billion in a matter of days in 1992 by trying to defend the over-valued British pound. Six years later, in 1998, Soros lost $2 billion of his investors' money when Russia defaulted on its sovereign debt. The Russian default also brought down LTCM, the world's largest and most profitable hedge fund up to its sudden collapse.

Fixed exchange rates allow all governments to borrow from any bank or in capital/debt markets anywhere in the world where money is cheapest, with the full credit backing of their central banks. With this new competition for funds, international financial markets can force each nation to get their monetary and fiscal houses in order according to international standards set by the Group of Seven (G7) if they want to receive foreign loans with the lowest interest rates.

These interlinked capital/debt markets penalize any nation with budget deficits or that permits hints of inflation by simply selling off its currency, robbing it of its sovereign authority to exercise monetary and fiscal policies in its national interest, for example, providing government credit to fight unemployment and support national industrial policy. Domestic development is sacrificed to support neo-liberal globalization, a process that allows unregulated markets to reduce poor nations to permanent indentured-servant status.

On April 18, Senators Joseph Biden and Rick Santorum and Congressmen Chris Smith and John LaFalce introduced companion bills in the House of Representatives and the Senate called the "Debt Relief Enhancement Act of 2002", S 2210 and HR 4524. These bills seek to amend the existing HIPC debt initiative of the IMF and World Bank with more generous terms, relieving qualified countries from having to pay more than 5 percent of its budget on debt service annually (10 percent if the country has no health crisis) from the level of over 60 percent in many countries. This would nearly double current debt relief by cutting an additional $1 billion in debt service payments.

HIPCs alone are making payments on an estimated debt of more than $220 billion at exorbitant interest rates. When other very low-income countries such as Nigeria, Bangladesh, Haiti, Peru, and the Philippines are included, the total is more than $350 billion. The Senate version of the bill would require that HIPC debt relief not be conditioned on certain policy measures often associated with "structural adjustment programs" including user fees on health care and education, the forced privatization of water, policies that degrade the environment or weaken labor standards. While this bill is a step in the right direction, it is merely a drop in the bucket.

Bank of International Settlement (BIS) regulations and the way that financial market liberalization has been expedited have exposed vulnerable countries to massive amounts of short-term foreign debt. IMF intervention, in situations where the panic is just starting, has often inflamed the panic or exacerbated it rather than calmed it.

In Indonesia, the IMF forced the closure of 16 commercial banks on November 1, 1997. The absence of deposit insurance set off a banking panic that set the country on political fire. IMF bailout loans not only did not prevent capital outflow, such loan often made it possible for capital to flee safely.

Even in the Mexican bailout, where the US Treasury put in the most money, it did not stop the panic through a return of so-called "confidence", which all monetarists talk about though few can identify what it is. The bailout money merely funded the outflow of previously trapped short-term capital.

The bailouts - $57 billion for South Korea, $41 billion for Brazil, $22 billion in the July 1998 program for Russia, the Mexican bailout - all went to finance the immediate outflow of financial capital. The new IMF $30 billion Brazilian bailout is no different. The money all went directly to the international creditors while imposing austerity on the local economies.

The conventional syndicated loan takes shape in stages. The first stage is where the borrower issues a mandate letter authorizing a lead bank to arrange the loan on its behalf. In this role, the lead bank advises and negotiates with the borrower to establish the terms of the facility and then provides a term sheet to selected institutions with which it wishes to share the loan. It will act in ensuring that the borrower compiles an information memorandum about its financial circumstances and relays this information to interested syndicate members. These memoranda are normally based on the forward-looking information provided by the borrower and are usually subject to disclaimers.

The position of the lead bank in this situation, in negotiating the terms of the loan agreement with other lenders, is that of an agent acting for the borrowers. In a syndicated loan, a number of lenders each agree to contribute a proportion of the loan through a single agreement. In a structural sense, there will normally be a pool of lenders (of which the lead manager is one), an agent for the loan, and inevitably a separate security agent who holds the security. This security agent will in almost all cases be a subsidiary of the lead bank.

In a participation, one lead bank will agree to take all of the direct loan at risk and lend the full debt amount. The lead bank will (often before drawdown but not always) seek participants to share either the risk or the funding. A participating financial institution will either take a funding or a non-funding liability. Where a participant is taking a funding liability it will be required to make advances to the lead bank matching an agreed proportion of the debt. It is not uncommon for participants to take a risk-only position, that is, that they will provide a contractual promise, letter of credit or bank guarantee to the lead lending bank. Funds are then payable to the debt provider upon default.

Participation can either be disclosed or undisclosed. Certain lenders take positions in undisclosed participation. There are a number of retail banks that, having moved to securitized products, now find that they have an appetite for use of their capital but not having retained teams with the required corporate management for syndicated loans. Time has shown this to be often an unwise decision both for the individual bank and for the system.

On September 30, 1996, Congress passed and the president signed into law a new statute, PL 104-208, that definitively establishes the standards for lender liability under the Superfund law, ie, the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA). One wonders why the IMF does not look to this legislation to extend lender liability to HIPC debt issues.

Many of these concepts and ideas provided the impetus for discussions and negotiations on RSD during the 1970s in the United Nations Conference on Trade and Development (UNCTAD) and at the Conference on International Economic Cooperation in Paris (1975-76). UNCTAD IV in 1976 provided the basis for decisions leading to the adoption of the first multilaterally agreed framework for the reorganization of official debt (Trade and Development Board resolution 222(XXI) of September 1980). This consensus resolution provides that international action should be expeditious and timely; enhance the development prospects of the country bearing in mind its agreed priorities and internationally agreed objectives; aim at restoring debtor countries' capacity to service its debt in both short term and long term and protect the interests of creditors and debtors equitably.

The "Operational Framework" accompanying the resolution establishes a number of guiding principles for the application of "common features" for debt reorganization. These include the principle that debt relief can be initiated only at the discretion of the debtor; and the recognition that debt problem may "vary from acute balance-of-payments difficulties requiring immediate action to longer-term situations relating to structural, financial and transfer of resources problem requiring appropriate longer-term measures".

Existence of externalities such as, for example, global consequences of unsustainable exploitation of natural resources to fund debt repayments or spillover/contagion effects on the international financial system of sovereign debt crises have been an important contributory factor in extending the search for solutions to debt problems beyond a particular sovereign's servicing difficulties.

Growing concern in the creditor community about the long-term viability of existing ad hoc and voluntary arrangements is perhaps the main reason for the IMF supporting the creation of independent machinery endowed with judicial powers to impose solutions on debtors and creditors alike. New legal strategies by individual creditors now pose serious threats to voluntary debt-restructuring exercises. By threatening interruption to the scheduled payments under restructuring plans, holdouts (as in the recent cases of some of Congo's and Peru's creditors) can nullify agreed arrangements and succeed in extracting full payments on its debts.

The present rules of engagement would therefore give the IMF a prominent role, by virtue of its earlier involvement and claims as a preferred creditor. The IMF also would assume for itself the role of analyzing the sustainability of debt, and be the likely lender of last resort in the standstill phase and during the post-restructuring period. Although the IMF/Krueger plan formally eschews a role for the IMF in the setting up of the mechanism (eg in the establishment of legal structures for debt reorganization), in the decision on initiating RSD, on whether or not to invoke and sanction a standstill (including imposing capital controls and a moratorium on debt service payments) and indeed in the design of a restructuring plan, it will in practice continue to have a decisive say at virtually all stages of the exercise.

The IMF now concedes that temporary controls may be necessary if a sovereign default threatens capital flight, undermining the country's ability to return to generalized debt servicing. But the advantages of controls have to be weighed against the risk that they might broaden a sovereign debt crisis to potentially solvent private firms. In any event, IMF insists that controls should be accompanied by policies that would allow them to be lifted as soon as possible. Countries should not be encouraged to leave them in place longer than they are needed.

Emerging markets have not performed well in recent years. Investment flows going through these markets have declined sharply; net private capital flows dropped from an average of $154 billion per year from 1992 through 1997 to $50 billion per year from 1998 through 2000.

Most sovereign foreign debts are unsustainable and restructuring often only postpones or exacerbates the problem. Ideally sovereign foreign debt should not be allowed to exist.

The neo-liberal aim of reforming the sovereign debt restructuring process is to maintain the incentives of sovereign governments to pay their debts in full and on time. Those incentives, primarily the benefit of continued access to foreign capital at market interest rates, may not be in a country's national interest. Proposals to have sovereign borrowers and their creditors put a package of new clauses into their debt contracts amounts to proposals of prenuptial agreements in marriages between parties of uneven wealth, usually to the disadvantage of the poorer party. Such clauses represent a decentralized, market-oriented approach to reform that deepens the root causes for the needs of reform.

These proposals for reform of the sovereign debt restructuring process should be exposed as an integral part of a broader strategy toward emerging markets to keep poor countries permanently chained to the tyranny of foreign debt and condemn them to the slavery of export to service such debt.

Foreign debt in the existing international financial architecture is in essence highway robbery of the poor countries by the rich in the form of predatory lending. Collective sovereign foreign debt default in a massive debtor revolt is the only rational solution, and lender liability action against foreign lenders is the only way out for the world's indebted poor.

A class-action suit claiming lender liability should be instituted at the World Court on behalf of the world's poor. Even if a judgment against the transnational banks is uncollectable, such a judgment will have value in future debt negotiations. Transnational banks will face regulatory and licensing problems in debtor jurisdictions with an unresolved judgment around their necks.

It is time that HIPCs exercised some debtor power. Remember, financial power under finance capitalism is not a function of how much you own, but how much you owe.