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Abstract:
This Article maps financial crisis containment - extraordinary measures to stop the spread of financial distress - as a category of legal and policy choice. I make three claims.

First, containment is distinct from financial regulation, crisis prevention and resolution. Containment is brief; it targets the immediate term. It involves claims of emergency, rule-breaking, time inconsistency and moral hazard. In contrast, regulation, prevention and resolution seek to establish sound incentives for the long term. Second, containment decisions deviate from non-crisis norms in predictable ways, and are consistent across diverse countries and crises. Containment invariably entails three kinds of choices: choices between wholesale and case-by-case response to financial distress, choices about whether to enforce private contracts and government regulations, and choices about distributing losses from crisis. I illustrate these with case studies from Indonesia in 1997-1998, Japan in 1994-1998, the United States in 1933, Argentina in 2001-2002, and Mexico in 1982. Third, containment measures are costly, but so is failure to distinguish containment from other tasks. Governments use prevention and regulation rhetoric to delay crisis response and to obscure distribution. Once they admit to a crisis, officials may leverage the urgency of containment to secure far-reaching economic reform.

Isolating and mapping containment can help recast well-worn crisis policy debates, and make crisis response more transparent and accountable.

Financial crisis, systemic crisis, systemic risk, economic emergency, financial regulation, crisis containment, macroprudential regulation, financial regulation, IMF, central bank, Japan, Indonesia, Argentina, Great Depression, Gold Clause, bankruptcy

Abstract:
On September 2, 2008, a group of leading sovereign wealth funds (SWFs) agreed on generally accepted principles and practices. The process that created the so-called Santiago Principles is important in its own right, as a milestone on the way to what might become international financial architecture. Since SWFs rose to prominence two years ago, they have been trapped in sterile domestic arguments between national security and open investment. These have obscured SWFs' significance and the governance challenge they present. The challenge reflects the power shifts and culture clashes of financial integration, which, thanks to capital flow reversals, no longer looks like an exercise to remake the world in the Anglo-American image. Integration goes beyond opening borders to trade and investment. It entails assimilating public capital in private markets on a vast scale, dealing with new forms of financial organization, and marrying financial systems premised on very different ideas about the role of the state in the economy. The task of governing global finance entails making coherent, legitimate, and accountable a patchwork of public laws, private codes, bureaucratic networks and institutional remnants left in last century's wake. Because SWFs embody so many recent shifts in finance, the new principles go to the heart of the governance task. Their ultimate success or failure will be equally telling. In the meantime, states that had played a limited role in shaping the norms of international finance have taken the lead writing the rules. Competitors came together in a policy coordination forum, and in a substantive, non-hierarchical relationship with established international institutions. Funds from wildly different political systems have had to negotiate domestic and external demands, and reconcile conflicting visions of mixing public and private.

Sovereign wealth funds, IMF, international finance, financial architecture

Abstract:
Not long ago, financial markets in most poor and middle-income countries were shallow to nonexistent, and closed to foreigners. Governments often had to rely on risky borrowing abroad; the private sector had even fewer options. But between 1995 and 2005, domestic debt in the emerging markets grew from $1 trillion to $4 trillion. In Mexico, domestic debt went from just over 20% of the total government debt stock in 1995 to nearly 80% in 2007. Foreign and local investors are buying. Over the same period, derivative contracts to transfer emerging market credit risk surpassed the market capitalization of the benchmark bond index. The growth of domestic bonds and risk transfer technology makes the emerging markets look more mature, or mainstream. Yet a closer look at recent changes suggests that the popular rhetoric of mainstreaming and convergence obscures more than it reveals. Emerging and mainstream markets may share participants and use similar instruments, but this formal resemblance rarely stands for substantive identity. Instead, investors use the same instruments differently in different markets, which, as the examples in the text suggest, can be its own source of risk. Law scholarship has yet to engage with the shift from foreign-law, foreign-currency to local-law, local-currency bonds and the rise of credit derivatives in the emerging markets. This symposium essay maps the ongoing transformation to highlight gaps between formal and substantive convergence of emerging and mainstream markets, and suggest implications for governance, risk management and future research.

emerging markets, sovereign debt, credit derivatives, domestic debt, development, financial integration, securities regulation, financial crisis

Abstract:
Modification-proof contracts boost commitment and can help overcome information problems. But when such rigid contracts are ubiquitous, they can function as social suicide pacts, compelling enforcement despite significant externalities. At the heart of the current financial crisis is a contract designed to be hyper-rigid: the pooling and servicing agreement (PSA), which governs residential mortgage securitization. The PSA combines formal, structural and functional barriers to its own modification with restrictions on the modification of underlying mortgage loans. Such layered rigidities fuel foreclosures, with spillover effects for homeowners, communities, financial institutions, financial markets, and the macroeconomy.

This Article situates PSAs in the context of theoretical and policy debates about contract rigidity, bond contract modification, and contractual bankruptcy. We propose a typology of contract rigidities, ranging from outright prohibition on amendment (formal rigidity) to extreme collective action problems (functional rigidity). We then draw on New Deal jurisprudence for strategies to overcome each kind of rigidity. These strategies include narrowly tailored legislation that renders the problem terms unenforceable on public policy grounds, administrative restructuring mandates, and special bankruptcy regimes.

The New Deal experience highlights the spillover effects of widespread contract practices, the limits of voluntary modification, and the utility of targeted government mandates to rewrite problematic terms. However, it also reveals the limits of such mandates. When different kinds of rigidity combine in a complex web of contracts, a comprehensive mechanism like bankruptcy may be necessary to break the logjam. Rewriting PSAs will not resolve today’s financial crisis. Yet voluntary foreclosure prevention initiatives are unlikely to succeed for as long as contract rigidities persist. The experience with PSAs also holds an important lesson for the future: even where contract rigidity makes perfect sense for the parties, pervasive rigidities can have catastrophic social consequences. A toolkit to overcome different forms of rigidity is essential to financial stability.

securitization, mortgages, foreclosure, servicing, PSA, pooling and servicing agreement, gold clauses, New Deal, public utility holding company act, Frazier-Lemke Act, contract, collective action, workout, modification, externalities, MBS, RMBS, bankruptcy

Abstract:
Political support for Argentina's currency board rested on distributing the early gains from ending hyper-inflation and the spending made possible with access to external credit. When these gains were exhausted and external shocks left the peso overvalued, neither Argentina's political system nor its economy could adjust. The needed adjustment went well beyond simple fiscal tightening: it required deciding who would incur the financial losses associated with the deep contraction needed to correct a real over-valuation in a heavily indebted economy. By 2000, Argentina faced the prospect of further economic contraction, a banking crisis and an external sovereign debt crisis. Even if none of the three crises was avoidable, preemptive action might have made one or more of them less severe. Yet preemption was a political orphan - no political constituency in Argentina argued to bring some pain forward for a chance of less pain down the road, and the IMF and G-7 preferred continued financing to the political risk of supporting a new macroeconomic strategy.

Abstract:
Argentina recently completed the largest sovereign bond restructuring in history. As soon as the government announced the results of its $100 billion tender in March 2005, editorial pages worldwide heralded a new era for sovereign debt, for the emerging markets and, occasionally, for international finance. Their views on Argentina's lessons were as disparate as they were definite. Some said the exchange would close the markets to middle-income countries. To others, it reaffirmed the markets' resilience. Some claimed it proved the need for statutory sovereign bankruptcy. Others said it clearly discredited the idea. Most spoke too soon. The deal took months to settle, and by the time it did, it had confirmed many presumptions about emerging-market debt and shattered none. The real lessons of Argentina's restructuring so far are more subtle and complex than the surrounding commentary. The default and the debt exchange were both points in a longer financial restructuring process that began before the default and will go on for years after the exchange. Argentina's unorthodox debt management immediately before and after the default is partly responsible for the outcome of the exchange. With $25 billion in defaulted debt still outstanding, Argentina's most important innovations may well be ahead.

sovereign debt, international finance, emerging markets, international law, international institutions, IMF, Argentina, Latin America

Abstract:
This article revisits a recent shift in standard form sovereign bond contracts to promote collective action among creditors. Major press outlets welcomed the shift as a milestone in fighting financial crises that threatened the global economy. Officials said it was a triumph of market forces. We turned to it for insights into contract change and crisis management. This article is based on our work in the sovereign debt community, including over 100 interviews with investors, lawyers, economists, and government officials. Despite the publicity surrounding contract reform, in private few participants described the substantive change as an effective response to financial crises; many said it was simply unimportant. They explained their own participation in the shift as a mix of symbolic gesture and political maneuver, designed to achieve goals apart from solving the technical problems for which the new contract terms offered a fix. Contract terms were adopted for what they said, instead of or in addition to what they did.

Contract, boilerplate, sovereign debt, development, emerging markets, financial crisis, IMF, sovereign bankruptcy, collective action clause

Abstract:
In November 2006 Wal-Mart's Mexican subsidiary received approval to open a bank. The application faced little opposition in Mexico, unlike the company's failed effort to start a bank in the United States. This was partly because in Mexico, Wal-Mart's entry was generally regarded as increasing competition in a historically concentrated banking sector. With over three-quarters of all Mexicans unbanked, the authorities also looked to Wal-Mart to reach the underserved. Along with the promise, Wal-Mart's entry presents a transnational regulatory dilemma with implications beyond Wal-Mart and Mexico. Because it is Wal-Mart's only banking venture, the new institution will have its Mexican host as the sole supervisor. The corporate headquarters in the United States will remain unregulated at home and beyond Mexico's reach. This home-host hole is inevitable where supervisory harmonization proceeds against the background of regulatory diversity: the United States has a policy against combining banking and commerce; Mexico does not. The hole presents risks for Mexico; however, this Article argues that patching the hole with more centralization at the international level may come at Mexico's expense.

Mexico, bank regulation, financial crisis, Basel Committee, Wal-Mart

Abstract:
This article argues that the doctrine of Odious Debt, which has enjoyed a revival since the U.S. invasion of Iraq in 2003, frames the problem of odious debt in a way that excludes most of the problematic obligations incurred by twentieth-century despots. Advocacy and academic literature traditionally describe the odious debt problem as one of government contracts with private creditors. Most theories of sovereign debt key off the same relationship. But in the latest crop of cases, including Iraq, Liberia, and Nigeria, private creditors represent a small fraction of the old regime's debts. Most of the creditors are other governments and public institutions. Private and official sovereign debt share formal similarities (such as the promise to repay), but are far apart in substance. Unlike private debt, official debt is never extended at arm's length or for direct economic gain; the usual goal is policy influence over the borrower. Governments often lend in dire economic circumstances where no arm's length money is available and repayment prospects are dim. The article suggests that these transfers are not really debt, but rejects the popular view that they are disguised grants. It uses the case of official debt as a starting point to explore the significance of debt form in sovereign finance. It focuses on the apparent disconnect between the form of official transfers and the substance of the economic and political relationship it represents to draw out implications for debates about odious debt and beyond.

odious debt, sovereign debt, foreign aid, debt relief, development, conditionality, Paris Club

Abstract:
Until recently, governments borrowed from domestic residents and foreign investors using very different instruments. Residents bought "domestic debt" - paper denominated in local currency and governed by domestic law. Foreign investors preferred "external debt", which offered foreign currency and foreign law. Because there was virtually no overlap between resident and nonresident holdings, it mattered little that lawyers and economists defined domestic and external debt differently: lawyers focused on features such as governing law and jurisdiction, economists on the holder's residence and currency of denomination. The legal and economic definitions of domestic and external debt were effectively bundled: "domestic debt" meant local-currency, local-law instruments held by local residents; "external debt" meant foreign-currency, foreign-law instruments held by foreign investors. In the end, lawyers and economists spoke of the same paper. Liberalization of the international capital markets has changed this. Foreigners now routinely invest in local currency, domestic law debt, and residents often dominate international sovereign bond issues. With these changes, the legal and economic definitions of domestic and external debt have unbundled. This change in the pattern of sovereign borrowing demands a new way of framing the core issues that arise in a financial crisis. Most existing approaches focus disproportionately on one set of legal instruments: foreign currency sovereign bonds governed by foreign law. Our essay argues that this focus is misplaced. It is the product of an analytic prism that no longer reflects reality well enough to offer a useful guide to crisis management.

sovereign debt, emerging markets, argentina, turkey, russia, financial crisis

Abstract:
Iraq and Argentina each launched a $100 billion debt restructuring last year. The two cases are rarely mentioned together. Most think of Argentina as the quintessential case of financial globalization gone awry - a lapsed market reformer that sank under the weight of (depending on your perspective) misguided liberalization or its own financial chutzpah, and took with it Argentine depositors, Italian retirees, Japanese banks, and offshore investment funds. Iraq's debt has a distinctly preglobalization flavor. Most of its obligations precede the recent wave of financial liberalization. In the words of Iraq's own advisers, its debt restructuring is a quintessential geopolitical case, a classic outlier framed by strategic more than financial concerns. Aside from the obvious intuition that no case of government debt is immune from politics and no multibillion dollar restructuring is devoid of finance, Argentina and Iraq appear to be on opposite ends of the finance-politics spectrum. Despite, or because of this distance between them, each of these two restructurings offers insights for policy and doctrinal problems normally associated with the other. This essay focuses on two such problems: shielding sovereign debtors from lawsuits, now most acutely associated with Argentina, and restructuring debts inherited from bad regimes, such as those Iraq had incurred under Saddam Hussein. Early evidence reveals that existing legal, policy and financial techniques offer governments considerable flexibility to achieve deep debt relief and frame it in the political terms of their choice. These techniques, invoked ad hoc with the blessing of major economic powers and accepted by the financial markets, help preempt the emergence of more radical doctrines such as sovereign bankruptcy and odious debt.

Abstract:
For over a decade, contracts literature has focused on standardization. Scholars asked how terms become standard, and why they change so rarely. This line of inquiry painted a world where a standard term persists until it is dislodged by another standard term, perhaps after a brief window of ferment before the second term takes hold. It also overshadowed the early insights of boilerplate theories, which described contracts as a mix of standard and customized terms, and asked why the mix might be suboptimal. This article brings the focus back to the mix. It examines the development of selected provisions in sovereign bond contracts after a widely publicized boilerplate shift in 2003. The adoption of collective action clauses in sovereign bonds five years ago moved the documentation standard in New York closer to the prevailing practice in London. However, contrary to expectations, the shift away from old boilerplate did not lead to convergence around new boilerplate. Issuers in London and, to a lesser extent, in New York, have been experimenting with diverse formulations and institutional arrangements, including trustees and creditor committees. The contracts we study, as well as our interviews with practitioners and officials, suggest that standardization may be a matter of degree, that the degree of standardization may vary across different markets, and that a shock of the sort that led the 2003 shift may dislodge a previously standard term without replacing it with a new standard - erstwhile boilerplate becomes a platform for customization.

Sovereign debt, collective action clause, sovereign bankruptcy, IMF, innovation, standardization, boilerplate

Abstract:
Every sovereign debt restructuring in recent memory has wrestled with the problem of inter-creditor equity. Governments have discriminated among creditors in ways that were hard to predict and often were not revealed until after a debt default. In contrast, debts of firms, individuals and even localities are ranked in order of priority established by contract and statute. This ranking is known at borrowing, generally corresponds to the order of repayment in bankruptcy liquidation, and helps define the creditors' relative bargaining power in reorganization. Without a bankruptcy backstop, most debts of national governments are legally equal. Yet in practice, sovereign immunity empowers a government to choose the order of repayment among its creditors based on political imperatives, financing needs, reputational concerns or any other considerations. A transparent, enforceable priority system for sovereign debt could reduce the risk of involuntary subordination, the attraction of lending to overindebted governments and the need for collateral. When all else fails, such a system could make restructuring less messy. But an effort to imagine sovereign priorities shows both the utility and the limits of domestic bankruptcy as a source for solutions to sovereign debt crises. This article suggests that while incremental improvement is possible and desirable, in the sovereign context, the most robust priority structures are doomed to fail.

sovereign debt, emerging markets, sovereign bankruptcy, international law, IMF, Latin America, Argentina

Abstract:
The traditional view of sovereign debt as a relationship between a developing country government and and its foreign private creditors is increasingly out of date. Financial institutions and individuals inside the borrowing countries are are becoming more and more important as creditors to their governments. At the same time, as countries remove restrictions on cross-border capital flows, foreign creditors are participating more actively in domestic law, local-currency debt markets. These developments imply fundamental changes in lending decisions and, where the loan goes bad, in the sovereign debt workout process.

sovereign debt, international finance, emerging markets, domestic and external debt, development

Abstract:
This essay highlights a phenomenon that has no place in the conventional theory of sophisticated business contracts: the term that makes no sense as an enforceable promise, one that defies functional explanation, one that drafters blush to rationalize in retrospect or chalk up to honest mistake. The subset of contract drafters and negotiators who stop and think about the term before the contract is signed know that it has little enforcement value. Even if a court were to enforce such a term, its interpretation would be extremely hard to predict at signing. Nevertheless, such clauses get included in contracts between sophisticated parties. Why? We speculate that some nonsense terms are in business contracts because the process of formalizing certain sentiments about the parties’ relationship in an official and routine manner characteristic of business contracting provides value to the parties. We suggest that such value is, at least in part, the satisfaction of expressing their sentiments publicly and formally.

Business contracts, sovereign debt, formalism

Abstract:
This essay considers standard-form over-the-counter (OTC) derivatives contracts from an organizational perspective. OTC derivatives contracts are highly standardized and have a peculiar modular structure. Most are drafted by a single trade group, which is not party to the contracts. These features in turn shape the behavior of the trade group, the contracting institutions, national regulators, and the global financial markets.

contracts, organizational theories, derivatives, financial markets, ISDA