The dangers of sovereign debt default

Greece is featuring regularly in the news at present, chiefly because of the possibility that it will not be able to fulfil its sovereign financial obligations and, therefore, may have to default on its debt repayments.  Greek workers are currently striking in protest at the austerity measures that their government is proposing/implementing. These workers are understandably angry that they are paying the price for many years of political mismanagement and corruption.

Greeks need to realise is that the consequences of default may make life even harsher for them than what their government is now proposing. Default is a situation a country should avoid at all costs (no pun intended).  Just because a country defaults does not mean that its debts are forgiven.  In fact, default can place onerous burdens on a country and its peoples for years.  For a start, borrowing money on global markets becomes that much more difficult, and the higher (penalty) interest rates charged effectively suck more precious money out of the system.  There are several South American countries — serial defaulters — that have periodically lost all access to sovereign debt markets.

Greek farmers protesting

Czar Bonds and repudiation of Russian debt by the Communists

Less common than default is debt repudiation, or refusal to either acknowledge or repay an existing sovereign debt. This situation typically occurs when there is a revolutionary change of government, with all key examples involving Communist takeovers of countries. Russia in 1917, China in 1949, and Cuba in 1960 all repudiated debt incurred by previous political regimes. Note, however, that this is a unilateral act and has little weight in the international community and the debt does not disappear from the records.

Take the case of Russia, for instance, and the repudiation of Czar-era debt in 1917 by the new Soviet government. Much of this debt was contained in Imperial Russian Bonds, also known as Czar Bonds, which were bought up in huge amounts right across Europe. These bonds were issued in the 1900s, when Russia was in dire financial straits under the reign of Czar Nicholas II. To raise necessary capital, these sovereign bonds were sold to the public right across Europe.  They were especially popular in France, where encouraged by the French government of the day, almost 50 per cent of French households invested in them. Consequently, large numbers of French families still hold Czar-era bonds.  Things turn sour in 1917, when following the revolution, the newly formed Communist government refused to honour any borrowings made by the former Czarist regime. As such, the bonds were deemed largely worthless for many decades – many were thrown away or just left to rot at attics.

For the French who retained the bonds, however, hope for a settlement was reignited in 1986 when the Soviet government changed tack and settled with British holders of Czar Bonds. This settlement was not for any altruistic reasons but because the Soviets wanted to get hold of large amounts of Czarist money frozen in 1917 that was still sitting in British banks. Logically, it follows that you cannot, on the one hand, refuse to repay Czar-era debt while, on the other hand, claiming Czar-era money, so a final compromise was reached with the British government and over £46 million was paid out to bondholders.

The French did get a settlement of sorts in 1996 when the Yeltsin government paid $400 million in an agreement with the French government. But large groups of bondholders refused to accept the payment, saying it was far too small, arguing instead that the amount should have been in the billions. In fact, Bloomberg last week reported that these outstanding bonds could be worth $100 billion!

This issue has arisen again recently because the Paris-based International Federative Association for Russian Bond Holders, or AFIPER, announced that it will be trying to recoup part of the century-old debt through the courts. It will be going after Russian property in both Paris and Nice. The property in Nice is the largest Orthodox cathedral outside of Russia and it was returned to Russia a few weeks ago by a French court:

The court upheld the Russian government’s position that since the czarists had bought the land and built the church using state money, the cathedral remains the property of the Russian government, meaning that Moscow could legally reclaim it now that ACOR’s lease has expired. Decades of Soviet uninterest in the property, the court decided, did not undermine Russia’s entitlement to it today.

And in Paris, the bondholders are targeting a recent purchase by the Russian government of the Meteo France building near the Eiffel Tower for an undisclosed sum.

The Russians have vowed to fight any court action, arguing that “when Russia made a $400 million payment that France said “definitively” settled debt incurred to it before 1945.”

Not so, said Eric Sanitas, director of AFIPER, which estimates that as many as 10 million czarist bonds may be in French hands: “The Russian state owes the French people a lot of money and there is no date limit for that, even if some of this debt is more than 100 years old,” .

Russian Czar Bonds can still be found on eBay

Mississippi: the oldest unpaid debt on record

In the oldest and one of the more reprehensible cases of default, then repudiation, of debt was by the state of Mississippi in 1840. As the story goes, Mississippi issued $7 million worth of bonds in the 1830s and used the money to establish two banks—the Planters’ Bank and the Union Bank. Both banks failed spectacularly, brought down by poor investments. Displaying no sense of Southern honour, thenceforth, the State refused to honour the bonds, even holding a referendum in which the people voted not to repay any of the lost money (wouldn’t the people always vote for this if given the choice?).

But this did not let Mississippi off the hook. The London based Corporation of Foreign Bond Holders (CFBH), set up in 1868 to protect the interest of British bondholders who invested anywhere in the world, pursued repayment of these bonds for more than 100 years. A request by the CFBH for a settlement of this debt in 1878 was responded to by the Mississippi legislature with a resolution passed in 1875:

“By the provisions of the present Constitution, the State is prohibited from ever legalising these bonds, the clause, which was adopted in 1875, reading: “Nor shall the State assume, redeem, secure, or pay any indebtedness claim to be due by the State of Mississippi, to any person, association or corporation whatsoever, claiming the same as owners, holders, or assignees, of any bond or bonds known as the Union Bank bonds, or Planters’ Bank bonds.”

The CFBH’s pursuit of this debt across time can be seen in letters such as the following, which was sent to the New York Times in 1913. In it, the CFBH seeks to correct an earlier assertion in the newspaper about the good standing of Mississippi’s then-current credit position.

 “Mississippi, between 1831 in 1838, borrowed $7 million, for which she obtained full value, and the proceeds of which she invested in a Planters’ and Union Banks.  As long as the banks were financially successful the State paid her debt to the holders of the bonds.  But when bad times came and the banks failed, largely, it is believed, owing to unfortunate speculation, Mississippi suspended payments, and has since consistently refuse to recognize defaulted obligations.”

When the Soviets settled their Czar-era debt with the British in 1986, Michael Gough, director of the Corporation of Foreign Bond Holders stated that “The lesson is that defaulted debts don’t go away, and it would be a mistake for any debtor to think that we will forget. We are still after Mississippi 145 years later.”

Unfortunately, two years later, in 1988, the Corporation of Foreign Bond Holders was placed in receivership. Mississippi never paid up but, for what it is worth, Mississippi was never again able to raise money on the London financial markets.

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9 Responses

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