The Latest Argentine Default

Sovereign debt has long had a semi-fluid system of seniority, what Anna Gelpern calls a "seating chart". Back in the 1980s, countries were generally pretty happy to default on foreign bank loans. They occasionally defaulted to their fellow governments, too, but they generally never defaulted on foreign bonds: back then, bonds and loans were very different animals. At the top of the seniority spectrum were the "preferred creditors" - the IMF, World Bank, and other multilateral institutions who always got paid, no matter what.

Things changed over the years: when the Brady Plan turned loans into bonds, bonds lost a lot of their special status - although it's worth noting that as recently as 1998 Russia never defaulted on its Eurobonds even as it was defaulting on everything else. Nowadays, no one considers bonds to be at all senior to loans, and there's a fair amount of debate over whether foreign debt, generally speaking, is a safer proposition than domestic debt. Most interestingly, even the formerly-inviolate preferred creditor status is coming under attack.

The first chinks in the preferred-creditor armor started appearing in 2001, when the World Bank wrote a guarantee on public Colombian bonds. The structure was seemingly very clever: if Colombia ever defaulted on a bond repayment, the World Bank would pay up, and take on the debt. Since the World Bank was a preferred creditor, it would get paid back by Colombia, and the guarantee would then roll over to the next bond repayment. That way, a relatively small World Bank guarantee could underpin a large number of sequential Colombian bonds.

That structure was broken by Argentina in 2002, with the complicity of the World Bank. When Argentina defaulted on a bond guaranteed by the World Bank, the World Bank stepped in and paid up, as it had to - but then changed its repayment terms with Argentina so that the sovereign wouldn't need to pay the World Bank back before the next bond was due. So much for the clever "rolling reinstatable guarantee", which hasn't been used since.

Today, Alan Beattie has an excellent piece on another way in which people try to extend the World Bank's preferred creditor status to private-sector obligations. It's called ICSID, the International Center for the Settlement of Investment Disputes, and it's an arm of the World Bank. If a company has a dispute with a country, it can take that dispute to ICSID for binding arbitration. (The country also needs something known as a Bilateral Investment Treaty, but those are extremely common and verge on the ubiquitous.)

Because ICSID is part of the World Bank, any ICSID award has the legal status of a treaty obligation: it's considered a good notch or two senior to any other sovereign debt. Until now. Argentina has simply ignored that bit of international law, and hasn't paid out on its ICSID obligations even though it's remained current on most of its other debt. Dani Rodrik, for one, is sympathetic.

The lesson of this story is simple: if you think your sovereign debt is senior to some other sovereign debt, think again. There are norms and rules of thumb and generally-accepted principles, but ultimately sovereigns are sovereign, and they can and will act as they please. Even if that means violating international treaty obligations.