American States and Sovereign Debt Restructuring: Lessons and Cautionary Tales

Abstract

As American states continue to struggle with low revenues and growing financial obligations, a number of commentators have proposed that states should be able to seek relief under bankruptcy law. Currently, there is no formal mechanism for facilitating the efficient restructuring of states’ obligations if that becomes necessary or desirable. American states and sovereign nations are similar in this respect. As this Article (forthcoming in Conti-Brown and Skeel, eds., Confronting Fiscal Crisis in American State Government) explains, however, the history of sovereign debt crises and debt restructuring reveals that much can be done in the absence of a formal mechanism. The primary lesson from the experience of sovereign debtors is that a state experiencing acute financial crisis will likely find a way to encourage its counterparties to agree to restructure or reduce their claims, even if they have no legal obligation to do so and have some legal basis for objecting. Thus, a formal mechanism is probably not necessary for a successful restructuring of a state’s obligations if one is truly necessary. It may be suboptimal to force a state to reach the point of acute crisis before it can gain its creditors full attention, and the overall costs of ad hoc restructuring may be higher for states and their creditors (and the federal government) than those of reorganization in bankruptcy. But the history of efforts to promote a sovereign bankruptcy regime or a sovereign debt restructuring mechanism indicates that even if there is room for improvement over an ad hoc approach, there is unlikely to be much of an appetite among policymakers for adopting a more formal mechanism.