Sovereignty and Debt in Nineteenth-Century Latin America

After their independence from Spain and Portugal, Latin American governments became frequent borrowers in international capital markets. However, the region’s political and economic instability also led to recurrent episodes of sovereign defaults. During the particular historical context of the nineteenth century, remedies to debt defaults were not limited to bilateral negotiations between creditors and governments. They also encompassed military interventions or control commissions formed by foreign governments, bondholders, or merchant bankers. In North Africa and the Middle East, debt defaults could even trigger military interventions from creditor states ending in the establishment of colonial regimes. This paper shows that such interventions were rare in Latin America, as creditors only enlisted their governments’ military intervention in the most extreme cases. In most cases, external control was exerted privately by bondholders and merchant banks through the imposition of economic policies promoting trade openness and fiscal management. Additionally, bondholders turned to legal methods of contractual enforcement to obtain debt settlements that limited the sovereignty of debtor states over their land, infrastructure, and resources. By the end of the century, Latin American jurists began to respond to the increasing use of legal techniques to settle sovereign debts by developing counter-legal discourses aimed at limiting foreign intrusion in sovereign affairs.

Sovereign Debt Restructuring: A Modest Proposal

Many sovereigns, including weaker credits, have taken on substantial debt during the COVID-19 pandemic. This raises the prospect of future defaults and sovereign restructurings, which will be informed by debt-sustainability analysis. But when analyzing notable recent sovereign defaults, we find a pattern of serially correlated errors: the analysis at the time of the restructuring is too optimistic about future sovereign debt dynamics. In light of this, I propose that future sustainability analysis should be based on more pessimistic expectations. In turn, this implies that sovereign creditors should face larger losses in future restructurings.

Sovereign Defaults and Banking Crises

This research is aimed at contributing to the endogenization of default costs. Higher exposure of a banking system to sovereign bonds increases the likelihood of banking panics due to sovereign defaults. Following (Gertler, Kiyotaki, 2015), the research models the possibility of a banking crisis occurring after a sovereign default. While a higher exposure of a banking system is associated with potential losses, this mechanism creates a stronger commitment to honor the sovereign debt. A marginal increase in the sovereign debt raises the ex-post costs of default through a higher likelihood of a banking crisis, thus making a default option less desirable. This mechanism might increase investors’ confidence and resolve the coordination problem of self-fulfilling crises. In part, this may explain the findings of Bocola and Dovis (2019), who claim that non-fundamental risk played only a limited role during the European sovereign debt crisis. Furthermore, as opposed to the standard solution of the coordination problem — to issue debt of longer maturity — a government can resolve this problem by forcing its banking system to hold more sovereign bonds.

SOVEREIGN DEFAULT CONTAGION AND MONETARY POLICY IN AN AGENT-BASED MODEL

Sovereign default contagion was one of the most debated topics during the Eurozone sovereign debt crisis. Despite all the improvements in the financial situation since 2010, namely after European Central Bank quantitative easing policies, the nature of the problem and the policy prescriptions are still under dispute today. Using an agent-based model, we simulate sovereign default contagion for different monetary policy options in a world where governments have random incomes, different heterogeneous borrowing behaviors and risk aversion levels and where countries can enter into ex-ante agreements to protect themselves against default. Our simulations showed that default contagion can be a very fast and “destructive” process, and that monetary policy can have a very important role in preventing sovereign defaults through zero interest rate and quantitative easing policies.

Natural Disasters, Climate Change, and Sovereign Risk

I investigate how natural disasters can exacerbate fiscal vulnerabilities and trigger sovereign defaults. I extend a standard sovereign default model to include disaster risk and calibrate it to a sample of seven Caribbean countries that are frequently hit by hurricanes. I find that disaster risk reduces government's ability to issue debt and that climate change further restricts government's access to financial markets. Next, I show that "disaster clauses", that provide debt-servicing relief, allow governments to borrow more and preserve government's access to financial markets, amid rising risk of disasters. Yet, debt limits may need to be adopted to avoid overborrowing and a decline of welfare.