Creditors can't have Messi. Photographer: Laurence Griffiths/Getty Images
Creditors can't have Messi. Photographer: Laurence Griffiths/Getty Images

Argentina has experienced what could be termed a Schroedinger's default: It has both paid its debts and failed to do so. The situation is so absurd that it may trigger the revival of efforts to establish an international sovereign bankruptcy mechanism. There's a good reason, however, that previous efforts failed.

Sovereign debt is essentially nonenforceable. If the sovereign doesn't deign to pay, all the lender can do is (try to) hold off further disbursements. He cannot lay claim to a country or its assets.

Argentina's holdout creditors, who refused to take part in debt restructuring after the country's 2001 default, have managed to get the government of President Cristina Kirchner into some awkward situations, including an attempted arrest of the presidential plane and a warship, as well as the current freeze of payments meant for less recalcitrant creditors. They haven't, however, recovered anything: For 13 years, they have been spending money on a chase that is still unlikely to make them much money compared with their peers who accepted the restructuring. "Not an attractive business model so far," Georgetown University law professor Anna Gelpern wrote in a paper on sovereign bankruptcy last year. "The residual power of sovereign immunity remains a disincentive to hold out and especially to sue."

Holdouts have been a major problem only in this one case. As the International Monetary Fund pointed out in its 2013 review of sovereign-debt restructurings that have taken place since 2005, most (Belize, Grenada, Jamaica, and St. Kitts and Nevis) achieved creditor participation rates of more than 90 percent. Greece managed a 97 percent participation rate despite imposing a 70 percent loss on creditors.

The difficulty and expense of fighting governments have given them a sense of impunity. Modern-day governments are not much different in that respect from King Ferdinand VII of Spain, who was restored to absolute power in 1823 and refused to honor the previous, constitutional government's "odious" debts, or from the Bolsheviks who wouldn't pay czarist Russia's debts after 1917. Both Spain and the Soviet Union eventually recovered access to financial markets, and so will any modern governments that refuse to pay up, including Argentina.

Even if the holdouts eventually make a deal with the Argentine government -- which is difficult considering all the bad blood -- or sell their bonds to other investors to end the crisis, that doesn't make it more likely that other investors will want to repeat their exhausting and costly experience.

Any sovereign bankruptcy mechanism would have to include a way to recover money from a government's assets, as in a corporate bankruptcy case. As Gelpern points out:

The tradeoff might include more secured lending, on the model of municipal revenue bonds or the U.S. oil-backed financing for Mexico in 1995. Sovereigns could find the bargain more attractive if it were combined with better protections for other property -- such as military ships and presidential airplanes, financial flows to third parties, and payment and clearing systems -- and the availability of discharge.

Why, however, would governments agree to such an infringement on their sovereignty? The possibility of a fresh start is enticing, but giving anything up in exchange is not.

If the mechanism were established under IMF auspices, the carrot could be emergency financing from the fund. But with large emerging economies, as well as Europe, setting up their own crisis funding facilities, there are likely to be holdout governments as well as holdout creditors. In any case, to quote Gelpern, "establishing a restructuring regime along these lines is a daunting political challenge. In fact, it may well be a pipe dream."

There may be no realistic, clean way to handle sovereign defaults. Caveat emptor should be the rule of thumb where government debt is concerned: In this sense, it is riskier than corporate bonds, which are governed by transparent and enforceable laws and issued by companies whose goal is to maximize profit rather than achieve often vague political ends.

To contact the author of this article: Leonid Bershidsky at lbershidsky@bloomberg.net.

To contact the editor responsible for this article: Mark Whitehouse at mwhitehouse1@bloomberg.net.