This WORKING PAPER argues that the United States policy of siding with sovereign defaulters against U.S. creditors is fundamentally misguided. The root of the sovereign debt problem is that sovereigns overborrow, borrowing in excess of their institutional capacity to efficiently employ the borrowed capital. Overborrowing results from the fact that sovereigns face few consequences as a result of default.

Often they are bailed out by International Monetary Fund (IMF) loans, with the consent of the United States. The default does not impede their access to future credit because creditors have short memories. The only effective remedy against sovereign overborrowing is to allow creditors to enforce their contract rights effectively against sovereigns in default. Any well functioning debt market depends on strong creditor

However, in recent years, the United States has attempted to block the ability of creditors to collect their debts. This was done for foreign policy reasons, to curry favor with debtors in distress. It has not worked, particularly in the case of the biggest defaulter of them all, Argentina. By favoring the Argentine state over private U.S. creditors, the government has fostered Argentina’s claim that it can defy the West with impunity, by offering poor restructuring terms, and walking away from $20 billion in debt still in default—with interest now $30 billion. Today Presidents Néstor Kirchner of Argentina and Hugo Chávez of Venezuela have become anti-American economic allies. If Kirchner had been subject to market discipline, his leftist antics would have carried a high price.

The United States must consider reversing its stand and back U.S. creditors against sovereign debtors, at least rogue ones like Argentina. In addition, it should consider strengthening creditor rights by paring back the protections debtors are currently afforded under the Foreign Sovereign Immunities Act.