We're now getting into other aspects of finance and so this is a lecture on public finance, which means finance of the government. Now you might think that the government is separate from finance, but it's not. The government is just another organization that confronts markets and lenders like others and it always has going back into the history. So I'm going to talk first about government debt and default, which is failure to pay. People, when you say that the government might default on its debt, the first reaction that many people get is, oh, that means that you'll lose everything if you've invested in it. That's not what it means. Default is not the same thing as repudiation. Repudiation of a debt occurs when the government announces, we're never going to pay, forget it, gone. Like the communist governments in Russia and China repudiated their government debt. There's also a concept called odious debt that's been offered. If a new government comes in, they can sometimes say, "The past government was so corrupt and stealing, this is not the debt of our people, it's the debt of some criminal that we've finally got rid of. So that's odious debt, it stinks. We will not pay it back and we're morally right not to pay back what this person took from all of us." So this happens, but usually not. Even after a revolution, they usually don't completely repudiate the debt. So the question is if governments default with some regularity, why do you invest in it? Well, that's a very basic question, which you should understand. You invest in it because it pays high interest rates. Governments that are in danger of default have to pay higher borrowing rates or the price is at such a discount like we mentioned 20% of the principal for the Venetian debt. That's actually a good investment, even though you're perfectly aware that they're going to partly default. The reason they don't repudiate typically, is because you can only do that once and no one's going to lend to you again, you might need to borrow again. It's also just damaging for a country's reputation, unless you have some real ideology that justifies calling the previous debt odious. So the Communists I guess got away with it. Although nobody would lend to them again, they weren't borrowing money. And you could say that it was a big mistake because in China for example, they had famines under the strict Maoist government and they didn't-- they should have borrowed money and kept the people alive, but they didn't do that. So Carmen Reinhart in her editorial is worried that we could be in for another debt crisis in multiple countries. She particularly outlines Ukraine and Puerto Rico. The plea that Puerto Rico is a dependent on the United States, but it has its own debt and its economy is not doing well. They issued all this debt and they think that in Puerto Rico maybe they have a justification for defaulting and they won't lose their reputation. This is the kind of thing that happens. You know, the Puerto Rican economy needs some kind of boost. Ukraine is another example. But the biggest example is Greece. You must have heard about that. Ever since the sovereign debt crisis in 2010, this crisis in Greece has been smoldering. In 2015, Greece actually defaulted on some of its debt. But it's not over yet. It just drags on for years and years. They'd been actually paying their interest until 2015. Now it's getting a little shaky. Again, when a country can't pay its interest on the debt, then what happens is there is a negotiation. They come to an agreement called a restructuring, which allows them to pay less. Typically, the owner of the debt will expect some loss given the reality of the situation, but try to make an agreement that will preserve some of the value. So that's what's happened in Greece, but it just tends to drag on. Now you mentioned that if a corporation defaults on its loan then the creditors can take over the company. But I'm just wondering what if a government defaults on its loan. Who should get paid first or how should the government do it? Great question. The problem involving governments, national governments is that there is no court of law, no international court of law that will handle that case. So it becomes difficult. You're dealing with the government which has a-- it's the ultimate power regarding these payments. So what you do is you call them up and you say, "We're really mad, you're not paying us." Well, they can say, "Forget it, you know, what do you--" They could hang up on you and that's it, it's over. But then you have to rely on the government's self-interest.You know, okay, the dictator of some little country hangs up and says, "We're not paying." Then he tells his advisor and he says, "You said that to these foreign investors. Do you realize they're never going to invest in us again? Right? You can't." So now he starts to have doubts that, "I shouldn't have said that, I shouldn't have just hung up on them." So he has someone put a call in back and they say, "Okay, we're not going to just not pay anything. Let's talk." Isn't that what-- if you were a dictator, you would probably come around to doing that right? You don't just hang up on them. So there's a meeting of all the different creditors. But you have trouble because you've sold your debt to many different countries and they don't all even show up at the meeting. And so then anyway you make an appearance. Now you realize you can't destroy your country's reputation by just refusing, so you're going to be reasonable. So you get up in front of your investors and you say, "Look, you know our economy isn't doing well. We have a revolt brewing in some regions. You really can't expect us when we're in such difficulties." And so the investors in their debt, on the other side start thinking, "Well, okay, you know, they're not going to pay us. Let's take the tactic of being reasonable and say okay, we'll offer to cut your debt by 30%. How about that?" Then you start negotiating. You can see how the negotiation-- it's not within a rule of law, it's all in the court of public opinion. Now here's what then happens. So say 70% of the countries agree, of the holders of the government debt agree, but 30% of them don't. And they would storm out and they'd say, "I don't like it." So they agree to cut the debt by 50%. Then what happens? Then it just dribbles. It goes on because they didn't get agreement on all of the debtors, all of the investors in their debt. Are you following me? And then it just makes things so difficult for a long time. So if you are living in Canada and Argentina hasn't-- Argentina defaulted in 2001. And if Argentina isn't paying you, you say, "Hey, I have an idea. I'll go to a Canadian court and I'll ask the Canadian court to take something from the Argentine banks that operate in Canada. Because hey, I have it in writing, they promised to pay this." And so then you starts harassing Argentina. So Argentina finds it difficult to do business in Canada because of this mess. They want to clear it up. So there's been a movement in sovereign debt towards adding what they call collective action clauses. So it has the following form. When you buy the debt from let's say Argentina, it says you sign a contract when you buy it that you will agree to anything that's voted by a super-majority of the other investors in the same bonds. And so, if there's a collective action clause, it prevents this hold-up problem. And so increasingly, countries are putting collective action clauses in their debt. But it's not always yet and it still involves this same kind of messy negotiation. By the way, sovereign defaults are not that rare in history. It's happened many times. So this is life in the debt market. This is from the Reinhart-Rogoff - well, it's from her editorial in December. But it's ultimately from her book with Rogoff. And this is for the world since 1800, the percentage of countries in the world who were, at that year, at that time in that year in an external - that means a default to foreigners outside their country, external default or restructuring. So it seems to me there are some good years, not so many of them. Right there that was, I think it's about 1818. That's right after the Napoleonic Wars. I'm surprised. Well, maybe they'd already restructured their debt and they didn't have any. So there wasn't any more restructuring or default for any country in the world. But that's the only time when there wasn't one. It's going up to like almost half of the countries there. You can see there are waves of defaults. Now this ends with the publication of their book. There wasn't actually much default right after the financial crisis, but she's suggesting that there might be another. We've seen these periods of default around the world happen repeatedly and it would be not surprising if we saw another one soon. I don't know about right away. These things seem to take-- it looks almost like a cycle, doesn't it? But the cycle is decades long. I'm not saying it's a cycle, but it shouldn't be a surprise if we see more default on debts.
