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Hello and welcome to another episode of the Odd Thoughts podcast. I'm Tracy Alloway.
And I'm Joe. Why isn't thal Joe?
You know what I like to say about bonds go on. I think there's this perception that bonds are all about finance and legalities. They are these contracts and borrowers have to stick to the contract, lenders have to stick to the contract. But actually I like to look at bonds as more stories. Yeah, and I know we've been talking on this podcast a lot about norms and the idea that a lot of the way the US operates is based on norms and habits that have developed over time.
Bonds are kind of the same way. It's all about the narrative of who owes, whom, what and why, and that can change really quickly.
You know.
It's actually interesting about you saying this. I was thinking back to our episode that we did with a Sujit end up about creditor and creditor violence, and perhaps one way to think about that whole phenomenon is the exploitation of rules above norms. Right, So you have all of these norms about how debt is paid back, et cetera.
And there's like extra alpha to be squeezed by actually redoubting to the courts and the rules that are literally written down in a fight between creditors about who gets the cash flows, et cetera. And it really is about this tension of like what's written on paper, what's technical, what does these words mean, et cetera versus Come on, that's not how we deal with bonds.
That's right. You can use the rules if you're really clever, to try to achieve your aims right and change the story on some of these. So we should talk about that because there is a lot of discussion about what the Trump administration could do when it comes to sovereign debt. Obviously, people have been talking about the potential Mara Lago accord,
which includes a possible debt swap. Again, all of that is hypothetical at the moment, but beyond that, there are some other things going on, and it certainly seems like nothing is off the table when it comes to the Trump administration. So we should we should.
Discuss Yeah, but can I just say one thing, which is my ethical reservations here of doing any episode. It feels like the entire world now operates in this system in which people both outside of the White House and inside the White House, the various people trying to like curry Trump's favor on a given day try to wish cast their ideas about policy into the ether. And they put out a tweet and they say it's a negotiation. They say it's not a negotiation. They say there should
be applause, et cetera. And there is this incredible mailstream of noise where it's all about trying to manifest some outcome that so and so person desires. And I have some ethical questions about this sort of contribution to the noise by introducing the idea of like further taking seriously the idea of debt swaps, which to me sounds like default into the world. But yes, this is one thing that in this great manifestation of ideas people are talking about. So I suppose we should talk about it.
You always say you want to take Trump literally and seriously, so.
I only take them literally anymore.
Okay, here's our disclaimer. This is not an actual policy suggestion for the Trump administration. But we are going to talk about it.
People are talking about it.
Let's talk about how realistic it is. And we have the perfect guest. We're going to be speaking with mittwu Galotti, law professor over at the University of Virginia and one of our favorites when it comes to all the ins and outs, the technicalities the legalities of sovereign debt. So Midwo, thank you so much for coming on all thoughts, I'm.
So excited to be here. I shouldn't be excited about all that. No crazy things that are being discussed, but from an academic perspective, this is just heavenly, even though I might be jobless soon.
Right.
So markets have been crazy, but the upside is, I guess we get to talk about bond contracts. When did you first become aware of the mar A Lago accord? When did people start talking about it?
So I actually think that I heard about it on one of your podcasts.
Oh God about it's wowerful.
And then I dug into it and looked at one of the proposals in particular interested me, which was sort of swapping out short term US treasuries for longer term, low interest US treasuries, which was talked a lot about it as a debt swap with our allies, but really was just an extension maturities at a low rate when the market might not actually be giving you the low rate. And that has become I mean, that was I think implausible. When you guys talked about it, it was just sort of, oh,
here's some crazy ideas. People are now emailing and asking sort of respected market people, how could this happen and what would the legal barriers be and what are the ramifications.
So what's basically going on in the last several weeks is that this very theoretical idea, which by the way, Trump himself actually I don't think he's ever used he's
certainly never used the term mar Alago court. But there's the people around him, some influential thinkers talking about this could be some endgame here where there's some sort of rethinking about the US dollar and the dead And now it's come to the point where people who are serious in markets, they're coming to mewtwo Gladia and they say, what's up, help me understand this?
Yes, I think so.
You know, we talked about Trump and taking him seriously and taking the kinds of things that he has done in the past seriously, and what he's willing to do, and restructuring distress debt is something that he has done a lot of, and he talked about it prior to his first presidency when he talked about, oh, the US debt not a big deal. We could just inflate it
away or something like that. A debt swap using the power of US governing law is really not that insane, both in historical contexts and in what we could do. It is insane in terms of norms that have been built carefully over the last sixty seventy years.
But Trump is not.
Alexander Hamilton, I think yes, to.
Put it mildly, explain this further. You said earlier a debt swap could be basically the equivalent of extending maturities on existing treasuries. But like I would hope that there is some clause in the bond documents that would rule that out. Am I wrong?
I guess I'm wrong, alas you are wrong. So really, anybody and everybody who holds US treasuries should go and look at the contract terms for their US treasuries and ask the question, do my contract terms restrict the US Treasury Department from saying to me tomorrow, you know we need a little more money, So we're just extending the maturity of your debt by another twenty years at the interest rate that you lent to us. Is there anything restricting that I don't think you'll find anything.
This blows my mind because to me, if I'm a holder of US treasuries and a creditor or I'm lender, the creditor says, you know what, I'm just paying you back a long time, to me, that sounds like default. And you're saying that in the research that you've done, this would not say trigger credit default shops, because to my mind, my assumption would be, oh, this breaks the entire system. This is a default, and we can't have
a default on the risk free assets. And you're saying that actually in the wording of the document is not there.
So we have to be clear and I have to be geeky here in my law professor mode, there are at least three different types of default. So there's a default on the contract. Something you could sue somebody for breach of contract. It would not be a breach of contract. US government is allowed to do this. Then there's default in terms of would it trigger the handful of credit
default swaps that are written on US Treasury. Well, that sort of depends on the credit rating agencies decide, and based on what we saw in Greece twenty twelve, they probably would say it was a default for credit default swaps. But that doesn't apply to everyone. So those are the two big default scenarios.
What do you mean that doesn't apply to everyone.
Well, they don't.
The default for a credit default swap really only applies to the people who are holding credit defaulse protection on US Treasury, so they would be able to get their money back from somebody who had provided them insurance. But the rest of US dupes like me would just have to sit with the US extending the maturities. Now, the details are important, but if you are willing to let me bore you with them, I can sort of sketch
out the scenarios always Okay. My students asked me this in class a couple of days ago, so I had to sketch it out for them. So I said, step one, the US Treasury Department and the Secretary of the Treasury have authority to manage the maturities of US treasuries. What does manage the maturities mean? It really does mean, you know, issuing bonds of different maturities, managing your yield curve. But could it include unilaterally extending the maturities? Seems implausible, but
this government has pushed its legal authority in many ways. Now, what is most likely to happen that the US Treasury if they ever went down this path because they needed money and rates had gone up and they wanted to take advantage of the fact that their old borrowing was at low rates, what they would do. I think the pattern we have seen is that they would extend the maturities and then Congress would quickly pass a law confirming it.
That's what we've seen in all of the other Trump executive orders, plus Congress quickly passing a law, and then there would be lawsuits. There would be lawsuits left and right saying this is a violation of the Constitution because remember there's no contractual protection. So now you have to say you've somehow taken my property and I have an implicit moralistic right to having my money paid back at the time when you said you would pay it back.
Now that's really tough, and we have historical precedent for this, going back to the nineteen thirties when we were in deep trouble because of gold. We didn't have enough gold to pay everyone in case. They invoked their gold clauses, which entitled whole of certain US treasuries to get paid in gold. If they had gotten paid in gold or asked to get paid in gold, US would have essentially
gone broke. So the President back by Congress abrogated the gold clause protection in contracts, and it was thought that surely the Supreme Court would say this is not allowed. You cannot just take away people's contractual rights. And the Supreme Court, in one of the most famous cases of that era, said it was okay. And the markets. I don't want to say this, but I'm gonna say it because it's true. The markets didn't crash. Yeah, I think
it's around nineteen thirty five. I'm going to mess up which year Congress did the abrogation and then when the Supreme Court decision came out. But the predictions were this will destroy the US ability to ever borrow in the future, and that did not happen. There's some famous articles about this.
What's your read then on why this didn't happen, like why did the market seem to just go like, Okay, this is unusual, but fine.
So my read, with no proof, is that there are these rare instances where the market thinks, you know, this abrogation of contractual rights, while it looks like a violation of the rule of law in every which way possible, is necessary to make us all better, and therefore, instead of penalizing the government does it, we're going to reward
them and we're going to lend even more. Arguably Greece in twenty twelve, where Greece also legislatively abrogated contractual rights and did something very similar, is a similar situation where the market didn't penalize them anywhere near the amount that many sages on Wall Street were saying would happen. Now. I'm not saying that that's what would happen now, I mean, this administration seems crazy.
What about Fourteenth Amendment Section four that says the validity of the public debt of the United States authorized by law, including debts and curd for payments of pensions and bounties for services and suppressing insurrection or rebellion, should not be questioned.
Oh, I love it that you're bringing up the Fourteenth Amendment and the debt language of the fourteenth Amendment that my students don't even know exist.
The only reason I know about this is because it comes up a lot during the dead Sertes.
Joe carries around a copy of it in his podcast at all times.
Okay, this language is so important for a variety of reasons relating to multiple debt crises around the world, but I won't go into those. Let's just look at the language about the validity of the US debt. Arguably, that language goes back to the eighteen hundreds at least, when often small municipalities would say a certain debt was illegally issued by this government in place that did not have
the proper authorization to issue it. So if that's the meaning of validity, that it's about the original issuance, the Trump administration could say, we're not challenging the validity. We think your debt is very valid. We're just extending the maturity, and we do promise to pay you. Let's say they extend the maturity by one hundred years. We promised to pay you in one hundred years.
When we're all dead. Yes, Okay, I hesitate to ask this question for some of the reasons that Joe laid out earlier. But we've established that there's a lot of creativity embedded in the rules of bonds, or at least you can use those rules rather creatively to achieve whatever aims you're trying to achieve. One of the things that has come up recently is the idea of maybe collecting on historical debt. Oh yeah, that was never paid to
the US, you know it. I called it the equivalent of like looking in your sofa under the cushions for spare change. How viable would something like that be?
Okay, legally that is much more viable. So this has come up in the context of there's a recent book, very recent by a senior US Treasury official about the negotiations between Andrew Mellon and Winston Churchill about the debts that were owed to the United States by Great Britain
after World War One. So I think it's about four point four billion or so that was owed, and Great Britain resisted paying, and the US tried to get it paid, and then finally we kind of gave up, and then we had World War Two and all sorts of things. Those debts have never been written off. Officially they are still official debts of now the United Kingdom to the US. They had interest rates on them. I think the interest rate was three percent. If you compounded that amount to
today's values, that would be many trillions of dollars worth. Okay, so that's old. But how would you engineer this. That's a debt that is owed by the United Kingdom to the US. The US owes the United Kingdom because the United Kingdom, by the Treasury Zone estimates, holds upwards of seven hundred billion in US treasuries, those can be and the legal term is set off. Two sets of debts can be set off against each other. It is a technique that is used every day in the markets.
It's just who would have thought.
That it could be applied in this context, But it can be, and in fact, in the Russia Ukraine contexts, the Biden administration thought very hard about using set off techniques to get funding to Ukraine. So this is an idea that's out there current. But applying it to the UK debt and then maybe even applying it to the French debt from World War One would be truly radical, but maybe it wouldn't destroy the markets in the same way as the first swap that we discussed.
That's a very big maybe. But okay, so theoretically the UK debt could cancel out some US debt. I think this is a really good example of where norms come into play, because Okay, after World War One, the US knew that the UK owed it a bunch of money, but the UK was arguing, well, this is actually emergency war funding and it's not fair if we have to pay it back, and ultimately the US just decided, you know what, it was better to keep the UK as an ally not annoy them over this particular loan, and
so they just never did anything about it. But obviously relations between the US and the UK are changing, not as friendly as they used to be perhaps, and so that opens up the question of whether the how youse around these loans and bonds can start to change.
No, well, this sort of anticipated the question that I was going to go to, which is like, say more about like why it was just accepted that these debts were not collected upon.
Well, I'm not sure there is extensive writing about the negotiations. I think they went all the way up to the nineteen seventies, and for those who study financial history. Post World War two was a truly horrible time in Europe.
The US was trying to help European countries recover. The UK in particular, had taken the position after World War One that the US should try to collect this money from Germany, because really Germany owed the money to the UK and France in reparations, and sort of the consensus was world War One reparations were a stupid idea and resulted in World War Two. This is Canes and all of that work, but generally, in the interest of letting Europe recover, I think the US decided better not to
push this. But Congress never allowed those debts to be wiped out completely, and so in some sense this has always been an option. I have heard Treasury officials, people negotiating debt restructurings talk, and every once in a while, when they can't get the UK to do what they want, US officials will kind of snidely mention, you know, there's that World War One debt that you never paid, and everybody laughs and in a knowing way, And then I have this.
Image of them having like a laminated copy of the bond documents and just whipping it out in negotiation. But actually that reminds me we don't know what the exact bond documentation is.
We don't know. We don't even know. I mean, we know the interest rate is three percent. I've never met anybody who's actually seen the document back in nineteen seventeen, I don't think it would have been governed by the law of New York or the law of England. So who knows what statutal limitations would be. Who knows today whether or not there is some kind of international statutal limitations that would apply, and would it apply in the context of setuff. This is just for lawyers. This is
a bonanza. We could be working on this forever. But it seems a bit crazy. But nothing's crazy these days.
The lawyers always win.
So speaking of all these old debts and world wars and stuff like this, I've gotten into my I'm in my mid forties, so of course I read about twentieth century history now. And one of the things that are actually like was like this big like light bulb revelation for me in reading history is that like modern fixed borders of countries, it's sort of a novel phenomenon that actually like the idea that like these are the lines around the country, we just all sort of accept that
is like very fresh in modern history. And what it was striking is like reading about the run up to World War two, or like the Germans would sign a border agreement with another country, but it would be only ten years. They're like, let's be peaceful for ten years and then we'll revisit war down the line, whether or not,
and then we might revisit the idea of conquest. But at least in the meantime, some of it's coming back, and it's coming back, particularly with respect to Trump's talk about Greenland, and people talked about how much a lot of people think it's a joke. But a lot of people have gotten burned by thinking that things Trump has been saying our a joke. And so that's why I've
become much more on the take Trump literally side. How should we think about the idea of like countries just sort of like acquire land from other countries as a thing that could happen in the twenty first century.
Okay, this is going to happen, This not could happen. You're raising an incredibly important question. So there is greenland, but Greenland's kind of fun to talk about. Yeah, although you know, Trump seems very serious about it. He keeps telling us, don't think this is a joke. We have to have it, and I will have it. But it's going to be directly relevant in the context of Ukraine. So let us say that mister Putin is able to negotiate with President Trump to take half of Ukraine. Okay,
so Ukraine becomes baby Ukraine. What happens to the enormous pile of debt that Ukraine has that is unpaid and that was restructured in the context of war, including billions and billions of dollars that are owed to the US and to European allies. Does all Ukraine pay all of this or does baby Ukraine pay all of this? Does it get divided? It turns out that the laws from the era of conquest, those are the laws that apply
even today. Of what happens when the borders of a state change, those laws are really unclear, and so we'd have to decide in the modern era, how would those old laws apply, given that we pretend that borders don't change, and we pretend that conquest is not allowed. I mean, Putin takes the position that what's happening in Ukraine is an independence movement that started domestically and that he's just encouraging it. Well, there is a whole set of laws
that apply to civil wars. And if they take the position of this is civil war, then there is nineteenth century debt law that applies to a civil war.
This is one of my favorite ever financial history topics, which is the repudiation of debt from the Soviet Union, also Imperial China. And there is this argument that, Okay, there's a revolution in a country, the new administration or the new policymakers should the new government should not be saddled with debt from the previous administration because that administration was wrong and was not supposed to be there and they were taking advantage of the people and spending all
their money. Blah blah blah blah. Talk about that.
So you have brought up one of our favorite topics, that doctrine of odious debts, and the doctrine of odious debts is really about some despotic leader, a kleptocrat who's borrowing a lot of money from usually foreign creditors and then absconds with that money, and should the new government that comes into place after kicking out the kleptocratic leader be responsible to those creditors, especially if those creditors knew
they were lending to a kleptocrat. What Joe raised with the change of state borders is a more obscure doctrine that falls within the subset of odious debts, but is a little bit different and more importantly, has much more legal basis for it. So Joe, can we go back to the fourteenth Amendment please? Okay, can we read that language that you read.
Joe's reaching into his pot.
The validity of the public debt of the United States, authorized by law, including debts incurred for payments of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned.
Okay, So that last part when Joe raised this at the beginning of the podcast, I think he was focusing and Joe, and you.
Know what it was, to be honest, and you probably sense this, to be honest, When I read this, I was like, oh, I never really paid much attention to that insurrection or rebellion point.
That stuff is so important. Okay, I'm getting so excited so I apologize for raising my volume. That is the US saying to international creditors, we will not pay if you lend for insurrection that is civil war, we will not pay. And we think this is fine by international law. Is remember in the early days, we were very concerned, actually none of us, remember, we were very concerned about following international law because we didn't want other countries to
send in the gunboats because we were violating law. It was accepted arguably at that time there was okay not to pay for debts incurred by the rebels in fighting in a civil war.
Right, and we all know at this point that one man's coup can be another man's fight for liberation. So it's open to interpretation. I got to ask just before we go going back to Greenland, can Trump get Greenland? How does that work legally?
Oh? This is good too, But can I just go back to what the implications of what Joe's language in
that in the fourteenth Amendment for Ukraine? If Putin takes the position that what has happened in Ukraine is an independence movement and there was a civil war, then Putin could invoke basically our fourteenth Amendment and the laws that followed since their's have been cases where the British took a similar position in the context of the Boer War and say I am not responsible for any of the debts incurred by Ukraine because that was a civil war context,
and the side that wins does not have to pay the debts of the side that loses. Bondholders I think have been quite unaware of this possibility. Now, maybe it will all get worked out, but I don't really see how we can avoid working this out. But back to Greenland. Now, can we get Greenland? Well, yes, we can get Greenland. Even though borders are not supposed to change. We could in theory, there's no international law prohibiting us purchasing Greenland.
The question is who do we purchase it from. In the old days, we would have just purchased it from Denmark. They kind of owned Greenland as property. But now we don't think of post colonial states as property, although we don't quite know. Maybe the property interests, to the extent you think of sovereignty interests as property interests lie with
the people of Greenland. And so the fifty seven thousand, quote unquote citizens of Greenland, maybe Trump could offer to pay them each one point five million dollars in a Swiss bank account and give them each a little house on the beach in Santa Monica and give them one of his Golden visas it could happen. It would be brand new international law, but entirely plausible. The question, though,
is where's he going to get the money from. He would really have to borrow a large amount of money, And so we come back to the question of issuing more US sovereign debt in a context in which we're trying to reduce the sovereign det I am, maybe the.
US could use the proceeds from recouping payment on those old UK bonds to buy Greenland.
We could, now, I suspect, okay, I'm building conspiracy theory upon conspiracy theory, and maybe this is just.
A bridge too far.
But if you go back to techniques that Trump was very fond of using, say in his casino days, he really didn't like market processes where say, the US would be bidding against Denmark and maybe Germany and maybe a France for who would pay the Greenlanders the highest amount in order to acquire Greenland. Instead, there's been a lot
of talk about security reasons. The security reasons and the imperative that the US must have Greenland, and no talk of, say, an auction for Greenland where the Greenlanders would get the highest price. This talk about security reasons sounds more like a regulatory taking where we get to take it at the price we set because it is important for security reasons. It is a technique that Trump has used in the past in his property dealings and could try to use here.
Although I don't think there's any international law equivalent, but we're making up international law in the modern era, okay.
So I think at a minimum we can say we are living through interesting times, and it's interesting times in bonds as well. So thank you MITCHU for coming on the show to explain all of that to us and hopefully not give two many policy suggestions to the administration.
I love talking to law professors. Thank you so much for coming back on.
It was so funny. Thank you both, Joe.
I love talking to Mit too. I know sovereign bond documentation is not necessarily everyone's idea of an exciting time, but he makes it exciting and interesting.
No, I wasn't kidding. I Actually it's fun to talk to law professors, especially on this kind of stuff because you can just see how their brain works and how they're like, well, this part of the sentence you think it's talk about this, but this part of the sentence is like, oh, are we talking about conquest law that's been in effect forever? Are we talking about the repudiation of odious debt? Et cetera. And I just find it a real pleasure to hear all of it.
Absolutely, And I think the whole conversation highlights that point about just how fluid some of these contracts actually can be. And again, there's so many assumptions and norms that are built into these things, even though often the documentation tries to be air tight. Once those assumptions and norms start to change, the way the bonds can be used or enforced starts to change as well. And the same applies to borders, as you pointed out, Yeah.
And that's funny.
Countries are so new, no, they really, Like I I realized this a little while ago, like almost every country is like it's basically day one around here. That you know, so many countries are post World War two. That was one of those things that I feel like only that clicked in my brain way too late.
I've been meaning to ask you, Yeah, how do you feel about the trillion dollar coin now? Because I said something like it's based on norms, that the treasure never done this and we should treasure norms.
I agree. I think an actual default where a mispayment would be really bad. And if the choice is between yet another norms violation, which at this point added to the list, versus a literal non payment of a coupon, which would be a default, I will I'll take the coin.
Okay, glad we settled that. Yes, shall we leave it there?
Let's leave it there.
This has been another episode of the Authlots podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway and.
I'm joll Wisenthal. You can follow me at the Stalwart. Follow our producers Carmen Rodriguez at Carman armand dash O Bennett at Dashbot and Kilbrooks at Kelbrooks. For more odd Lots content, go to bloomberg dot com slash odd Lots, where we have all of our episodes in a daily newsletter and you can chat about all of these topics. Twenty four to seven in our discord Discord dot gg slash Outlock.
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