CACs and Doorknobs

In response to debt crises, policy makers often feature Collective Action Clauses (CACs) in sovereign bonds among the pillars of international financial architecture. However, the content of official pronouncements about CACs suggests that CACs are more like doorknobs: a process tool with limited impact on the incidence or ultimate outcome of a debt restructuring. We ask whether CACs are welfare improving and, if so, whether they are pillars or doorknobs. The history of CACs in corporate debt suggests that CACs can be good, bad or unimportant depending on their vulnerability to abuse and the available alternatives, including bankruptcy and debt exchanges. The history of CACs in sovereign bond workouts is recent and thin. Without restructuring data, the empirical literature has focused on the ex-ante (pricing) effects of sovereign CACs. To the extent that CACs leave borrowing costs unchanged or even lower them, they are likely to be welfare improving. But the magnitude of the welfare effects cannot be inferred from these studies. Based on the evidence so far, we conjecture that sovereign CACs are like doorknobs: useful, but perhaps not essential. To date, there is no evidence of abuse of the sort observed in U.S. corporate bond restructurings in the 1920 and 1930s. The bulk of pricing studies suggests that any increases in borrowing costs are small. On the other hand, debt exchanges using transactional techniques other than CACs have had a decent track record, suggesting that CACs are not the only way to resolve a debt crisis in the absence of a treaty-based bankruptcy alternative. Future empirical work should focus on how CACs perform in debt restructuring rather than on their ex ante effects.