Crises and Consequences: The Role of U.S. Support in International Bond Markets

Abstract

Sovereign default should theoretically lead to creditor punishment through higher borrowing costs or market exclusion. However, empirical evidence shows that punishment is inconsistent across defaulters. We argue that this disconnect can be explained by examining the role of geopolitical relationships, particularly with the United States. US support conditions expectations of both borrowers and creditors by providing a fiscal cushion and subsidized insurance. This dynamic incentivizes riskier financial behavior, increasing default likelihood. Paradoxically, post-default US support signals a greater ability to pay, reducing creditors’ incentives to punish. Using data on commercial defaults from 1970 to 2012, we find that states with higher levels of US support are more likely to restructure their debts. After restructuring, these states face lower borrowing costs and experience shorter periods of exclusion from bond markets. Our findings contribute to our understanding of the complex interplay between geopolitics and sovereign debt.