It’s all about reputation. That’s the argument Stanford professor Michael Tomz makes – and credibly supports – in this 241 page work. Released in 2007 before the financial crisis, Reputation and International Cooperation:  Sovereign Debt across Three Centuries is a serious but readable academic study of sovereign debt that says a lot about how sovereign loans are valued.
Theoretical Approach
Of course to a seasoned banker, saying that reputation is the key to underwriting loans is trite.
But in the world of sovereign debt, where finance intersects with the maze of international politics, reputation’s preeminence in explaining creditor decisions can be obscured by a smokescreen of other theories. Tomz covers several of these perspectives, including the availability of enforcement measures like military threats, loss of trade, and collective creditor retaliation – and systematically dispels them through a methodical analysis of qualitative and quantitative historical data.
Tomz uses an empirical analysis of military disputes and financial relationships to refute beliefs that military intervention is a potential consequence of sovereign financial default. He also persuasively disputes that an oft-cited 1902 British intervention in Venezuela is a true historical precedent for intervention following default by showing that the British intervened primarily because Venezuela ransacked British residents, not to avenge jilted bondholders.
To show that reputation is superior to the threat of trade sanctions in explaining why sovereigns pay their debts, he reviews the case of Argentina in the early 1930’s. Argentina owed money to Britain, its major trading partner, as well as to the United States. Because, Tomz hypothesizes, the British bonds were less costly to service, Argentina could have easily defaulted against the U.S. – with which it had far less trade – and focused on paying the British debt. Instead Argentina implemented exchange controls that discriminated against British exporters to service its American debt, preferring to bolster its overall financial reputation at the cost of irritating a major trading partner.
