Asset backed contracts and sovereign risk

A fundamental problem with sovereign default is the lack of a legal enforcement mechanism. Since the 1920s, there have been an ongoing set of initiatives undertaken by the League of Nations and the UNCTAD to set international laws on borrowing and lending standards, all of which have failed. To address the unenforceability problem, this paper proposes to use asset backed contracts where the usufruct of the asset transfers to the asset holder. Unlike conventional sovereign borrowing, there are international laws governing asset backed contracts which allow the international assets of a country to be seized. This paper exemplifies on the idea that asset backed contracts, which are also widely practiced in Islamic finance, can provide a solution to unenforceable sovereign debt contracts. The paper focuses specifically on Argentina which has defaulted twice in 13 years. If Argentina had utilized asset backed contracts prior to its 2001 debt default, it would have gained from the following advantages: higher debt-to-GDP ratios, larger welfare gains, lower probability of default and thus lower borrowing costs.