Mitu Gulati on Whether Trump Could Restructure US Debt
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Bloomberg Audio Studios. Podcasts. Radio. News. Hello and welcome to another episode of the OddLots Podcast. I'm Traci Allaway. And I'm Joe Weisenthal. 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 U.S. 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. Yeah.

You know what's actually interesting about you saying this? I was thinking back to our episode that we did with Sujit Indap about creditor-uncreditor 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 and

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 bonds.

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 Mar-a-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 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 a pause, et cetera. And there is this incredible maelstrom 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. I only take him 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, so let's talk about it. How realistic it is. And we have the perfect guest. We're going to be speaking with Mithu Gulati, 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

So, Mithu, thank you so much for coming on All Thoughts. I'm so excited to be here. I shouldn't be excited about all the crazy loony 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 the Mar-a-Lago Accord. It's all our fault. 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 U.S. treasuries for

for longer-term low-interest U.S. treasuries, which was talked a lot about as a debt swap with our allies, but really was just an extension of 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 about

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 certainly never used the term Mar-a-Lago Accord. 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 U.S. dollar and the debt. And now it's come to the point where people who are serious in markets, they're coming to you, me too, Gulati, and they say, what's up? Help me. Help me understand this.

Yes. And 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 distressed debt is something that he's done a lot of. And he talked about it prior to his first presidency when he talked about, oh, the U.S. debt, not a big deal. We could just inflate it away or something like that.

A debt swap using the power of U.S. governing law is really not that insane, both in historical context and in what we could do. It is insane in terms of norms that have been built carefully over the last 60, 70 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 anybody and everybody who holds U.S. treasuries should go and look at the contract terms for their U.S. treasuries and ask the question, do my contract terms restrict bonds?

the U.S. 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 20 years at the interest rate that you lent to us. Is there anything restricting that? I don't think you'll find anything. Really? This blows my mind. Because to me, if I'm a holder of U.S. Treasuries and the creditor or 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 defaults off. 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, it's not there. So we have to be clear, and I have to be geeky here in my law professor mode. Please, please. 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. U.S. 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 U.S. Treasury? Well, that sort of depends on what the credit rating agencies decide. And based on what we saw in Greece 2012, 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, the default for a credit default swap really only applies to the people who are holding credit defaults protection on U.S. 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 U.S. 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 scenario. Always, 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 U.S. Treasury Department and the Secretary of the Treasury have authority to manage the maturities of U.S. 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 U.S. Treasury, if they ever went down this path because, say, 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

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 right

moralistic right to having my money paid back at the time when you said you had paid back. Now, that's really tough. And we have historical precedent for this going back to the 1930s 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 holders of certain U.S. treasuries to get paid in gold. If they had gotten paid in gold or asked to get paid in gold, U.S. would have essentially gone broke.

So the president, backed 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 ever,

of that era said it was okay. And the markets, I don't want to say this, but I'm going to say it because it's true. The markets didn't crash. Yeah. What year was this? I think it's around 1935. 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 U.S. ability to ever borrow in the future. And that did not happen. There are some famous articles about this.

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What's your read, then, on why this didn't happen? Like, why did the market seem to just go like, OK, this is unusual, but fine? So my read with no proof is that there are these rare instances where

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 that does it, we're going to reward them and we're going to lend even more. Arguably,

Greece in 2012, 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 14th Amendment Section 4 that says the validity of the public debt of the United States authorized by law, including debts incurred 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 14th Amendment and the debt language of the 14th Amendment that my students don't even know exists.

The only reason I know about this is because it comes up a lot during the debt ceiling crisis. Joe carries around a copy of it in his pocket 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 U.S. debt. Arguably, that language goes back to the

1800s 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 100 years. We promise to pay you in 100 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 that was never paid to the U.S. You know, I called it the equivalent of like looking in your sofa under the cushions for a 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 U.S. 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 I. So I think it's about $4.4 billion or so that was owed. And Great Britain resisted paying, and the U.S. tried to get it paid, and then finally we kind of gave up, and then we had World War II 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 U.S. They had interest rates on them. I think the interest rate was 3%.

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 U.S. The U.S. owes the United Kingdom because the United Kingdom, by the Treasury's own estimates, holds upwards of $700 billion in U.S. 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 context, 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 I 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 OK, 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 I, the U.S. knew that the U.K. owed it a bunch of money, but the U.K. was arguing, well, this is actually emergency war funding and it's not fair if we have to pay it back. And ultimately, the U.S. just decided, you know what? It was better to keep the U.K. as an ally, not annoy them over this particular loan.

And so they just never did anything about it. But obviously, relations between the U.S. and the U.K. are changing, not as friendly as they used to be, perhaps. And so that opens up the question of whether the values 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 1970s. And for those who study financial history, post-World War II was a truly horrible time in Europe. The U.S. was trying to help European countries recover.

the UK in particular had taken the position after World War I 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 I reparations were a stupid idea and resulted in World War II. This is Keynes and

all of that work. But generally, in the interest of letting Europe recover, I think the U.S. 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,

U.S. officials will kind of snidely mention, you know, there's that World War I 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.

We don't know. We don't even know. I mean, we know the interest rate is 3%. I've never met anybody who's actually seen the document. Back in 1917...

I don't think it would have been governed by the law of New York or the law of England. So who knows what statute of limitations would be? Who knows today whether or not there is some kind of international statute of limitations that would apply? And would it apply in the context of set off? This is just...

For lawyers, this is a bonanza. We could be working on this forever. But it seems a bit crazy, but nothing is 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-40s, so of course I read about 20th century history now. And one of the things that actually was this big lightbulb revelation for me in reading history is that modern fixed borders of countries, it's sort of a novel phenomenon. That actually the idea that these are the lines around the country and we just all sort of accept that is very fresh in modern history. And what was striking is reading about the run-up to World War II

where like the Germans would sign a border agreement with another country, but it would be only 10 years. They're like, let's be peaceful for 10 years and then we'll revisit war down the line. Then we'll decide whether or not to be enemies again. And then we might revisit that idea of conquest, but at least in the meantime...

Some of that'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 are a joke. And so that's why I've become much more on the take Trump literally side.

side. How should we think about the idea of like countries just sort of like acquiring land from other countries as a thing that could happen in the 21st century? Okay, this is going to happen. It's not could happen. You're raising an incredibly important question. So there is Greenland, but Greenland's kind of

fun to talk about. 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 to

in the context of Ukraine. So let us say that Mr. Putin is able to negotiate with President Trump to take half of Ukraine. Okay. So Ukraine becomes baby Ukraine. What happens next?

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 U.S. and to European allies.

Does old 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 a civil war,

Then there is 19th century debt law that applies to a civil war. KPMG makes the difference by creating value, like developing strategic insights that help drive M&A success and embedding AI solutions into your business to sustain competitive advantage or deploying tech-enabled audits to deliver more accurate and transparent insights.

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This episode is brought to you by Intuit Enterprise Suite, helping your business grow smarter. All right, let's chat to all the CFOs and business leaders out there. As your company grows, so do the headaches. You're juggling multiple entities, locations, and subsidiaries all across different systems. And that's just the beginning. It's tough to get a clear view of your business when the data's a mess. And understanding intercompany transactions or eliminations can feel like solving a puzzle.

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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, OK, there's a revolution in a country. The new administration or the new policymakers should the new government should not be saddled with.

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, blah.

Talk about that. So you have brought up one of our favorite topics, the 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 governs

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 14th Amendment? Please.

Okay. Can we read that language that you read? Joe's reaching into his pocket. I still have it on. 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 on

And Joe, correct me on the validity of the debt. And you know what? It was to be honest. And you probably sensed this. To be honest, when I read this, I was like, oh, I never really paid much attention to that insurrection or rebellion point there. That stuff is so important. OK, I'm getting so excited. So I apologize for raising my volume. That is the U.S. 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, that it 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 that in the 14th 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 14th Amendment and the laws that followed since. There 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 57,000, quote unquote, citizens of Greenland, maybe Trump could offer to pay them each $1.5 million in a Swiss bank account and give them each a little house of

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 U.S. sovereign debt.

in a context in which we're trying to reduce the sovereign. Maybe the U.S. could use the proceeds from recouping payment on those old U.K. bonds to buy Greenland. We could. Now, I suspect, OK, 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 U.S. would be bidding against Denmark and maybe Germany and maybe 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 U.S. 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, Mitu, for coming on the show to explain all of that to us and hopefully not give too many policy suggestions to the administration. I love talking to law professors. Thank you so much for coming back on. It was so fun. Thank you both.

Joe, I love talking to Mitu. 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 this kind of stuff, because you

You can just see like how their brain works and how they're like, well, this part of the sentence you think it's 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 really 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 airtight. 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. Isn't that funny? Countries are so new. No, they really like I read this a little while ago. Like almost every country is like it's basically day one around here. 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? Yeah.

No, because I said this is something like it's based on norms that the Treasury has never done this. And we should treasure norms. I agree. I think an actual default or a missed payment 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 nonpayment of a coupon, which would be a default violation.

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 All Thoughts Podcast. I'm Traci Allaway. You can follow me at Traci Allaway. And I'm Jill Wiesenthal. You can follow me at The Stalwart. Follow our producers, Carmen Rodriguez at Carmen Arman, Dashiell Bennett at Dashbot, and Kale Brooks at Kale Brooks.

For more OddLots content, go to Bloomberg.com slash OddLots, where we have all of our episodes and a daily newsletter. And you can chat about all of these topics 24-7 in our Discord, Discord.gg slash OddLots. And if you enjoy OddLots, if you like it when we talk about bond documentation, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes online

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