The national debt is surging. Foreign central banks have stopped buying U.S. Treasury bonds. Interest rates are on the rise. And a president needs legal advice on how to implement an aggressive plan to head off a crisis with global implications.
This was a potential scenario explored by a panel of experts during a recent session of Advanced Contracts: When Financial Contracts Blow Up, a University of Virginia School of Law class taught by Professor Mitu Gulati and Peter Lyons, a lecturer and senior counsel at Freshfields.
The goal, according to Gulati, was to give students a sense of “how decisions are made in really tense times. What is the lawyer’s role? And how are you weighing the different options about what has to be done in real time?”
While the discussion focused on a hypothetical, it was one rooted in concern about the potential for an actual debt crisis, according to Gulati.
“The global system can’t function if we go down. It would take the entire global banking system down,” he said of the stakes at play.
In recent years, the U.S. national debt has surged to nearly $38 trillion, in part due to the spike in government spending that followed the Great Recession and the COVID-19 pandemic. According to the Treasury Department, the U.S. government will spend more than $1 trillion in fiscal year 2025 on debt interest payments, amounting to 17% of total federal spending.
“If our borrowing costs go up even a little bit … it’s painful for us. It’s unbearably painful because of the large size of our debt and because we borrow on a very short-term basis,” Gulati said.
It was against this backdrop that the discussion of the hypothetical debt catastrophe occurred. Among the panelists were leading scholars and media figures, including Lee Buchheit, an honorary professor at the University of Edinburgh Law School who has assisted on numerous sovereign-debt restructurings across the globe, and Mary Childs of National Public Radio, host of “Planet Money.”
In the class, experts explored what the fictional president could do to safeguard the nation’s credit rating if the United States couldn’t borrow new money to pay off old debt and decided to stop repaying the principal on debt held by foreign investors.
Potential implementation approaches included everything from collective action mechanisms, a tool used by Greece to restructure its sovereign debt during its 2012 crisis, to freezing certain payments.
Following the class, Gulati said he was surprised by the consensus that emerged on the approach to recommend to the fictional president.
“The part that I found really interesting was that the experts didn’t think that the best option was the legally cleanest option,” he said, defining that as “the one that we could do in the most streamlined fashion with fewest legal challenges.”
That option, according to Gulati, was taxing foreign government investments. Rather, he said, the group favored the collective action mechanism tactic used by Greece, which allows a large majority of bondholders to approve a plan where they would receive less money, binding the entire group to that plan.
“That’s a much more onerous process, meaning you have to have the legislature, meaning Congress, put in place those provisions, and then you have to get approval,” Gulati said.
He added: “I thought what was really helpful for me, and hopefully for the students, was to see how when you’re doing something like this, you have to balance politics, market sentiments and law.”
In a statement after the class, Buchheit agreed that the exercise reflected the realities of actual situations lawyers face.
“This exercise was a rehearsal for two situations well known to practicing lawyers. First, how to counsel a client (in this case POTUS) that is seeking advice only about how — not whether or when — a particular policy should be implemented,” he said. “Second, how to steer a client toward the best course of action when there isn’t a best, or for that matter even a good, course of action visible to the lawyer.”
Professor Paul B. Stephan ’77, an expert on international dispute resolution who participated in the exercise, described the scenario as “not at all inconceivable,” given the current state of national finances, and noted the important role attorneys would play in a response.
“Good business lawyers focused on problem-solving and willing to let others take credit for their good ideas always will be indispensable,” he said.
In the days following the class discussion, a real-world situation illustrated the global reach of debt challenges when the U.S. government announced it would offer Argentina a $20 billion bailout to address its latest currency crisis.
“I probably would have designed the class around that,” Gulati said, if the news had broken earlier.
Gulati, a veteran of numerous international sovereign debt restructurings, said a true national debt crisis on the scale of the scenario he devised, while “still unlikely,” is not that “far-fetched.”
“The U.S. does have levers that we can use. We’re not going to default. We have ways to stave off default,” he said. “But, if we have to use those ways, we’re never going to be able to borrow in the way in which we have been. But maybe that’s a good thing.”
https://www.law.virginia.edu/news/202510/how-avert-national-debt-crisis
